An Insider’s View – Three California Dispensaries

Last Sunday I joined a group of Arizona MMJ industry folks who had the rare privilege of visiting three L.A. area dispensaries. It was an excellent study in contrasts.

Our first stop was The Farmacy, a tidy and tiny (850 sq ft) storefront shop laid out in conventional fashion on the edge of the UCLA campus. Large windows with nice displays, good interior lighting, a long counter and fully stocked glass showcases set the tone.

This shop does a brisk business in a variety of herbal remedies, effectively broadening it’s revenue base.  A lack of seating discourages lingering before or after the sale.  A lone, contracted security guard keeps a watchful eye. Unarmed except for pepper spray, he said he can most often talk the occasional bad actor out of aggressive or other unlawful behavior.  All in all, a nice, everyday retail environment, with the only unusual element, at least to we ‘Zonies, being the many small jars of MMJ bud on display behind the counter.

Our next stop was The Herbal Caregiver, a second-story walkup in a somewhat grittier part of town.

After being buzzed into the stairwell of this converted apartment, patients ascend to the second story and enter a lightly furnished, somewhat funky former living room and do their transactions at the counter, behind which is a video monitor showing the front door and around inside.  Literature and business cards of interest to patients could be found on the coffee table.  The effect was kind of homey, in a college dorm sort of way.

Our last stop was the Rainforest Collective, located in a comfortable neighborhood of mixed business and residential uses.  It features an ambiance all it’s own, with walls covered in a colorful jungle motif and astroturf underfoot.  Furnishings inside the large waiting room consist of a small desk for the receptionist and couches, a tv and space enough for members to congregate before heading out to their weekly volunteer community project.

Again, one had to be let into the building.  After completing the requisite paperwork the receptionist buzzes patients into a small vestible separating the front room from the dispensary itself.  After the first door closes, the budtender opens the second door to allow entry into the dispensary.  Both she and the receptionist wore remote panic buttons, and the store’s manager is certified in security techniques.

If you’ve ever been inside a Trails or similar store, this dispensary would look familiar, with a couple of important differences: first, the jarred buds – at Rainforest collective there are many on display.  We also saw more infused products here than in the other locations.

Interestingly, on the infused products there was very little labeling – mostly just the manufacturer’s logo and perhaps some contact information.  It seems advisable, however, to list all ingredients, nutritional values and doseage information for the patient’s sake, and indeed this is a strict requirement by insurance carriers offering product liability coverage. 

Undoubtedly Arizona dispensaries will share some characteristics with those in California, but with the industry rapidly evolving and our program coming online nearly a decade and a half later, Arizona’s MMJ entrpreneurs can benefit from the many lessons learned by the movement’s original pioneers. 

Many thanks to our dispensary hosts, with special gratitude to guide Bob Calkin – here’s wishing you all much continued success.  For more information about what I learned on this tour, email me at: dougb@PremierDispensaryInsurance.com

By |2011-05-04T17:17:53-07:00May 4th, 2011|Dispensary Insurance, Stories & Articles|Comments Off on An Insider’s View – Three California Dispensaries

Lawyer in the CHAMPS Marijuana Dispensary Tax Comments on IRS Dispensary Audits

Taxes.com:  “Henry Wykowski . . . represented Californians Helping to Alleviate Medical Problems . . .  in that dispensary’s landmark 2007 case against the IRS.  Now, many of the growing number of California dispensaries facing what could amount to debilitating audits have sought out Wkyowski’s services. . . . ‘The most successful dispensaries do more than strictly offer cannabis.’  Says Wykowski, ‘I personally believe that a large part of the government decided that because they had not been successful through the DEA to shut [the dispensaries] down, maybe they could tax them out of business’.”

By |2015-04-06T18:57:50-07:00March 26th, 2011|Federal Dispensary Attacks, Tax Issues|Comments Off on Lawyer in the CHAMPS Marijuana Dispensary Tax Comments on IRS Dispensary Audits

IRS is in the Early Stages of a War to Kill Medical Marijuana Dispensaries

Question:  Does a medical marijuana dispensary that is legal under state law have anything to fear from the Internal Revenue Service?

