Disallowance of Tax Deductions that Violate Public Policy

Good ol’ Congress allows tax deductions to encourage desirable behavior. A classic example is the deduction for charitable contributions. Conversely, Congress restricts tax deductions to deter “undesirable” behavior. Hmmmm. The most notable example is the disallowance of deductions that frustrate public policy. Taxpayers may not deduct, for example, the following:

Illegal bribes, kickbacks, and other payments paid to government officials, government employees or other persons, including, for example, kickbacks, rebates, and bribes under Medicare and Medicaid. Makes sense.

Lobbying and political expenditures. Not surprising.

Expenses of illegal drug sale trade or business. What?! What about all those marijuana dispensaries in California? Internal Revenue Code Section 280E states: “No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances (within the meaning of schedule I and II of the Controlled Substances Act) which is prohibited by Federal law or the law of any State in which such trade or business is conducted.” In the case of Californians Helping to Alleviate Med. Problems, Inc. v. Commissioner, 128 T.C. 173 (2007), the Tax Court held that the provision of medical marijuana under California law is subject to Section 280E. Additionally, the court held that drug-trafficking related expenses used to determine the cost of goods sold are not subject to Section 280E.

As you can see, not all Public Policies are created equal.