I'm just starting to sell my first crop of the year, and I'm not sure how much federal tax to pay and how to report it. I'm just trying not to end up like Capone.

CONGRATULATIONS on your harvest and sale. By law, you are required to report your weed income in the same way you would report any other income—by filing a federal tax return the following year. This is because the Internal Revenue Code (IRC) defines gross income as "all income from whatever source derived." That includes income from selling pot.

Unfortunately, pot merchants are required to pay far more tax than people in other industries. I have seen differing, credible opinions on the tax rates imposed on marijuana companies—from 40 to 70 percent, and as high as 90 percent. All of these are higher than the 35 percent corporate tax rate paid by most US businesses (the ones that actually keep their money in the country).

You can blame the oppressive taxation of pot income on IRC 280E. Congress enacted that rule in 1982 in response to a tax court ruling that someone named Jeffrey Edmondson could deduct expenses relating to his sale of controlled substances, specifically: 1,100,000 amphetamine tablets, 13 ounces of coke, and 100 pounds of weed. Mr. Edmonson was one of the last people who sold pot, paid taxes, and legitimately deducted costs of rent, travel (Minneapolis to San Diego), and even packaging and scales.

Despite the fact that Section 280E has been around for nearly 35 years, there's still considerable debate about what the provision actually is and does. In reality, Section 280E is a single sentence that says, "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 [involving] trafficking in controlled substances... prohibited by federal law or the law of any state...."

The Internal Revenue Service (IRS) uses Section 280E to prohibit marijuana businesses from deducting ordinary and necessary business expenses. Things like rent, advertising, and employee salaries won't reduce your taxable income unless they can be allocated to costs of goods sold (COGS). For cannabis growers like yourself, COGS include expenses directly related to growing plants (i.e., seeds, electricity, and labor needed to grow and prepare the flowers for sale). For dispensaries, it's far more restrictive, and COGS only include the amounts paid for product, plus a few additional allocations.

The best advice I can give you here is to get your books in order, keep good records, and remember that the IRS is years behind in audits. Just because you haven't been audited for last year's return does not mean you won't be hit with a large tax bill a few years from now. Good luck!