A significant tax bill may await RICO plaintiffs involving cannabis lawsuits because in most cases the plaintiffs will be taxable not only on amounts recovered but also on the amounts spent on lawyers and court costs.

We recently discussed the latest in a series of Oregon RICO cases that generally involve property disputes. Plaintiffs and plaintiff attorneys find RICO cases attractive given the status of cannabis under the Controlled Substances Act and the availability of treble damages plus attorney’s fees. The most recent complaint alleges property damage from “noxious” odors and illegal activities that resulted in reduced property values.

There is at least an argument that the dollar value attributable to these items is zero or some nominal amount. One of the earlier RICO cases settled out of court. There are no public details of the agreed upon settlement. However, a number of the defendants successfully fought the cases against them and obtained dismissals. The remaining defendants probably found it cheaper to settle than face a drawn out legal battle. It is probably fair to say that a significant amount of the settlement went to pay attorney’s fees. This conclusion is, in part, based on the fact that the same attorney has represented multiple plaintiffs in cannabis RICO claims. While these claims might provide plaintiff attorneys a meal ticket, the plaintiffs themselves might be left holding the bag when they determine their federal income tax liability.

Specifically, section 61 of the Internal Revenue Code of 1986, as amended (“Code”) defines “gross income” for federal income tax purposes as income from “whatever source derived.” This means that the general starting point for determining taxable income is that any amount received is taxable to the recipient. Furthermore, under the “assignment of income” doctrine, a taxpayer is often taxed on the gross amount recovered, even if the taxpayer does not directly receive custody or take possession of the income amount. Thus, in the typical contingent fee arrangement, a plaintiff might agree to pay an attorney 40 percent of any damage award. Any settlement is generally paid to the plaintiff attorney’s client trust account where 60 cents of every dollar goes to the plaintiff and the remaining 40 goes to the plaintiff’s attorney. For tax purposes, this is generally treated as the plaintiff receiving the entire dollar and spending 40 cents for legal fees notwithstanding the contingency fee arrangement.[1]

Several code provisions provide for excluding certain types of damage awards from taxable income. For example, section 104 of the Code excludes from taxable income amounts received that are on account of personal physical injury or physical sickness. Those income exclusion provisions are not likely to apply in these RICO cases.

Deductions from gross income are a “matter of legislative grace.”[2] Trade or business expenses are generally deductible under section 162 of the Code — subject to denial under section 280E for any trafficking business. Alternatively, section 212 of the Code allows a deduction for all ordinary and necessary expenses paid or incurred for the production of income and for the conservation of property held for the production of income. Regulations under section 212 note that expenses paid or incurred for conservation of property used by taxpayer as a residence are not deductible under section 212, but are deductible if the property is used for the production of income (e.g., rental property).

Prior to 2018, section 212 expenses were considered miscellaneous itemized deductions that were subject to a minimum floor, typically two percent of adjusted gross income. If the expenses did not exceed the floor, then they were not deductible to the taxpayer. However, code section 67(g), added by the so-called Tax Cuts and Jobs Act of 2017, temporarily eliminates the availability of such miscellaneous itemized deductions even over a taxpayer’s 2 percent floor. Section 165 casualty losses were also materially limited by the same “tax reform” — now allowing itemized deductions for such losses only to the extent they exceed 10 percent of a taxpayer’s adjusted gross income.

Section 62 of the Code provides several so-called above-the-line deductions. Above-the-line deductions are not miscellaneous itemized deductions and subject to the temporary elimination noted above. They remain deductible for federal income tax purposes. Section 62(a)(2) provides a deduction for attorney fees and court costs involving most discrimination lawsuits, and claims under chapter 37 of title 31 of the United States Code. However, RICO claims typically fall under section 1962 of title 18 of the United States Code. Therefore, the deduction available under section 62 for legal fees in certain cases would not be available in connection with cases involving RICO damages.

In sum, if the RICO claims relate to property used for personal purposes (e.g., as a residence), then no deduction should be available under sections 162, 165 or 212 for any legal fees incurred. Indeed, whenever RICO plaintiffs are not engaged in the active conduct of a trade or business they probably cannot deduct their legal fees or even offset the gross amount recovered in such suits by legal fees retained by their lawyers.

