IRS Claims Harborside Health Center Owes $2.5 Million in Back Taxes on Sales of $22 Million

The Bay Citizen:  “IRS Claims Harborside Health Center Owes $2.5 Million in Back Taxes on Sales of $22 Million – Oakland’s Harborside Health Center — the largest medical marijuana dispensary on the West Coast — lost the first round in a high-stakes battle with the Internal Revenue Service that could spell trouble for the booming pot industry. In a letter to Harborside late last week, the IRS ruled that the dispensary cannot deduct standard business expenses such as payroll and rent, because it is involved in what the agency terms ‘the trafficking of controlled substances,’ said Luigi Zamarra, Harborside’s chief financial officer. . . .If the IRS ultimately prevails, ‘we would close our doors and go away because the business model wouldn’t work,’ he said.”

See also “Harborside’s Death Tax,” which says:

“The federal government is attempting to tax Oakland’s Harborside Health Center — perhaps the country’s largest and most prominent medical marijuana dispensary — out of existence. “

Read Richard Keyt’s article called “IRS is in the Early Stages of a War to Kill Medical Marijuana Dispensaries.”

By |2017-10-07T09:54:52-07:00October 5th, 2011|California News, Federal Dispensary Attacks, Tax Issues|Comments Off on IRS Claims Harborside Health Center Owes $2.5 Million in Back Taxes on Sales of $22 Million

Medical Marijuana Dispensaries; the Federal Income Tax Deductibility Nightmare

Given the recent enactment of the Arizona Medical Marijuana Act, we anticipate a number of new business enterprises in the Arizona market attempting to comply with its “dispensary” provisions. Thoughtful entrepreneurs engaged in this fledgling industry will be wondering whether they will be permitted to deduct the expenses incurred in their business operations. This article will consider relevant tax provisions and attempt to provide a meaningful “rule of thumb” that these businesspersons, or their tax preparers, may find useful.

Background

The Arizona Medical Marijuana Act authorizes the establishment of nonprofit medical marijuana dispensaries (“dispensaries”). These dispensaries are to be licensed, tightly regulated, and inspected and are intended to provide medical marijuana to qualified patients, with their doctor’s approval, or their designated caregivers. Although, under Arizona Revised Statutes Section 36-2806, these dispensaries are to be nonprofit entities (but they need not be tax-exempt organizations for IRS purposes), they are clearly authorized by Arizona Revised Statutes Section 36-2801 to receive payment for all expenses incurred in their operations. As a result of receiving such revenue, they will undoubtedly be required to file income tax returns. Before considering these tax returns, however, an important legal issue must be dealt with. Is this business legal or illegal?

Although this may seem like a strange question to be asking, given that we are able to review specific Arizona statutes that authorize the business and provide detailed rules on numerous aspects of the creation and operation of such dispensaries, we would be remiss if we failed to do so. Since, however, the focus of this article is not the legality of a dispensary, we will rely on existing analysis of the issue as it has arisen in connection with California statutes, which have been around for the past decade and a half.

Since the passage of the Compassionate Use Act of 1996 and the California Medical Marijuana Program Act, California businesses have been wrestling with a number of legal issues and have had the opportunity to create a growing base of case law that will undoubtedly provide precedence as these same issues arise under Arizona law. The most important issue is whether the creation of these state statutes that authorize the possession and use of marijuana for medical purposes provides some protection, some defense, from Federal prosecution for the possession or use of illegal drugs.

A number of cases make it clear that the possession and use of marijuana, even for medical purposes, is still illegal under Federal law. See, for example, Footnote 10 of the California Supreme Court case, People v. Kelly (2010). According to the Controlled Substances Act, marijuana remains a Schedule I drug and, state statutes authorizing medical use to the contrary, Federal law does not contain any exception for “medical use”. Furthermore, Federal law still supersedes state law (Gonzalez v. Raich US Sup. Ct (2005)). In short, except perhaps for certain, specific research purposes, no use of marijuana is legal.

Thus, it would appear that any person or business possessing marijuana, even if in compliance with state medical use laws, is involved in an illegal business activity. This fact explains the many legal conundrums arising in advice given in the industry. Should a doctor merely “approve” of a patient’s medical use of marijuana or may she “recommend” it? May the product be “sold” or must it be given away (in exchange for a donation)? What is the difference between distribution by a “dispensary” and a “collective”? It should be noted that these issues arise, not necessarily as a result of any ambiguity in the state statutes, but because of concern over exposure to legal liability at the Federal level.

