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

I. The Conflict: The Long Arm of Federal Law

Recreational cannabis businesses operate in a world of conflicting state and federal laws. Several states have legalized recreational cannabis, yet, under federal law, cannabis remains an illegal Schedule I drug under the Controlled Substances Act (CSA). The CSA created five classifications of controlled substances. These classifications range from Schedule I to Schedule V, with varying qualifications for a substance to be included in each. The criteria for a Schedule I controlled substance includes a high potential for abuse, a lack of currently accepted medical use, and a lack of accepted safety for use under medical supervision. Controlled substances in Schedules II through V generally have a lower potential for abuse and/or some degree of currently accepted medical use. On April 4, 2016, the Department of Health and Human Services, the Drug Enforcement Administration (DEA), and the Office of National Drug Control Policy issued a letter indicating the DEA intends to reconsider the classification of cannabis in the first half of 2016. It is unclear if the DEA will continue to classify cannabis as a Schedule I drug, reclassify it to a different schedule, or remove it from the five schedules of controlled substances. Legalization at the state level does not protect recreational cannabis businesses from federal prosecution. The federal government continues its war on drugs and drug trafficking. This war currently includes cannabis. Cannabis businesses need cannabis to be removed from the schedules of controlled substances in order to eliminate the threat of federal prosecution.

State legalization rules are limited in scope to in-state purchase and consumption in an effort to “legitimize” the legislation and avoid federal intervention. For instance, state laws in Oregon and Washington do not permit a recreational cannabis consumer to acquire cannabis in Washington and later consume it in Oregon. States have carefully drafted their laws to prohibit importing or exporting cannabis. It is not so easy, however, to prevent federal intervention in all respects, and the long arm of federal law is felt most deeply in two areas: taxation and banking. This article addresses the tax challenges.

Continue Reading Recreational Cannabis — Section 280E and Tax Efficient Structuring