Hypothetically, a plaintiff could settle a RICO case for a nominal amount of say $10,000 plus attorney’s fees of $50,000. The taxpayer-plaintiff probably needs to recognize the entire $60,000 as taxable gross income under section 61 and in many cases will not be entitled to claim a deduction for the $50,000 paid (or deemed paid) to the attorney. Assuming a 40 percent combined federal and state tax rate on the $60,000 of income, the tax due is $24,000, which significantly exceeds the plaintiff’s net proceeds of $10,000. The irony of this situation is that it is the exact problem many cannabis businesses face under section 280E — the taxpayer’s net income is less than the tax liability.

The takeaway? Potential RICO plaintiffs should consult with a tax advisor before pursuing RICO claims. Failing to do so could leave them with a tax debt exceeding a damage award or settlement amount.

[1] Commissioner v. Banks and Commissioner v. Banaitis, 543 U.S. 426 (2005).

[2] Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934).

On June 13, the U.S. Tax Court issued Tax Court Memo 2018-83, Alterman and Gibson v. Comm’r. Based on the way this case is being reported in the trade press, one might think that this decision portends doom and gloom for taxpayers in the cannabis industry. Such fears are not justified for anyone who maintains good records and does even basic tax planning.

The Alterman Tax Court held:

  • Taxpayers selling both cannabis and paraphernalia were not carrying on a separate non-trafficking business and, therefore, could not allocate expenses between trafficking and non-trafficking businesses;
  • Taxpayers failed to substantiate amounts allocable to cost of goods sold (COGS); and
  • Taxpayers were subject to 20 percent accuracy-related penalties.

The doom and gloom of the holdings fade once you appreciate the relevant facts:

  • Taxpayers’ non-trafficking business was limited to selling products that contained no cannabis (e.g., pipes, papers and other consumption-related items) and represented less than 5 percent of total revenue;
  • Taxpayers’ kept very poor books and records;
  • Taxpayers’ filed tax returns, which included facially “questionable” amounts for beginning and ending inventory, and which could not be traced to the balance sheet or general ledger;
  • Taxpayers’ accountant prepared a profit and loss statement, but failed to produce supporting work-papers; and
  • “The 2011 general ledger bizarrely recorded that ‘Total Inventory’ was $12,279, which was the same dollar amount recorded in the ‘Total Inventory’ entry in the 2010 ledger.”

The last point is an actual quote from the Tax Court’s findings of facts. Bad facts often result in bad law, especially when jurisprudence is summarized in the trade press where headlines attract readers and clicks. However, bad facts provide opportunities to distinguish yourself with good (or at least better) facts. So here are the key takeaways from the Aterman case that are worthy of attention:

  • Taxpayers should maintain true, accurate and complete books and records; this taxpayer lost because of bad records not because the court overreached or applied Internal Revenue Code Section 280E in a particularly egregious manner;
  • Alterman is a memorandum opinion that does not create new law or alter existing law;
  • Taxpayers should identify and follow an inventory costing method that maximizes COGS;
  • Taxpayers using a CHAMPS strategy to allocate non-COGS items between trafficking and non-trafficking businesses arguably requires some level of substance and recordkeeping — we generally recommend that clients conduct non-trafficking businesses in a separate legal entity and report on a separate income tax return;
  • Taxpayers should engage competent accountants, bookkeepers and tax return preparers that understand applicable accounting methods and tax planning strategies; and
  • Failing to keep accurate books and records may result in significant tax exposure and penalties.

With a little bit of luck, legislation pending in Congress will soon be enacted and henceforth relieve the state-legal industry of the unfair burden imposed by IRC Section 280E. But we can promise that no legislation will help taxpayers with shoddy record keeping.

On June 7, 2018, a supermajority of the Washington Legislature blessed financial institutions and accountants providing services for the licensed marijuana industry.[1]

The new law is comfort legislation for a special class in Washington. It is also a protest against impressions about the threat of federal prosecution. But what comfort is the legislation for persons falling outside the protected group? Does it provide any comfort or is it the proverbial cold comfort? The answer may be economics and politics (limited funds to target violent crime, federal/state relations and votes) should reduce the threat of prosecution, regardless of the new legislation.

