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Revenue Administrative Bulletin 2022-26
REVENUE ADMINISTRATIVE BULLETIN 2022-26
TREATMENT OF ORDINARY AND NECESSARY EXPENSES FOR
CERTAIN MARIHUANA ESTABLISHMENTS
Approved: December 21, 2022
RAB 2022-26.1 The Michigan Revenue Act authorizes the Department of Treasury (“Department”) to periodically issue bulletins that explain the Department’s interpretation of current state tax laws.2 The purpose of this Revenue Administrative Bulletin (“RAB”) is to explain and clarify the income tax expense deduction applicable to certain marihuana3 establishments that is provided under the Michigan Regulation and Taxation of Marihuana Act (Initiated Law 1 of 2018) (“MRTMA” or the “Act").4
This RAB addresses only the income tax expense deduction provided under the MRTMA. It does not address the marihuana excise tax imposed under the MRTMA. For a discussion of and guidance on that topic, see RAB 2020-17, Taxation of Adult-Use (Recreational) Marihuana Under the Michigan Regulation and Taxation of Marihuana Act.
- What is the scope of the income tax expense deduction provided under the MRTMA?
- How does the income tax expense deduction apply to taxpayers holding licenses to operate both medical and adult-use marihuana businesses?
- How should taxpayers holding licenses to operate both medical and adult-use marihuana businesses account for their expenses for purposes of the income tax expense deduction?
ANALYSIS AND DISCUSSION
1. Scope of the Income Tax Expense Deduction Under the MRTMA
The MRTMA provides as follows:
In computing net income for marihuana establishments, deductions from state taxes are allowed for all the ordinary and necessary expenses paid or incurred during the taxable year in carrying out a trade or business.5
As used above, the term “marihuana establishments” includes marihuana growers, marihuana safety compliance facilities, marihuana processors, marihuana microbusinesses, marihuana retailers, and marihuana secure transporters.6
Although the MRTMA does not directly amend the Michigan Income Tax Act (“MITA”), the deduction provided under the Act for the “ordinary and necessary expenses” of marihuana establishments operates to effectively amend the MITA by decoupling Michigan from Internal Revenue Code (“IRC”) Sec. 280E. IRC Sec. 280E prohibits the federal tax deduction of “ordinary and necessary expenses” by certain businesses engaged in activities determined to be contrary to federal law. In opposition to the laws of states such as Michigan that have decriminalized or legalized the sales and use of marihuana, marihuana remains a Schedule I drug under the Controlled Substances Act of 1970,7 and the use, sale, and distribution of marihuana remains illegal under federal law. This means that a Michigan marihuana business may not deduct on its federal tax return its “ordinary and necessary” business expenses.
However, the MRTMA provision referenced above permits a validly licensed marihuana establishment to deduct on its Michigan income tax return those “ordinary and necessary” business expenses that it is otherwise prohibited from deducting on its federal return due to the operation of IRC Sec. 280E. The “ordinary and necessary expenses” of a business are not the same as the expenses used to determine the business’s “cost of goods sold,” a calculation intended to reflect direct business expenses, such as direct labor, raw materials, and overhead production costs. Regardless of IRC Sec. 280E, all businesses may subtract the “cost of goods sold” for federal tax purposes, and that subtraction is subsumed in the initial gross income calculation that is the basis of the Michigan income tax return. Accordingly, the “ordinary and necessary expenses” of a validly licensed marihuana establishment under the MRTMA may be taken as a Michigan deduction from adjusted gross income for individuals and from federal taxable income for corporations.
Taxpayers should consult their own tax professionals to determine what business expenses may be considered “ordinary and necessary” for them, and would therefore be deductible under IRC Sec. 162(a) but for the Sec. 280E prohibition. These are the expenses that may validly be deducted on the Michigan income tax return. In general, “ordinary and necessary” business expenses include the costs of things such as renting office space, and purchasing office equipment and supplies used in the business. For additional information on expenses that qualify as “ordinary and necessary” business expenses under IRC Sec. 162(a), see IRS Publication 535 (Business Expenses). It is important to note that the deduction does not include any of the costs of setting up and starting a new marihuana-related business, as these are “start up expenditures” and not “ordinary and necessary” business expenses under the IRC.
