Here’s why: Ordinary businesses are taxed by subtracting their business expenses from their gross revenue to arrive at their net income, or profit. That amount is subject to tax. By contrast, sellers of controlled substances—in other words, drugs, including marijuana—are not permitted to deduct any ordinary business expenses other than the cost of the goods they are selling. That’s because of § 280E of the federal tax code, which Congress enacted in the 1980s to punish drug dealers. The provision was largely symbolic for decades, since few drug dealers filed income tax forms. But now, state-licensed marijuana sellers must pay federal taxes not only on their profits but also on the money they spend on salaries, rent, advertising, and all the other expenses related to running a business. In fact, it is conceivable that § 280E could require a business to pay more in tax than its total profits for the year.

I teach tax law, and I have a solution: Marijuana sellers should operate as nonprofit “social welfare organizations.” To qualify for a federal tax exemption, a social welfare organization must have as its primary purpose the promotion of the common good and general welfare of the people in its neighborhood or community. Currently, many social welfare organizations operate businesses in poor and distressed neighborhoods, providing jobs and job-training for residents and improving the conditions for economic development. For example, Homeboy Industries is a tax-exempt nonprofit that trains and employs former gang members in Los Angeles to work in a bakery, a café, and a retail store. ...

Eventually, it probably makes sense for Congress to repeal § 280E and treat marijuana sellers the same as any other business. If the states want to legalize and regulate marijuana, the federal government shouldn’t use the tax code to interfere. But until that question is settled, avoiding § 280E by operating as a social welfare organization will allow a neighborhood-based seller to be at the forefront of the legalization experiment—while furthering the interests of the local community. All it takes is a few visionary nonprofit entrepreneurs, and an IRS not afraid to do the right thing.