Discussion

The new state law had broad support; supermajorities passed the law, 81 percent in the senate and 85 percent in the house.[2]

Public safety and other policies. The law targets the public safety problem caused when licensed businesses move cash in 80-pound duffel bags and thieves drill through roofs to steal the stored cash. Overlapping policies support the law:

  • The adage (less cash, less crime);
  • The elimination of the black market;
  • The promotion of transparency and traceability of funds; and
  • The promotion of access to banking and regulated financial services.

Public testimony and lawmakers’ statements.[3] Who supports the Comfort legislation? The support was wide spread.  The Northwest Credit Union Association supported the law. Three credit unions serve the industry and provide almost $1 billion in safe banking. The testimony emphasized the public policies listed above along with the stringent compliance requirements and due diligence for each transaction, and the risk of prosecution for money laundering. Additional policies were the promotion of small marijuana businesses, health research, the protection of employees of the licensed marijuana businesses to have bank accounts and credit cards rather than cash, especially the young, entry-level workers who may be unfamiliar with the financial services world.

Washington Association of Sheriffs and Police Chiefs supported the law as amended. Their support rested on the “incredible public safety issue” stemming from the amount of cash from the industry that was not safeguarded in a financial institution.

The staff summary of the public testimony was:

Washington needs to shut down the black market for marijuana and get cash out of the marijuana market. Having financial services that are traceable would improve the regulation of the industry. Previously, there was federal guidance for financial institutions interacting with the regulated marijuana industry. However, recent guidance by the federal government has caused uncertainty regarding providing financial services to the marijuana industry.[4]

The sound bites from the hearings included:

  • Important first step.
  • Step in the right direction.
  • Can’t wait for the feds to act.
  • Position for time when action is taken by Congress.
  • Eliminate some of the uncertainty resulting from the Sessions memo.

Testimony alluded to one bank stopping services to the industry after the Sessions memo.

But why did the lawmakers feel the need to adopt special legislation when the number of financial institutions nationally reporting that they served state licensed marijuana businesses rose from 340 to 400 by September 2017?[5]

Continue Reading 2018 Washington State <em>Comfort Legislation</em> for the Financial Industry and Accountants Dealing With Licensed Marijuana Businesses

In our last installment, we discussed the reasons why Oregon’s cannabis sales tax should not apply to cannabis seeds. So what do you do if you believe that a retailer wrongfully charged you sales tax on seeds or any other cannabis item? There’s a law for that!

Oregon Revised Statute (ORS) 475B.740 requires that cannabis retailers return taxes imposed on a sale that is not taxable upon written notice from the Oregon Department of Revenue (ODOR). The relevant ORS on the refund process is not clear or easy to follow. However, the Oregon Legislature granted ODOR broad authority to establish rules and procedures regarding the cannabis sales tax — and it did just that.

ODOR created Oregon Administrative Rule (OAR) 150-475-2060, which provides the relevant how-to of the specific process a consumer must follow for obtaining a refund of excess taxes paid, as follows:

  1. Within 30 days from date of sale, the consumer requests a refund in writing to the retailer by mail or hand delivery. The request must include the retailers (i) name, (ii) the nature of the excess tax paid, (iii) the remedy requested, and (iv) the receipt clearly identifying the date of purchase and proof of payment.
  2. If within 60 days of the request the retailer does not return the excess tax paid, then the consumer may appeal to ODOR within 120 days of the date of the original request for a refund.
  3. ODOR must refund excess cannabis sales taxes upon satisfactory proof that (a) the consumer paid an excess tax to the retailer, (b) the excess tax was not refunded, and (c) the consumer made a timely request for a refund.

One small problem: ODOR believes the sales tax equally applies to seeds and immature plants, (i.e., ODOR concluded the sales tax on seeds is legal). So don’t hold your breath waiting for ODOR to voluntarily send you a check.

