We recently discussed the impact of the Harborside opinion on cannabis tax planning, a tax court decision that disturbed, but didn’t really surprise, those of us who regularly work on the application of tax rules in the cannabis industry. The industry faces a secondary assault following the U.S. Tax Court’s opinion in Alternative Health Care Advocates. The opinion in Alternative raises new — more surprising and more disturbing — concerns regarding common cannabis tax planning strategies and focuses on the use of management companies.

The facts in Alternative include the following persons:

  • Alternative Health Care Advocates (Alternative), a California nonprofit mutual benefit corporation classified as a C corporation for U.S. tax purposes.
  • Wellness Management Group, Inc. (Wellness), a California corporation classified as an S corporation for U.S. tax purposes.
  • Duncan (D), 80-percent owner of Wellness and President of Alternative.
  • Richard Kearns (K), 10-percent owner of Wellness and Secretary of Alternative.
  • Kwit (E), 5-percent owner of Wellness and patient-member/consultant of Alternative.
  • Rozmarin (R), 5-percent owner of Wellness and manager of Alternative.
  • The individual mutual benefit members of Alternative.

Alternative operated a medical marijuana dispensary. Wellness handled daily operations for Alternative, which included hiring employees and paying expenses (advertising, wages, and rent). Alternative and Wellness maintained separate offices (but shared a mailing address) and maintained separate books and records on a shared computer.

Alternative obtained cannabis from its patient-members. It would prepare and process this cannabis for sale to its patient-members, which included trimming, drying, breaking down cannabis into gram or eighth-of-an-ounce increments, and maintaining clones. Additionally, Alternative obtained edibles, tinctures, oils, concentrates and topicals from its members in a condition ready for resale. The opinion notes that Alternative hired “processors” “through Wellness.”

Interestingly, both Alternative and Wellness maintained bank accounts with Bank of America and Chase Bank. Alternative operated within a “closed-loop” system. The closed-loop system required Alternative to limit both purchases and sales to patient-members. As such, Alternative purchased items from patient-members and sold cannabis items to them. Wellness paid Alternative’s other expenses, including advertising, wages and rent. Alternative reimbursed Wellness for these items. However, at times, Alternative directly paid for such items.

For the years in question, Alternative filed C corporation returns (Form 1120) and Wellness filed S corporation returns (Form 1120-S) while reporting the distributable share of Wellness income or loss to each Wellness shareholder on a schedule K-1. Both Wellness and Alternative reported gross income and other deductions. Additionally, Alternative reduced its gross receipts by its cost of goods sold. The tax returns filed by Alternative and Wellness did not reflect any disallowed expenses under IRC section 280E, and the IRS challenged each taxpayer’s respective position.

It should not surprise any of our readers that Alternative, a California medical marijuana dispensary, was disallowed expenses other than cost of goods sold under section 280E. What may be surprising is that the Tax Court extended the application of section 280E to Wellness, an S corporation acting as a “management” company for the dispensary.

The opinion cites the Tax Court’s earlier opinion in Olive and a tax code provision related to criminal activities related to USPS stamps to define “trafficking.” Olive held that dispensing medical marijuana constitutes trafficking for purposes of section 280E. Section 7208 defines trafficking — for purposes of prohibited stamp transactions — as buying, selling, offering for sale or giving away. The opinion also cites the Controlled Substances Act, noting that it prohibits importing, manufacturing, distributing and possessing controlled substances.

The analysis is limited to the following quote:

 

[T]he only difference between what Alternative did and what Wellness did (since Alternative only acted through Wellness) is that Alternative had title to the marijuana and Wellness did not. Wellness employees were directly involved in the provision of medical marijuana to the patient-members of Alternative’s dispensary. While Wellness and Alternative were legally separate, Wellness employees were engaged in the purchase and sale of marijuana (albeit on behalf of Alternative); that was Wellness’ primary business. We do not read the term “trafficking” to require Wellness to have had title to the marijuana its employees were purchasing and selling. Neither that section nor the nontax statute on trafficking limits application to sales on one’s own behalf rather than on behalf of another. Without clear authority, we will not read such a limitation into these provisions.

The analysis is troubling for several reasons. First, it ignores any contractual relationship between Alternative and Wellness. Second, it ignores any principal and agent relationship between Alternative and the employees provided by Wellness to Alternative. Third, a reasonable and logical expansion of the analysis suggests that dispensary employees are subject to section 280E. Fourth, the holding violates the tax principle that ambiguity in revenue raising provisions — notably IRC section 280E — should be construed in the taxpayer’s favor rather than the government’s favor.