Only those “ordinary and necessary” expenses paid or incurred after the date of licensure by the Cannabis Regulatory Agency (“CRA,” formerly the Marihuana Regulatory Agency), as determined by using the taxpayer’s method of accounting used for federal income tax purposes, may be deducted under this provision. The applicability of the deduction is restricted to “state taxes”; accordingly, there is no deduction from local taxes such as city income taxes. Additionally, this deduction is applicable exclusively to marihuana establishments licensed by the CRA under the MRTMA; it is not applicable to any other marihuana-related businesses, including marihuana-related businesses licensed by the CRA under the Medical Marihuana Facilities Licensing Act (“MMFLA”)8 or under other statutes.
The MRTMA defines the term “marihuana establishment” to include various specific types of MRTMA licensees, as well as “any other type of marihuana-related business” licensed by the CRA; therefore, it could be argued that the income tax expense deduction also applies to marihuana-related businesses licensed under the MMFLA and other marihuana-related statutes that require CRA licensure. However, because the connection with the MRTMA is definitional, if a business is a “marihuana establishment” under the MRTMA for purposes of the applicability of the income tax expense deduction, that business is necessarily also a “marihuana establishment” for all other purposes under the MRTMA. If provisioning centers and other marihuana-related establishments licensed by the CRA under other statutes were included in the definition of “marihuana establishments” under the MRTMA, however, those businesses would, among other things, be subject to various restrictions, requirements, and limitations that the MRTMA explicitly places upon “marihuana establishments.” These include the restriction that “marihuana establishments” may not sell or transfer marihuana that has not been produced, distributed, and taxed in compliance with the MRTMA. Nonsensically, a medical marihuana provisioning center would thus be restricted to selling marihuana that meets all requirements of the MRTMA for adult-use sales, an unworkable result that is also in conflict with the provisions of the MMFLA. Accordingly, the applicability of the income tax expense deduction is necessarily limited to marihuana-related businesses licensed by the CRA under the MRTMA. The definitional reference to “any other type of marihuana-related business” is an acknowledgement that the CRA may have the authority to license other types of businesses under the MRTMA in the future.
2. Dual Licensing
The MRTMA permits a marihuana establishment validly licensed under that Act to concurrently be licensed to operate a medical marihuana business under the MMFLA.9 For example, a marihuana retailer licensed to sell adult-use marihuana under the MRTMA might also be licensed as a “provisioning center” under the MMFLA, and thereby authorized to sell medical marihuana to registered qualifying patients as defined by the Michigan Medical Marihuana Act.10 Additionally, an entity holding licenses to operate both adult-use and medical marihuana businesses is expressly permitted to operate both businesses out of a shared physical location.11 For example, a marihuana safety compliance facility holding licenses issued under both the MRTMA and the MMFLA might conduct testing activities on adult-use and medical marihuana at the same physical facility.
Because the MRTMA’s marihuana excise tax is imposed on sales of adult-use marihuana, but not on sales of medical marihuana, an entity holding dual licenses permitting it to make retail sales of both adult-use and medical marihuana is required to separately identify, itemize, and account for sales of medical marihuana to registered qualifying patients, so that such (excise-tax free) sales are clearly differentiated on the entity’s books and records from its sales of adult-use marihuana.
Although dual licensing of adult-use and medical marihuana businesses is statutorily authorized, the income tax deduction provided under the MRTMA, as noted above, applies only to marihuana establishments licensed under that statute, and does not apply to “provisioning centers” or other medical marihuana businesses holding operating licenses under the MMFLA. Consequently, only “ordinary and necessary” expenses incurred by the MRTMA licensed (adult-use) business of an entity holding licenses to operate both adult-use and medical marihuana businesses12 may validly be deducted on the entity’s Michigan tax return. Expenses incurred by the business licensed to operate as a “provisioning center” or other medical marihuana business under the MMFLA cannot validly be deducted on the individual's or entity’s state income tax return.