Once you’ve exhausted these options, you are left with the Oregon Tax Court. The Tax Court is the sole, exclusive, and final judicial authority for questions of law and fact in Oregon. The Tax Court is broken into two separate divisions — the magistrate and the regular divisions. Cases typically start at the magistrate division and may later be appealed to the regular division. A taxpayer that is unhappy with a regular division decision may appeal to the Oregon Supreme Court.

A taxpayer appeals the failure of ODOR to issue a refund by filing a complaint against ODOR with the Tax Court no later than 90 days following the decision to deny the request for refund. With any luck, the Tax Court will agree with our position that the cannabis sales tax does not apply to seeds. As the saying goes, there are only two certainties in life — death and taxes.

One more thing. Even if you win, you’ve probably lost. ORS 305.490 requires that taxpayers pay a filing fee for each complaint or petition. The current filing fee is $265. The statute also provides for the recovery of costs and reasonable attorney’s fees in limited circumstances. However, those circumstances are generally limited to situations involving an individual’s request for a refund for a tax measured on net income and property tax matters. Costs and reasonable attorney’s fees are not recoverable in sales tax matters.

Takeaway for Consumers

ODOR probably got it wrong in concluding that the cannabis sales tax applies to cannabis seeds. Anticipating a challenge to their weak position, ODOR has created a number of onerous obstacles for anyone willing to challenge their authority.  Fighting ODOR on this issue is probably not worth the cost. A consumer spending $100 on seeds this spring will generally pay $20 in sales tax. Getting that sales tax refunded requires that you jump through the hoops noted above. If the retailer and ODOR refuse to make the refund, then you’re stuck paying $265 to recover $20 — creating a loss of at least $245, because the $265 cannot be recovered under current law. This doesn’t begin to account for the time and effort involved jumping through all of these hoops. The only way we’ll ever know if ODOR got it wrong is if someone is willing to take up the fight on principal. Even then, a win in Tax Court probably means the Oregon Legislature will “fix” the law in a future legislative session. If this happens, we can only hope that the Legislature will be kind enough to expand recovery of costs and reasonable attorney’s fees to sales tax matters.

Takeaway for Seed Retailers

Be wary of refunding any taxes to your customers because you can be held liable for not collecting and remitting the tax.

The Oregon Department of Revenue (ODOR) recently issued a permanent administrative rule relating to the retail sales tax imposed on certain marijuana items. OAR 150-475-2100. The rule itself provides guidance to retailers on how certain types of marijuana items should be classified and how such items should be subject to the retail sales tax imposed on them. However, the administrative rule reaches beyond the statutory language adopted by the Oregon Legislature to suggest that, somehow, cannabis seeds are subject to the retail sales tax. Prepare yourself for a bit of legal analysis and simple logic. Let’s take a look at how ODOR got it wrong.

The Law

The Oregon Revised Statutes (ORS) cannabis tax rules are codified in ORS 475B.700 through ORS 475B.760. ORS 475B.700 contains the relevant definitions for the cannabis tax. The provision includes definitions for the terms “cannabinoid product,” “immature marijuana plant” and “useable marijuana.” Each of these terms are defined by reference to their definition under ORS 475B.015.

ORS 475B.705 contains the enabling language and the tax rates. It states that a tax is imposed on “the retail sale of marijuana items” in Oregon. The tax is imposed on the consumer, but withheld and remitted by the retailer. ORS 475B.705(2) imposes a 17-percent tax on the retail sales price of several marijuana items, including “immature marijuana plants” and cannabinoid products other than those intended to be used by applying the product to the skin or hair.

ODOR’s Administrative Rule

ODOR adopted Oregon Administrative Rule (OAR) 150-475-2100 regarding the retail sales tax imposed on certain cannabis items. The rule states that the definitions found in ORS 475B.015 apply the terms used in the rule and that “seeds” are taxed at the rate in ORS 475B.705(2)(c).

Getting It Wrong The Legal Analysis

The Oregon statute covering the retail sales tax begins by creating defined terms. There is nothing inherently wrong with doing this. In fact, ORS 475B.700 creates defined terms not otherwise used by chapter 475B. However, it fails to do something important. It fails to incorporate the many defined terms found in ORS 475B.015. The defined terms found in ORS 475B.015 only apply to ORS 475B.010 through 475B.545. Among the terms incorporated are cannabinoid product, immature marijuana plant, marijuana items and usable marijuana.

