Could the IRS use the tax code to shut down medical marijuana dispensaries?

In 1931, mobster Al Capone was finally put behind bars because he was convicted of multiple tax-evasion charges, and the IRS is taking a similar approach with medical marijuana today. Many dispensaries in California now face audits that could result in their owing millions of dollars in back taxes.
According to Forbes columnist Robert W. Wood, the agency is relying on Internal Revenue Code Section 280E, which "precludes deductions for any business trafficking in controlled substances." While dispensaries are legal in some states, including California, marijuana trafficking remains illegal on a federal level. The IRS is arguing that normal business expenses that most companies can deduct on their taxes are not applicable to dispensaries.
The Marin Alliance for Medical Marijuana in Fairfax, Calif., was the first dispensary to be hit with this ruling earlier this month. Founder Lynette Shaw told the Marin Independent Journal of California that the IRS audited the company's returns for 2008 and 2009 and disallowed all of the alliance's business deductions such as buying marijuana, hiring employees, and renting office space. Shaw did not disclose the amount the IRS told her she owes, but she described it as "a staggering sum" totaling several million dollars.
"Every dispensary in the nation, past, present and future is dead if this is upheld," Shaw said. An IRS spokesperson declined to discuss the case. Shaw is currently planning an appeal.
According to a report from The American Independent, at least 12 dispensaries in California are currently being audited by the IRS.
As columnist Wood points out, the law isn't completely clear. A previous tax court ruling allowed dispensaries to deduct expenses for activities not directly related to dispensing marijuana, such as caregiving, counseling, education and advocacy.
Allen St. Pierre, executive director of the National Organization for the Reform of Marijuana Laws (NORML), told The American Independent that the immaturity of the medical marijuana industry could have opened the door for these audits, since dispensaries are trying to take normal business deductions while also asking for special treatment for their product's medicinal value.
"Not many people show up in the newspapers screaming that they make millions of dollars and don't want to pay taxes," said St. Pierre.