Why an Arizona Medical Marijuana Dispensary Should Form an Arizona Nonprofit Corporation

Question:  I know my Arizona medical marijuana dispensary must be operated on a not for profit basis, but does not have to be an Arizona nonprofit corporation.  Why would I want to form an Arizona nonprofit corporation that is also a tax-exempt organization under the Internal Revenue Code?

Answer:  Neither the Arizona medical marijuana law nor the Arizona Department of Health Services proposed rules require that an Arizona medical marijuana dispensary be a nonprofit corporation.  My recommendation is that all Arizona medical marijuana dispensaries be an Arizona limited liability company.  See “Must an Arizona Medical Marijuana Dispensary be a Nonprofit Corporation?

One of the best ways to help satisfy the requirement that the dispensary be operated on a not for profit basis is for the dispensary to make substantial donations of profits to a tax-exempt charitable organization such as the American Red Cross, the Arizona Humane Society or any one or more of the many tax-exempt charities that have purposes consistent with those of the dispensary’s owners.  Donations to local tax-exempt charities that give to the local community are especially good choices.  The dispensary should have a regular policy of publicizing its charitable donations such as handouts given away at the dispensary or signs on the walls of the dispensary.

Dispensary owners should also consider creating an Arizona nonprofit corporation that applies for and becomes an IRS approved tax-exempt charitable organization.  One or more of the owners could be on the board of directors of the charity.  The charity’s purpose would not involve the growing, possession or sale of marijuana.  Instead, the charity’s purpose could be picked by the founders of the nonprofit corporation.  I recommend its purpose be to engage in charitable activities in which the dispensary owners have an interest and that the money donated to the charity be spent in the local community.  The tax-exempt organization must not  have a purpose that is related to marijuana, including medical marijuana.

Here are some potential charitable purposes for a tax-exempt organization founded by an Arizona medical marijuana dispensary:

  • Provide monetary assistance to people who are in a terminal condition or who cannot afford medical treatment
  • Pay the cost for low income people to live in a care home
  • Pay for nursing care for low income people
  • Pay for legal drugs for low income people

The tax-exempt organization cannot be a subsidiary of the dispensary entity.  It must be a separate stand-alone corporation governed by its board of directors.

Caveat:  The dispensary owners and insiders cannot control the tax-exempt organization.  The IRS will not grant tax-exempt status to a nonprofit corporation that is controlled by a person or a group of people.  The board of directors of the tax-exempt organization can have one or more owners or insiders of the dispensary on its board of directors as long as the board of directors has enough independent members who could out vote the dispensary’s owners and insiders.

I would love to form your Arizona nonprofit corporation that you intend to become a federal tax-exempt organization.  To learn more about forming an Arizona nonprofit corporation read “How to Form an Arizona Nonprofit Corporation” and “Arizona Nonprofit Corporation Formation Service.”

By |2011-02-14T08:23:31-07:00February 14th, 2011|Legal Issues, Questions People Ask|Comments Off on Why an Arizona Medical Marijuana Dispensary Should Form an Arizona Nonprofit Corporation

My Articles of Incorporation Contain Tax Exempt Language: Is that a Problem?

Question:  My attorney put language in the Articles of Incorporation for my Arizona medical marijuana nonprofit corporation that say it will be operated as a 501(c)(3) charitable organization and that no part of the earnings of the corporation can go to insiders.  Is that a problem?

Answer:  Yes.  Big time!  If you want to operate a pure charity then the language is appropriate.  Here is some common language I have seen in Articles of Incorporation of Arizona nonprofit corporations:

“This corporation is organized exclusively for charitable purposes such as religious, educational, literary and scientific purposes, including, for such purposes, the making of distributions to organizations that qualify as exempt organizations under section 501(c)(3) of the Internal Revenue Code, as amended, or the corresponding section of any future federal tax code (the “Code”).

“The Corporation is not organized and shall not be operated for pecuniary gain or profits. No part of the net earnings of the Corporation shall inure to the benefit of or be distributable to its directors, officers, members, or any other private person; provided that the Corporation shall be authorized and empowered to pay reasonable compensation for services rendered and to make payments and distributions in furtherance of the purposes set forth herein.”

You definitely do not want the above language in the Articles of Incorporation for a corporation that intends to own and operate an Arizona medical marijuana dispensary.  The first problem with the above language is that it is used in Articles of Incorporation of nonprofit corporation.  You should not be using a nonprofit corporation to own your dispensary because Arizona nonprofit corporations do not have owners/shareholders.  See “Is It a Mistake to Form an Arizona Nonprofit Corporation to Operate an Arizona Medical Marijuana Dispensary?