Let’s jump to the low hanging fruit. ORS 475B.015(24)(a) defines the term “marijuana seeds” to mean “the seeds of the plant Cannabis family Cannabaceae.” The definition of “marijuana seeds” is not carried over to the tax section by virtue of ORS 475B.700. It’s glaringly omitted. OAR 150-475-2100 attempts to remedy this by rule and adopting all defined terms in ORS 475B.015.

Next, the term “marijuana” is defined by ORS 475B.015(17)(a). It means “the plant Cannabis family Cannabaceae, any part of the plant Cannabis family Cannabaceae and marijuana seeds.” The definition of “marijuana” is not carried over to the tax section by virtue of ORS 475B.700. It’s also glaringly omitted. Again, the administrative rule attempts to remedy this by adopting all defined terms in ORS 475B.015.

One important term that is carried over to the tax section is the term “marijuana item.” The enabling language found in ORS 475B.705(1) states “a tax is hereby imposed on the retail sale of marijuana items in this state.” Marijuana items are defined by ORS 475B.015(19) to mean “marijuana, cannabinoid products, cannabinoid concentrates and cannabinoid extracts.” Cannabis seeds do not fall within the definition of cannabinoid products, cannabinoid concentrates or cannabis extracts. That only leaves “marijuana” as the potential category for cannabis seeds. If we assume that the defined terms in ORS 475B.015 carried over to the tax section, then it is clear that cannabis seeds are “marijuana” as that term is defined, and therefore, would be a “marijuana item.” However, we cannot make this assumption because ORS 475B.700 fails to incorporate the defined term “marijuana” from ORS 475B.015.

But wait, there’s more. ORS 475B.705(1) simply states that taxes are imposed on the retail sale of marijuana items. ORS 475B.705(2) sets the applicable tax rates — and this is where the Oregon Legislature really swung and missed. Tax rates are set for the following items:

  • Marijuana leaves,
  • Marijuana flowers,
  • Immature marijuana plants,
  • Cannabinoid edibles,
  • Cannabinoid concentrates,
  • Cannabinoid extracts,
  • Cannabinoid products intended to be applied to the skin or hair, and
  • Cannabinoid products not intended to be applied to the skin or hair.

Cannabis seeds do not fit within any of these. The only reasonable possibility is that they are cannabinoid products not intended to be applied to the skin or hair. So let’s take a look at the defined term “cannabinoid products.”

ORS 475B.015(5)(a) defines cannabinoid products to mean “a cannabinoid edible and any other product intended for human consumption or use, including a product intended to be applied to the skin or hair, that contains cannabinoids or dried marijuana leaves or flowers.” Cannabis seeds are not edibles, and they are not intended for human consumption. They are also not used for any cannabinoids that they may contain. Cannabis seeds are intended to be germinated, grown and harvested. ODOR may argue that this intent constitutes “use” within the meaning of ORS 475B.015(5)(a), but this should be a losing argument.

ODOR did not look to the cannabinoid product argument when making their permanent administrative rule. OAR 150-475-2100(2)(c) states that seeds are subject to the rate set by ORS 475B.705(2)(c). That section imposes a 17-percent tax on “immature marijuana plants.” It doesn’t impose a tax on seeds. A plant is not a seed. Therefore, the tax imposed by ORS 475B.705(2)(c) cannot apply to cannabis seeds.

You may recall our prior blog post on making a difference. We provided written comments to ODOR suggesting that they lacked statutory authority to tax seeds. They disagreed with our position. In their written response (PDF), ODOR makes two arguments. First, they argue cannabis seeds are a “marijuana item.” Second, they argue that there was legislative intent to tax all marijuana items, including seeds. Lastly, they believe it is appropriate to tax seeds at the rate imposed on immature plants in an attempt to comply with the statutory language.

The first argument fails a law school admissions test (LSAT) logic problem.  ODOR’s argument relies on the defined term “marijuana” found in ORS 475B.015(17)(a). The defined term “marijuana” does not apply to the tax statutes. The defined terms relevant to the retail sales tax on cannabis items are found in ORS 475B.700. Those terms do not include a definition for “marijuana.” Reliance on the definition found in ORS 475B.015(17)(a) is misguided.