Answer:  Yes.  In 2007 the United States Tax Court issued its opinion in the case of Californians Helping to Alleviate Medical Problems, Inc. v. Commissioner of Internal Revenue.  The issue in this case was what business expenses could a California medical marijuana dispensary deduct on its federal income tax return in light of Internal Revenue Code Section 280E, which 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 CHAMPS case, the IRS conceded that the taxpayer could deduct its cost of goods sold, which included $575,317 for marijuana.  Based on news reports about recent IRS audits of big California medical marijuana collectives, it appears that the IRS wants to revisit Section 280E and how it applies to medical marijuana dispensaries.

Warning to All Would-Be and Existing Medical Marijuana Dispensaries about Federal Income Taxes

The IRS is auditing a number of high dollar revenue medical marijuana dispensaries in California.  See for example “IRS tells California Medical Marijuana Dispensary it Owes Millions in Unpaid Taxes” and “Millions at Stake in IRS Audit of Oakland Medical Marijuana Dispensary.”  I believe that the ultimate goal of the IRS is to change the result in the CHAMPS case, which will have the practical affect of putting almost all state legal medical marijuana dispensaries out of business.  If a dispensary spends $1,000,000 to grow its marijuana in 2011 and none of that expense is deductible because of Section 280E, then the dispensary will pay federal income taxes of $340,000 that it would not pay if the expense were deductible.  This means it actually will cost the dispensary $1,340,000 to grow $1,000,000 of marijuana.

I do not know why the IRS conceded in CHAMPS that the taxpayer could deduct the cost of goods sold.  COGS was the taxpayer’s biggest expense.  I believe the IRS regrets conceding in CHAMPS that the COGS was deductible.  I predict the IRS  will disallow the  COGS of the medical marijuana dispensaries it audits.  I believe the IRS wants to litigate this issue in federal district court rather than in Tax Court with the ultimate goal of having the 9th Circuit Court of Appeals rule that COGS is not deductible by a state legal medical marijuana dispensary.  If the IRS can get one or more appellate courts to agree that the COGS is not deductible, the practical result may be to kill the medical marijuana industry in every state that has legalized it.

Tax Court vs. Federal District Court & Circuit Courts of Appeal

The CHAMPS case was a U.S. Tax Court case that had a good result for the medical marijuana dispensaries in states that have legalized the growing and sale of medical marijuana.  Neither federal district courts nor Circuit Courts of Appeal are required to follow the decisions of the Tax Court.  That is why the IRS wants to relitigate Section 280E in the federal district courts and then the appropriate Circuit Court of Appeals.   The IRS wants to reverse the CHAMPS case by winning at the Circuit Court of Appeals level.

When the IRS conducts an audit and demands more taxes from a taxpayer, the taxpayer who wants to dispute the results of the audit has two choices:

  1. Pay the entire amount of taxes in dispute and ask the U.S. Tax Court to determine how much additional taxes, if any, the taxpayer owes, or
  2. Pay none or less than all of the amount of taxes demanded by the IRS and ask the U.S. district court to determine how much additional taxes, if any, the taxpayer owes.

Tax court decisions cannot be appealed.  Federal district court decisions can be appealed by the losing party to the appropriate Circuit Court of Appeals, which is the 9th Circuit for California and Arizona. district courts.   Any legal medical  marijuana dispensary that is assessed additional taxes by the IRS will want to pay the additional taxes and have the Tax Court rule on the dispute.  The practical problem with this tactic, however, is that most dispensary taxpayers will not have the cash to pay the amount of taxes in dispute and will be forced to litigate in the federal district court.

The choice of venue to litigate the dispute is significant.  Dispensaries will want to pay the tax and go to the Tax Court where they expect the Court to apply the holdings of the CHAMPS case.  Clearly the IRS does not want these medical marijuana dispensary Section 280E cases to go to the Tax Court where the CHAMPS case is bad precedent for the IRS.  What the IRS is doing is going after dispensaries that have high income and expenses so that when it demands more taxes, the dispensaries most likely will not have the money to pay the amount in dispute and must then go to the U.S. district court.  Because the amount of tax dollars in dispute will be so big, the loser in the district court will appeal to the 9th Circuit Court of Appeals where the IRS hopes it will get a favorable Section 280E ruling that will effectively allow it to tax legal medical marijuana dispensaries out of existence.

