On August 2, 2014, the Tax Court held that: (i) Martin Olive underreported gross receipts from the sales of medical marijuana by the Vapor Room medical marijuana dispensary, (ii) IRS Section 280E prevented him from deducting business related expenses, and (iii) he was liable for accuracy-related penalties.  The court did allow Olive to deduct his cost of goods sold.  The case is Olive v. Commissioner, 139 T.C. No. 2 (Aug. 2, 2012).  The court said:

“A vaporizer is an expensive apparatus that extracts from marijuana its principal active component and allows the user to inhale vapor rather than smoke. Petitioner chose the name of his business to publicize that the Vapor Room had the requisite equipment to allow patrons to vaporize marijuana there. …

Petitioner’s testimony and the testimony of his other witnesses was rehearsed, insincere and unreliable. We do not rely on petitioner’s testimony to support his positions in this case, except to the extent his testimony is corroborated by reliable documentary evidence. We also do not rely on the uncorroborated testimony of petitioner’s other witnesses, three of whom are (or were) patrons of the Vapor Room and all of whom are closely and inextricably connected with the medical marijuana industry and with a desired furtherance of that movement. …

We hold that the Vapor Room’s gross receipts for the respective years were $1,967,956 and $3,301,898. …

We conclude that the Vapor Room’s COGS for each year at issue equals 75.16% of the Vapor Room’s gross receipts for the year, as further adjusted to take into account our finding that petitioner gave away 6.5% of the Vapor Room’s purchases. …

The parties agree that § 280E disallows deductions only for the expenses of a business and not for its COGS. … [We] reject petitioner’s contention that § 280E does not apply because the Vapor Room was a legitimate operation under California law. We have previously held that a California medical marijuana dispensary’s dispensing of medical marijuana pursuant to the CCUA was “trafficking” within the meaning of § 280E. [Californians Helping to Alleviate Med. Problems, Inc. v. Commissioner (CHAMP), 128 T.C. 173 (2007).] That holding applies here with full force. …

Respondent argues that petitioner is liable for the accuracy-related penalty to the extent he has understated the Vapor Room’s gross receipts and failed to substantiate the Vapor Room’s COGS and expenses. Petitioner’s sole argument in brief is that the penalty does not apply because, he states, any inaccuracy underlying an understatement was “accidental, not substantial, and/or not negligent on the part of the taxpayer.” Petitioner asserts that the Vapor Room was his first business and that he was not instructed on the proper way to keep the books and records of a business. We agree with respondent that the accuracy-related penalty applies in this case.”