Legislative intent is a tool used to interpret statutes, contracts and other items when an item is ambiguous. Legislative intent is not used when a document or statute is facially clear — meaning there is no ambiguity in the drafting. There is only one potential term that might be ambiguous. That term is the word “use” in the definition of cannabinoid product. My view is the term “use” is intended to mean utilizing and consuming the THC, CBD or other cannabinoids the product contains. It should not mean germinating a seed to create a seedling, immature plant, mature plant and finally useable marijuana.

Even if we lost the cannabinoid product argument, ODOR’s permanent administrative rule states that seeds are subject to the tax rate imposed on immature plants. Seeds and immature plants are separately defined terms — a seed is not a plant. Therefore, the tax rate imposed on immature plants should not be imposed on seeds.

What’s Next?

So what do you do if you’ve purchased seeds in Oregon and paid the sales tax ODOR says you must pay? Stay tuned for our next post on the fun hoops ODOR set out for you to request a refund!

Sometimes the best place to hide something is in plain sight. That’s what Congress did in December when they passed the tax reform. In plain sight they (inadvertently?) muted the impact of 280E for corporate taxpayers.

How? Why? Because Congress lowered the corporate tax rate to 21%. IRC 280E denies deductions for costs associated with “trafficking in controlled substances,” which includes marijuana because it is still listed as a Schedule I substance under the Controlled Substances Act. Consequently, unless business expenses can be included in the cost of goods sold (COGS), expenses incurred in a cannabis-related business are not deductible when computing federal taxes. This rule presents a material tax problem for retailers, though other cannabis-related businesses can certainly be caught in this web.

By lowering the Federal corporate tax rate to 21% from 35%, the law now reduces the impact of the IRC 280E expense disallowance to about 60% of what it was prior to January 1 of this year. For example, a C corporate taxpayer who had $100X of net income after $30X of IRC 280E disallowance would pay tax of $35X last year. That same taxpayer with the identical income now pays tax of only $21X, muting the impact by 21% of the disallowed expense.

Taxpayers organized as C corporations don’t need to do anything except celebrate. Taxpayers organized as flow-through taxpayers, such as subchapter S corporations and LLCs taxed as partnerships, should look at their 280E exposure and consider whether restructuring might make sense.

Most government agencies rely on an informal rulemaking process when drafting and finalizing rules interpreting the law. This process generally requires the appropriate government agency to notify the public of the proposed new rule or proposed modifications to existing rules. The government agency generally must consider all comments received before finalizing a rule.

An exception to the public-comment period generally applies for “emergency” or “temporary” rules. Emergency and temporary rules are usually effective immediately, but are temporary in length. Unless the agency takes additional action, most temporary and emergency rules will expire.  A formal rulemaking and comment period generally applies before an emergency or temporary rule becomes permanent.

We encourage our clients and blog readers to participate in the rulemaking process.

The Oregon Department of Revenue (ODOR) issued a Notice of Proposed Rulemaking on October 19, 2017. ODOR scheduled a public hearing regarding these proposed rules on November 28, 2017 in Salem, Oregon.

ODOR proposes the adoption of two new rules – OAR 150-475-2030 and 150-475-2030. The stated need for the latter rule is to “codify the tax categorization of various products sold by marijuana retailers.” However, our review of the proposed rule includes a drafting error, inconsistent defined terms between the proposed rule and state statute, and an attempt to subject the sale of cannabis “seeds” to the state’s 17 percent retail sales tax. Our view of the applicable Oregon statute is that the retail sales tax does not apply to cannabis seeds as currently drafted and the proposed rule improperly classifies cannabis seeds as “immature plants.” Our Cannabis Team drafted and submitted the following public comments to ODOR and intends to attend the public hearing in Salem later this month.

A federal judge in Colorado recently upheld a summons issued by the IRS to the Marijuana Enforcement Division (MED) of the Colorado Department of Revenue. Rifle Remedies, LLC v. U.S., 120 AFTR 2d 2017-5447, (DC CO), 10/26/2017. The ruling contains very few facts but suggests that a taxpayer actively engaged in the cannabis industry objected to an IRS summons issued to MED for information related to such taxpayer.