The second problem is the above language is appropriate in the Articles of Incorporation of an Arizona nonprofit corporation only if the corporation intended to become a tax-exempt organization under the Internal Revenue Code.  If you intend for your nonprofit corporation that will own a medical marijuana dispensary to file an IRS Form 1023 or 1024 and apply for tax-exempt organization status with the IRS you should know that:

  1. Arizona Revised Statutes Section 36-2806.A states:  “A registered nonprofit medical marijuana dispensary need not be recognized as tax-exempt by the internal revenue service”
  2. The IRS will not grant an organization an exemption from federal income taxes if the activities of the organization involve the violation of federal criminal law.

The third big problem arises from the language in the second paragraph quoted above.  The language is used in the Articles of Incorporation of nonprofit corporations that want to become tax-exempt organizations because it is required by the IRS.  Tax-exempt organizations are prohibited by the Internal Revenue Code from paying excess benefits to insiders such as officers, directors and members.  Violations of the excess benefit rules are taxed at the rate of 100% of the excess amount for every year the excess is not repaid to the organization.

If the insiders of an Arizona nonprofit corporation that intends to own an Arizona medical marijuana dispensary want to be able to be paid more than reasonable compensation and most do, then the corporation’s basic governing document, its Articles of Incorporation, should not limit the insiders compensation to reasonable amounts.  Consider the insider who provides no services, but receives $5,000 a month from the corporation.  The payment is a violation of the corporation’s Articles of Incorporation and makes the directors and officers who are responsible for the payment liable to the corporation for exceeding their authority.

Bottom line:  Neither Proposition 203 nor the Arizona Department of Health Services rules require dispensaries to be nonprofit corporations.  The rules say that the entity must be operated on a not-for-profit basis, but do not require any specific type of entity. Dispensaries may be a for profit corporation (I don’t recommend this type of entity), a nonprofit corporation (ditto), a general partnership (the worst type of entity to form), a limited partnership (ok, but now obsolete in Arizona), a sole proprietorship (bad choice) or a limited liability company (yes – this is the one!).  See “Must an Arizona Medical Marijuana Dispensary be a Nonprofit Corporation?”  If you formed any type of entity other than an Arizona limited liability company to own an Arizona medical marijuana dispensary, you need to dump it and switch to an Arizona limited liability company.

By |2012-01-29T11:01:57-07:00February 4th, 2011|Legal Issues, Questions People Ask|Comments Off on My Articles of Incorporation Contain Tax Exempt Language: Is that a Problem?

Is It a Mistake to Form an Arizona Nonprofit Corporation to Operate an Arizona Medical Marijuana Dispensary?

Question:  My attorney formed an Arizona nonprofit corporation for me to own and operate an Arizona medical marijuana dispensary.  Was that a mistake?

Answer:  Yes because Arizona nonprofit corporations do not have owners/shareholders.  Why would you invest a lot of money in an entity that you cannot own and cannot leave to your heirs if you were to die? For the reasons mentioned below, you should ask your attorney to refund the money if he or she formed your nonprofit corporation after December 17, 2010.  See “Must an Arizona Medical Marijuana Dispensary be a Nonprofit Corporation?

For profit Arizona corporations are owned by their shareholders.  Arizona limited liability companies are owned by their members.  Arizona partnerships are owned by their partners.  Arizona nonprofit corporations do not have shareholders.  If authorized in the Articles of Incorporation, an Arizona nonprofit corporation can have members and the criteria and characteristics of members can be set forth in the Articles of Incorporation or in the corporation’s bylaws.  However, members are not shareholders/owners and are not treated as such by Arizona’s nonprofit corporate statutes.

Admission:  Before the Arizona Department of Health Services issued its first draft of the rules on December 17, 2010, it was my opinion that Arizona medical marijuana dispensaries had to be Arizona nonprofit corporations.  I formed a number of Arizona nonprofit corporations for my clients before DHS issued the first draft of the rules because the only type of nonprofit entity recognized by Arizona statutes is the nonprofit corporation.

Proposition 203 stated that a dispensary had to be a nonprofit “organization,” which I thought was a strange choice of words.  Last December I asked the lawyer for the Marijuana Policy who is in charge of the model medical marijuana code on which Proposition 203 was based why Proposition 203 used the word organization instead of corporation, limited liability company and/or partnership.  She said she did not know.  I could tell she did not understand the significance of the fact Arizona nonprofit corporations do not have shareholders/owners.