3. Treatment of Expenses Incurred by Dual Licensees
The MRTMA permits the deduction by eligible licensees of “ordinary and necessary” business expenses. Entities holding valid licenses to operate both adult-use and medical marihuana businesses are likely to incur two types of “ordinary and necessary” business expenses in carrying out or operating those businesses during a particular tax year. First, they may incur “ordinary and necessary expenses” that are costs borne only by the adult-use marihuana business or the medical marihuana business, or are by their nature attributable to one of the two marihuana businesses, whether adult-use or medical. For example, the costs of creating and running a newspaper advertisement promoting the general retail sale of adult-use marihuana would be an “ordinary and necessary” business expense attributable wholly to the entity’s adult-use marihuana business. Second, entities holding dual licenses may incur certain “ordinary and necessary expenses” that are shared by the two types of businesses and cannot easily be separated or attributed to one of the two marihuana businesses. For example, rent paid to lease physical premises that an entity uses concurrently for its adult-use and medical marihuana business operations would likely be considered a shared expense.
For entities holding dual licenses, and for purposes of the Michigan income tax expense deduction provided under the MRTMA, “ordinary and necessary” business expenses that represent costs borne only by the entity’s adult-use marihuana business or its medical marihuana business, or are by their nature attributable to one of the two marihuana businesses, must be separately allocated, and only an expense incurred by or allocated to the adult-use marihuana business may be deducted on the Michigan income tax return.
Example A: Cannabis Store is licensed as a “provisioning center” authorized to sell medical marihuana under the MMFLA and is also licensed as an adult-use marihuana retailer under the MRTMA. CRA rules require that Cannabis Store keep its medical marihuana and adult-use marihuana inventories physically separate. Cannabis Store purchases a small set of warehouse shelving to be used for storage of its medical marihuana inventory, which is much smaller than its adult-use marihuana inventory. The cost of the shelving, while an “ordinary and necessary” business expense, cannot be deducted on Cannabis Store’s Michigan income tax return because the expense was incurred only by the medical marihuana provisioning center.
Example B: Green Grow holds a “Class A” license to grow medical marihuana (up to 500 plants) and also holds a “Class A” license authorizing it to grow adult-use marihuana (up to 100 plants). Green Grow grows the two types of marihuana in separate areas of its physical facility. Green Grow purchases six security cameras to be installed in the marihuana growing areas. Four cameras are installed in the medical marihuana growing area, and two cameras are installed in the adult-use marihuana growing area, which is smaller. Green Grow may deduct the cost of two of the six security cameras on its Michigan income tax return because the expense was incurred in connection with the plants grown under the adult-use marihuana license.
On the other hand, “ordinary and necessary” business expenses that are shared by a dually licensed entity’s medical and adult-use marihuana businesses and cannot easily be separated or attributed to one of the two types of marihuana businesses must be apportioned for purposes of the Michigan income tax deduction provided under the MRTMA. In determining how to apportion “ordinary and necessary” business expenses that are shared between the taxpayer’s medical marihuana business and its adult-use marihuana business, the taxpayer may use any method to apportion such shared expenses between the medical and adult-use marihuana businesses, provided that (i) the method is reasonable and appropriate in light of all relevant facts and circumstances; (ii) the same method is used to apportion all shared business expenses eligible for the deduction; (iii) the taxpayer applies the chosen method uniformly and consistently; (iv) the taxpayer generally uses the same method to apportion shared expenses each year;13 and (v) the chosen method is supported by the taxpayer’s business records that existed when the expense was incurred. Provided that the taxpayer generally uses the same method each year, the following are examples of acceptable apportionment methods:
Example C: Cannabis Store is licensed as a “provisioning center” authorized to sell medical marihuana under the MMFLA and is also licensed as an adult-use marihuana retailer under the MRTMA. Cannabis Store tracks and categorizes its sales transactions on a monthly basis and calculates that, of the 400 sales transactions it conducted each month in the previous year, 100 were medical marihuana sales. Accordingly, when apportioning shared expenses for purposes of the income tax expense deduction, Cannabis Store apportions 25% of such expenses to its medical marihuana business, and 75% to its adult-use marihuana business.