The IRS may enforce a summons when the following conditions are met:

  1. The investigation will be conducted pursuant to a legitimate purpose,
  2. The information sought may be relevant to that purpose,
  3. The information sought is not already in the IRS’s possession, and
  4. The IRS follows the required administrative steps.

In this particular case, the IRS asserted that it sought records from MED pertaining to the taxpayer’s federal tax liabilities to 1) verify financial records and 2) determine if the IRS could substantiate information contained in the taxpayer’s returns.

The taxpayer’s arguments against the summons focused on whether or not the IRS had a legitimate purpose for obtaining MED records. The taxpayer argued the IRS summons was pretext for a criminal investigation. The fact that an IRS summons could have a criminal investigation impact is not relevant to determining its validity when the summons has an otherwise valid and non-criminal basis such as revenue recognition or section 280E compliance.

The taxpayer also asserts that the IRS summons includes MED “Transfer Reports” that could be used by the IRS as a fishing exercise for determining other taxpayers in the cannabis industry and subject to section 280E. According to the court, the taxpayer’s argument did not put “much meat on the bone” because the summons applied to a single taxpayer. So-called John Doe summons are subject to section 7609(f) when a summons does not identify the person with respect to the potential tax liability.

IRS examination of taxpayers in the cannabis industry may lead to John Doe summons in the future. See U.S. v. Coinbase, Inc. 120 AFTR 2d 2017-5239 (DC CA), 07/18/2017. In general, an IRS John Doe summons is valid when:

  1. The summons relates to the investigation of a particular person or ascertainable group or class of persons,
  2. There is a reasonable basis for believing that such persons or group or class of persons may fail or may have failed to comply with any provision of any internal revenue law, and
  3. The information sought to be obtained from the examination of the records (and the identity of the person or persons with respect to whose liability the summons is issued) is not readily available from other sources.

The first and third prong should not be much of an IRS obstacle. The validity of an IRS John Doe summons will likely depend on the second prong — whether or not the IRS can assert a reasonable basis for believing cannabis-industry taxpayers generally fail to report revenue includable under section 61 or comply with section 280E. A systemic failure of taxpayers to accurately report revenue or calculate taxable income may lead to widespread issuance of John Doe summons of MED (and other state’s) records.

The takeaway? Taxpayers subject to state seed-to-sale tracking requirements should expect and anticipate that the IRS (and state taxing authorities) have complete and full access to such records. Furthermore, taxpayers lucky enough to have access to bank accounts should expect their financial institution to perform due diligence including comparing seed-to-sale records to financial records and tax returns. See FinCEN memo — “BSA Expectations Regarding Marijuana-Related Businesses.” Any differences should be reconciled and explained.

Money backgroundIs your cannabis business ready for an IRS exam? IRS examinations are increasingly focused on IRS Form 8300 reporting requirements. These requirements are the result of USA PATRIOT Act provisions requiring all trades or businesses to report their receipt of more than $10,000 in currency in a single transaction or in two or more related transactions. 31 USC §5331 and 31 CFR §1010.320.

The required currency filing must be made in accordance with IRS Form 8300 instructions. The instructions provide that the form must be mailed to the IRS Detroit Computing Center or electronically filed within 15 days of receipt of the currency. Filers must also provide each person named on its filed Forms 8300 with a specified written statement by January 31 of the year following the calendar year in which the currency was received. The statement must show the name, telephone number, and address of the information contact for the business, the aggregate amount of the reportable cash received, and note that the information was furnished to the IRS.

Continue Reading Cashed Cannabis: Required Reports for Amounts Exceeding $10,000

The U.S. Drug Enforcement Agency (DEA) recently denied a petition to initiate proceedings to reschedule cannabis under the Controlled Substances Act (CSA). Thus, cannabis will remain a Schedule I substance under the CSA. Prior to the announcement, there was a good deal of speculation that the DEA was considering rescheduling cannabis to Schedule II.

Continue Reading DEA Just Said No to Rescheduling Cannabis: Why It Matters