Before December 17, 2010, I recommended to clients that they form an Arizona nonprofit corporation to own the dispensary because Proposition 203 was uncertain and because the nonprofit corporation is the only type of nonprofit entity authorized under Arizona law.  I told my clients in writing of this issue.

When the first draft of the rules was issued on December 17, 2010, it clarified that a dispensary could be owned by any type of entity recognized by Arizona law.  Since that date, I recommend to everybody that they form an Arizona limited liability company to own a dispensary and that the LLC be operated on a not-for-profit basis.

If you formed a nonprofit corporation to own your dispensary, it is not too late to replace it with an Arizona LLC.  If your nonprofit corporation has already entered into one or more leases, get approval from your landlord to allow the tenant’s rights to be assigned by the corporation to the new LLC.

P.S.  If you find a lawyer today who advises you to form a nonprofit corporation to operate your dispensary, run away as fast as you can.

By |2014-01-05T09:57:22-07:00February 3rd, 2011|Legal Issues, Questions People Ask|Comments Off on Is It a Mistake to Form an Arizona Nonprofit Corporation to Operate an Arizona Medical Marijuana Dispensary?

Must an Arizona Medical Marijuana Dispensary be a Nonprofit Corporation?

Question:   Must an Arizona Medical Marijuana Dispensary be a Nonprofit Corporation?

Answer: Apparently not!  Although the text of Proposition 203 says that an Arizona medical marijuana dispensary must be a ““a not-for-profit entity that acquires, possesses, cultivates, manufactures, delivers, transfers, transports, supplies, sells or dispenses marijuana or related supplies and educational materials to cardholders,” and it refers to Bylaws (a corporate governing document), officers (typically associated with corporations) and directors (exclusively associated with corporations), the Arizona Department of Health Services expanded the definition of not-for-profit entity to include types of entities in addition to corporations.

The December 17, 2010, first draft of the proposed DHS rules states that an “Entity means a person as defined in A.R.S. § 1-215.”  Section 1-215 says that “Person” includes a corporation, company, partnership, firm, association or society, as well as a natural person.”  Since an Arizona limited liability company is a company, DHS apparently will allow LLCs to own dispensaries unless it changes the rules to eliminate LLCs.  Here is an additional provision in the first draft of the rules that sanctions the use of a limited liability company:

“R9-17-301. Individuals to Act for a Dispensary Regarding Requirements.  When a dispensary is required by this Article to provide information on or sign documents or ensure actions are taken, the following shall comply with the requirement on behalf of the dispensary: . . . 4. If the dispensary is a limited liability company, a manager or, if the limited liability company does not have a manager, a member of the limited liability company”

As an Arizona business and entity formation attorney who has formed over 2,800 Arizona entities, I am surprised, but very glad that DHS is not requiring that people form Arizona nonprofit corporations to own and operate medical marijuana dispensaries.  The only type of entity that is specifically recognized under Arizona as a nonprofit entity is the Arizona nonprofit corporation.  The big problem with an Arizona nonprofit corporation is that it does not have any owners.  It simply would not be right for the government to require people to spend substantial amounts of time and invest large amounts of money into a nonprofit corporation that does not have any owners.

If you want more background and analysis of this nonprofit entity issue, read my article called “Arizona Proposition 203 – Legalization of Medical Marijuana.”

Arizona Medical Marijuana Dispensaries Should be Arizona Limited Liability Companies

My recommendation is that all entities that seek to obtain a license to operate an Arizona medical marijuana dispensary be Arizona limited liability companies.  People who have already formed an Arizona nonprofit corporation with the intent to have it obtain the license should put the corporation on the shelf and form a new Arizona LLC to be the nonprofit entity that seeks and obtains the license.

I would love to form your Arizona LLC that will own and operate a medical marijuana dispensary.  My fee is $1,599, which includes the all important nonprofit LLC Bylaws.  See my articles called “Why Every Arizona Medical Marijuana Dispensary Must Have a Buy Sell Agreement,” “Bylaws – We Don’t Need No Stinking Bylaws or Do We?” and “Bylaws for Arizona Medical Marijuana Dispensaries.”

By |2017-02-12T07:05:51-07:00December 23rd, 2010|Legal Issues, Questions People Ask|2 Comments