The Marin Alliance for Medical Marijuana is being audited by the IRS.  When asked how much the IRS is demanding in back federal income taxes, Lynnette Shaw, the owner of this dispensary, would not disclose the amount, but she said, “It’s a staggering sum, millions and millions.”  I’m guessing this dispensary does not have a few spare millions of dollars lying around to pay the IRS so it can litigate the dispute in tax court.

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Disclaimer

Although I have a masters degree in income tax law from New York University Law School, I am  no longer a practicing tax lawyer.  I recommend that every dispensary hire a good  experienced tax CPA or tax lawyer to advise the dispensary on the federal and state income tax issues arising from the operation of a medical marijuana dispensary.

Circular 230 Notice:  Pursuant to recently-enacted U.S. Treasury Department regulations, I am required to advise you that, unless otherwise expressly indicated, any federal tax advice contained in this communication, including websites linked to, is not intended or written to be used, and  may not be used, for the purpose of  (i) avoiding tax-related penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any tax-related matters addressed herein.

Medical Cannabis Dispensaries: Minimizing the Cost of IRC Section 280E

Luigi Zamarra, CPA is the Chief Financial Officer of Harborside Health Center, recognized as one of the largest medical cannabis dispensaries in the United States.  Mr. Zamarra has written an interesting article entitled “Medical Cannabis Dispensaries: Minimizing the Cost of IRC Section 280E” that is a must read for all prospective owners of Arizona medical marijuana dispensaries.  The article explains how a medical marijuana business that is legal under state law can allocate its expenses between deductible and nondeductible expenses so as to comply with the Californians Helping to Alleviate Medical Problems, Inc. v. Commissioner of Internal Revenue Tax Court case and also deduct a substantial portion of its “nontrafficking” expenses.  Mr. Zamarra says:

“Making a 280E calculation is a three-step process. First, allocate all occupancy costs between Retail (this term is used herein to denote those operations, a portion of which would ordinarily be considered “trafficking” as this term is used in Section 280E) and Non-Retail operations. Second, make the same allocation for all payroll-related costs. Third, apply the ‘Transactional Factor’.”

Circular 230 Notice:  Pursuant to U.S. Treasury Department regulations, I am required to advise you that, unless otherwise expressly indicated, any federal tax advice contained in this communication, including  links, is not intended or written to be used, and  may not be used, for the purpose of  (i) avoiding tax-related penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any tax-related matters addressed herein.

By |2015-04-06T18:49:23-07:00December 27th, 2010|Tax Issues|Comments Off on Medical Cannabis Dispensaries: Minimizing the Cost of IRC Section 280E

Internal Revenue Code Section 280E

How to Calculate the Taxable Income of a Medical Marijuana Dispensary Business Under Section 280E of the Internal Revenue Code

In the U.S. Tax Court case of Californians Helping to Alleviate Medical Problems, Inc. v. Commissioner of Internal Revenue, 128 T.C. No. 14 (2007), the issue before the court was whether the Petitioner (CHAMP) could deduct ordinary expenses of $213,000 incurred in its medical marijuana business, a business that was legal under California law.  The Tax Court held that Internal Revenue Code Section 280E prohibited the deductions.  Here are some relevant statements made by the Court in its opinion:

Accrual method taxpayers such as petitioner may generally deduct the ordinary and necessary expenses incurred in carrying on a trade or business. See sec. 162(a).

Items specified in section 162(a) are allowed as deductions, subject to exceptions listed in section 261. See sec. 161. Section 261 provides that“no deduction shall in any case be allowed in respect of the items specified in this part.”

The phrase “this part” refers to part IX of subchapter B of chapter 1, entitled “Items NotDeductible”. “Expenditures in Connection With the Illegal Sale of Drugs” is an item specified in part IX. Section 280E provides:

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 context of section 280E, marijuana is a schedule I controlled substance. See, e.g., Sundel v. Commissioner, T.C. Memo. 1998-78, affd. without published opinion 201 F.3d 428(1st Cir. 1999). Such is so even when the marijuana is medical marijuana recommended by a physician as appropriate to benefit the health of the user.