Example D: Marihuana Market is licensed to make retail sales of both medical marihuana and adult-use marihuana. Based upon its record-keeping, Marihuana Market calculates that, on average, it transacts $500,000 in total marihuana sales each month, and that medical marihuana sales account for approximately $100,000 of that amount. It further finds that that proportion generally holds even when its total sales are more or less than average. Accordingly, when apportioning shared expenses for purposes of the income tax expense deduction, Marihuana Market apportions 20% of such shared expenses to its medical marihuana business, and 80% to its adult-use marihuana business.
Example E: Green Testing, a marihuana safety compliance facility holding licenses issued under both the MRTMA and the MMFLA, conducts testing activities on adult-use and medical marihuana at the same physical facility, and incurs some shared expenses. Green Testing has more contracts to conduct testing activities on medical marihuana than on adult-use marihuana, and two-thirds of the testing activities it conducts each month are on medical marihuana. For purposes of the income tax expense deduction, Green Testing apportions 67% of shared expenses to its medical marihuana business, and 33% to its adult-use marihuana business. The following year, Green Testing determines that those percentages have changed, and that it conducts testing on medical and adult-use marihuana on an even basis. For the income tax expense deduction for that year, Green Testing apportions shared expenses 50% to its medical marihuana business and 50% to its adult-use marihuana business.
Unlike certain other deductions taken on the Michigan income tax return, for this deduction, specific documentation supporting the amount claimed on the return, including apportionment methodology, should be submitted at the time that the marihuana business or individual business owner files its income tax return. In addition, in case of audit or other inquiry by the Department, the taxpayer is required to maintain adequate documentation through its business books and records to support its determination regarding apportionment of shared expenses between its medical marihuana business and its adult-use marihuana business, as well as the calculations made by the taxpayer to determine the actual amount of the expense deduction taken on the taxpayer’s corporate or individual Michigan income tax return.
1 Pursuant to MCL 205.6a, a taxpayer may rely on a Revenue Administrative Bulletin issued by the Department of Treasury after September 30, 2006, and shall not be penalized for that reliance until the bulletin is revoked in writing. However, reliance by the taxpayer is limited to issues addressed in the bulletin for tax periods up to the effective date of an amendment to the law upon which the bulletin is based or for tax periods up to the date of a final order of a court of competent jurisdiction for which all rights of appeal have been exhausted or have expired that overrules or modifies the law upon which the bulletin is based.
2 See MCL 205.3(f).
3 “Marihuana,” rather than the more common “marijuana,” is the spelling used in the MRTMA.
4 MCL 333.27951 et seq
5 MCL 333.27962.
6 MCL 333.27953(h).
7 21 USC 801 et seq.
8 MCL 333.27101 et seq
9 MCL 333.27959(6).
10 MCL 333.26424 et seq.
11 MCL 333.27958(3)(c).
12 Although this RAB refers to the dual licensee operating separate “businesses,” dual licenses are often held by a single entity operating from a shared location; for example, a retail establishment that makes both medical and adult-use marihuana sales. The use of the term “businesses” in this context is intended to reflect the fact the two types of marihuana businesses (medical and adult-use) are statutorily distinct and require separate licensure, and that the administrative rules promulgated by the CRA require strict separation between the two types of businesses, including the maintenance of separate inventories and sales records.
13 A business may change its chosen method of apportionment for shared expenses from one year to another if there is a valid and demonstrable reason for doing so.