Starting in 1996, Californians Helping to Alleviate Medical Problems (CHAMP) operated a caregiving facility in San Francisco for people with debilitating illnesses. Approximately 47% of itsmembers suffered from AIDS, and the rest were afflicted with other serious diseases, including cancer and multiple sclerosis. One component of CHAMPs caregiving program was to provide members with medical marijuana, in compliance with all relevant California laws. CHAMP required each member to have a valid medical marijuana card and it forbadeits members from redistributing or selling the marijuana they received. CHAMP also provided one-on-one counseling; daily healthy lunches, hygiene supplies, yoga lessons, and Internet access. Itsmembers paid a monthly membership fee which was roughly enough to allow CHAMP, a public benefit corporation under California law, to break even.
In 2002, CHAMP discontinued operations and filed its final income tax return with the IRS. The IRS found a deficiency of approximately $355,000 and assessed a penalty of approximately $70,000. The deficiency reflects numerous business deductions taken by CHAMP, such as salaries, maintenance, and rent. The IRS argued that all of these otherwise allowable business expense deductions were precluded by Section 280E of the Internal Revenue Code, which prohibits deductions related to trafficking of controlled substances. CHAMP brought suit in United States Tax Court, which held for CHAMP in part and the IRS in part.
The court began its analysis by determining whether CHAMP was operating one or two trades or businesses for purposes of 280E. CHAMP argued it was engaged in two trades or businesses: provision of caregiving services (its primary trade or business) and supplying medical marijuana (its secondary trade or business). The IRS countered that because CHAMP had undisputedly trafficked in a controlled substance, Section 280E would disallow all its business expense deductions. The court disagreed with the IRS, looking to legislative history that showed Section 280E was intended to disallow deductions attributable to a cannabis trade or business, but not to deny deductions for a taxpayers business expenses in connection with other, non-trafficking pursuits. The court held that the testimony of CHAMPs director, the quality and quantity of services provided to members, and CHAMPs setting of the membership fee at the amount needed to recover costs for all services supported the claim that there were two distinct trades or businesses:
We do not believe it to have been artificial or unreasonable for petitioner to have characterized as separate activities its provision of caregiving services and its provision of medical marijuana. Petitioner was regularly and extensively involved in the provision of caregiving services, and those services are substantially different from petitioners provision of medical marijuana. By conducting its recurring discussion groups, regularly distributing food and hygiene supplies, advertising and making available the services of personal counselors, coordinating social events and field trips, hosting educational classes, and providing other social services, petitioners caregiving business stood on its own, separate and apart from petitioners provision of medical marijuana.