As a result of the CHAMP case and Section 280E of the Internal Revenue Code, it is very easy to calculate the taxable income of a business that’s only business is growing or selling medical marijuana.  Here’s how it works:

Gross Income – Cost of Goods Sold = Taxable Income

By |2012-08-05T10:31:54-07:00December 27th, 2010|Tax Issues|Comments Off on Internal Revenue Code Section 280E

Californians Helping to Alleviate Medical Problems, Inc. v. Commissioner of Internal Revenue

In 2007 the U.S. Tax Court held that Internal Revenue Code Section 280E prevents expenses incurred in a business of growing or selling medical marijuana that is legal under California law from being deductible in determining the taxable income of the business for federal income tax purposes.

128 T.C. No. 14

UNITED STATES TAX COURT

CALIFORNIANS HELPING TO ALLEVIATE MEDICAL PROBLEMS, INC., Petitioner
v.
COMMISSIONER OF INTERNAL REVENUE
, Respondent

Docket No. 20795-05
Filed May 15, 2007

P provided counseling and other caregiving services (collectively, caregiving services) to its members, who were individuals with debilitating diseases. P also provided its members with medical marijuana pursuant to the California Compassionate Use Act of 1996, codified at Cal. Health & Safety Code sec. 11362.5 (West Supp. 2007). P charged its members a membership fee that generally reimbursed P for its costs of the caregiving services and its costs of the medical marijuana. R determined that all of P’s expenses were nondeductible under sec. 280E, I.R.C., because, R determined, the expenses were incurred in connection with the trafficking of a controlled substance.

Held: Sec. 280E, I.R.C., precludes P from deducting its expenses attributable to its provision of medical marijuana.

Held, further, P’s provision of its caregiving services and its provision of medical marijuana were separate trades or businesses for purposes of sec. 280E, I.R.C.; thus, sec. 280E, I.R.C., does not preclude P from deducting the expenses attributable to the caregiving services.

Matthew Kumin, Henry G. Wykowski, and Willian G. Panzer, for petitioner.

Margaret A. Martin, for respondent.

LARO, Judge: Respondent determined a $355,056 deficiency in petitioner’s 2002 Federal income tax and a $71,011 accuracy related penalty under section 6662(a) . (Note 1)  Following concessions by respondent, including a concession that petitioner is not liable for the determined accuracy-related penalty, we decide whether section 280E precludes petitioner from deducting the ordinary and necessary expenses attributable to its provision of medical marijuana pursuant to the California Compassionate Use Act of 1996, codified at Cal. Health & Safety Code sec. 11362.5 (WestSupp. 2007).   (Note 2)  We hold that those deductions are precluded. We also decide  whether section 280E precludes petitioner from deducting the ordinary and necessary expenses attributable to its provision of counseling and other caregiving services (collectively, caregiving services). We hold that those deductions are not precluded.

FINDINGS OF FACT

Certain facts were stipulated and are so found. The stipulation of facts and the exhibits attached thereto are incorporated herein by this reference. When the petition was filed, petitioner was an inactive California corporation whose mailing address was in San Francisco, California. Petitioner was organized on December 24, 1996, pursuant to the California Nonprofit Public Benefit Corporation Law, Cal. Corp. Code secs. 5110-6910. (West 1990). (Note 3)  Its articles of incorporation stated that it “is organized and operated exclusively for charitable, educational and scientific purposes” and “The property of this corporation is irrevocably dedicated to charitable purposes”. Petitioner did not have Federal tax-exempt status, and it operated as an approximately break-even (i.e., the amount of its income approximated the amount of its expenses) community center for members with debilitating diseases. Approximately 47 percent of petitioner’s members suffered from Acquired Immune Deficiency Syndrome (AIDS); the remainder suffered from cancer, multiple sclerosis, and other serious illnesses. Before joining petitioner, petitioner’s executive director had 13 years of experience in health services as a coordinator of a statewide program that trained outreach workers in AIDS prevention work. (more…)

By |2010-12-27T19:00:28-07:00December 27th, 2010|Tax Issues|1 Comment