One may find some comfort (but, perhaps, not much) in statements issued by/on behalf of the Department of Justice (DOJ). In 2009, the Attorney General indicated that even though the DOJ does not condone any possession or use of marijuana, in an effort to use its resources efficiently, it would limit its prosecution efforts and target only dispensaries being used as a front for dealers of illegal drugs. However, in the DOJ guidelines issued in October 2009, I believe it expressed its intention more broadly, that is, it intended to prosecute “for profit” enterprises. Its statements have also indicated that it will not require its agents to prove any violation of specific state (Medical Use) statutes during such prosecutions (that is, such statutes do not matter and, even if followed precisely, offer no defense).

Thus, although AS 36-2811(B) clearly states that those complying with the provisions of the Arizona Medical Marijuana Act are not subject to arrest, prosecution or penalty for their possession or use of marijuana, this statute should not provide much comfort for anyone using or possessing marijuana for medical purposes. It may serve to give guidance to state police on the proper use of their resources but will apparently not affect Federal law enforcement officials. For further analysis of this issue, and others, you may wish to consider the White Paper on Marijuana Dispensaries, issued by the California Police Chief Association’s Task Force in April 2009 (www.counties.org. , under the CSAC Advocacy tab), as a possible starting point.

We will leave the resolution of this issue to the interested lawyers among you. For the remainder of this article, we will assume that a medical marijuana dispensary is an “illegal” business activity for Federal tax purposes.

Tax Guidelines (more…)

By |2011-02-17T07:56:34-07:00February 16th, 2011|Tax Issues|1 Comment

Why Your Dispensary Needs to Rent More Space than Needed for its Retail Store

Question:  I know that in 2007 the U.S. Tax Court ruled in the CHAMPS case that Section 280E of the Internal Revenue Code prohibits deducting from gross income any business expenses that are paid or incurred in connection with trafficking in marijuana.  Is there a way that my nonprofit entity that operates an Arizona medical marijuana dispensary can deduct any of its expenses from its gross income on the dispensary’s federal income tax return?

Answer:  Yes.  In the CHAMPS case, the IRS conceded that the taxpayer could deduct its cost of goods sold, which included $575,317 paid for marijuana.  The fight in the CHAMPS case was over what business expenses the taxpayer could deduct.  The IRS argued that the taxpayer had only one business – trafficking in marijuana – and therefore none of its business expenses other than its cost of goods sold were deductible.  The taxpayer successfully argued that it operated two businesses – its medical marijuana sales business and its care-giver business.  The Tax Court agreed with the taxpayer and allowed the taxpayer to allocate its expenses to its two separate businesses and deduct expenses attributable to the care-giver business.

If your Arizona medical marijuana dispensary wants to be able to deduct anything from its gross income above and beyond its cost of goods sold, the dispensary must engage in one or more trades or businesses that do not  involve medical marijuana.  Every would-be dispensary should carefully study the CHAMPS case and learn how CHAMPS operated its care-giver business, which was very extensive and real.  The case illustrates that the sale of medical marijuana was in fact a small portion of everything that the dispensary offered to its patients.  Note also that the salaries paid to management and staff were very nominal – $14,914 paid to officers and directors and $44,799 salaries paid to 25 employees of a dispensary that collected just over $1,000,000 in gross revenue.

Example 1:  Dispensary 1 operates a 2,000 square foot retail dispensary in Phoenix where its sole activity is displaying its products and selling products to patients over the counter.  This dispensary’s entire business involves trafficking in marijuana so it cannot deduct any of its expenses from its federal income tax return.

Example 2:  Dispensary 2 operates a 2,000 square foot retail dispensary in Phoenix, but next door to the dispensary it has an additional 2,000 square feet of space where it provides other services and products to the public such as:

  • yoga classes
  • acupuncture
  • massage therapy
  • classroom instruction on the use of medical marijuana and other pain medications
  • classroom instruction on health care related topics
  • library of books, DVDs and other materials about medical marijuana that patients of the dispensary can use for reading on the premises or to check out and view at home.
  • coffee bar with pastries where people can congregate and relax

Dispensary 2 can now:

  1. allocate occupancy expenses to retail and nonretail
  2. allocate payroll expenses to retail and nonretail
  3. apply a transactional factor

Consider this simple allocation of dispensary 2’s expenses:

  1. Since 1/2 of the leased space is not used for the sale of marijuana, fifty percent of the total rent expense is deductible.  This includes ancillary expenses such as security for the premises, utilities, landscaping, common area expenses and maintenance, janitorial service and premises maintenance.
  2. Dispensary 2 can deduct its payroll expenses attributable to personnel who work solely in the non-marijuana side of the business.  For personnel that work in both aspects of the business, the dispensary must have a method for allocating their payroll to the marijuana related services and the non-marijuana related services.

For more on this important topic, see “IRS is in the Early Stages of a War to Kill Medical Marijuana Dispensaries.”

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.

By |2014-05-21T19:42:45-07:00February 12th, 2011|Dispensary Leases, Real Estate Issues, Tax Issues|Comments Off on Why Your Dispensary Needs to Rent More Space than Needed for its Retail Store

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