The collateral damage of Alternative is unclear, and may suggest that cannabis companies should carefully (re)consider the use of management companies. Query whether it makes sense to restructure some management companies as so-called employee leasing companies. In the employee leasing arrangement context, the employees should be under the direction and control of the licensed entity rather than the employer of record. While the holding involves entities “directly involved” with cannabis, it suggests that real estate leasing and intellectual property leasing structures may face similar attacks in the future. Cannabis companies should carefully consider the tax risks of any tax planning strategies and determine if the potential benefits outweigh the associated risks.

The U.S. Tax Court’s recent Harborside opinion confirmed what we have warned our clients for quite some time: section 263A is unavailable for any cannabis business that traffics a Schedule I or II controlled substance. This conclusion is consistent with the IRS view espoused in a 2015 IRS Chief Counsel Advice memorandum and the flush language in section 263A, which states taxpayers cannot use section 263A to deduct an otherwise nondeductible item. Many cannabis businesses have relied on section 263A to capitalize expenses that would otherwise be non-deductible under section 280E. Those taxpayers should reconsider their tax return filing positions on not only a go-forward basis, but also for purposes of correcting previously filed returns.

Query: How should cannabis businesses account for their inventories going forward?

There are really two parts to the answer. First, taxpayers should consider the impact of changing their method of accounting for determining cost of goods sold (COGS), and whether it is appropriate to file IRS Form 3115 (Application for Change in Accounting Method) because they adopted a different COGS accounting method. Remember, even an erroneous method of accounting is still a method that usually requires filing that form and sometimes requires IRS permission.

Second, taxpayers should identify and use a permitted method under section 471. Those methods include the following:

Certain Small Businesses (section 471(c))

Taxpayers that are not a tax shelter under section 448(a)(3) and meet the gross receipts test found in section 448(c) may rely on their book method of determining COGS for tax purposes. Stated differently, qualifying taxpayers do not need to make book-to-tax adjustments for COGS. The gross receipts test in section 448(c) generally requires average annual gross receipts for the trailing three tax years not to exceed $25 million. Taxpayers in this category may face little or no impact when they aggressively capitalize costs into COGS for book purposes.

Herd Mentality (Reg. § 1.471-2(a)(1))

Section 471(a) grants broad authority to the IRS to adjust inventories to (1) clearly reflect income and (2) conform to the best practices of the trade or business. The conjunctive “and” requirement is interesting. It suggests that if the industry adopts best practices of capitalizing the majority of direct and indirect costs into COGS, then the IRS cannot adjust the taxpayer’s method solely for the purpose of “clearly reflecting income.” The IRS can only make an adjustment to “clearly reflect income” if it also satisfies the second prong of conforming as nearly as possible to best accounting practices. This suggests that a herd mentality within the industry may limit IRS ability to make COGS adjustments using authority granted to them in section 471.

Inventories at Cost (Reg. § 1.471-3)

Most accountants are familiar with using the inventories at cost method. Taxpayers calculate COGS using the following formula: Beginning inventory + purchases – ending inventory = COGS.

For companies that manufacture the inventory they sell, the formula modifies the purchase component to include: (1) the cost of raw materials and supplies entering into or consumed in the production process, (2) direct labor costs, and (3) indirect production costs incident and necessary for the production of the inventory (not including management expenses, selling costs, or return on capital). As you may suspect, cannabis producers receive a much better result under this method than resellers get.

Lower of Cost or Market (Reg. § 1.471-4)

The lower of cost or market method generally permits taxpayers to write down ending inventory when the carrying or book cost of that inventory is less than its current market value. Such a rule is generally taxpayer favorable because it permits the taxpayer to claim earlier the loss that otherwise arises when the taxpayer eventually sells the inventory. Cannabis businesses should receive a similar benefit. For instance, most markets face declining prices. Using the lower of cost or market method might increase the business’s COGS when production or purchasing costs are higher than the market value of their ending inventory.

Retail Merchants (Reg. § 1.471-8)

The retail method of inventory accounting is the following formula: a “Cost Compliment” multiplied by the retail sales price of goods on hand at the end of the taxable year. The cost compliment is a fraction calculated as (1) the value of beginning inventory plus the cost of goods purchased during the year divided by (2) the retail selling prices of beginning inventory plus the retail selling prices of goods purchased during the year, adjusted for all permanent markups and markdowns. This method is unlikely to produce a very favorable result for most cannabis companies as it does not capitalize indirect costs into COGS. As such, taxpayers would likely be denied deductions for indirect costs under section 280E.

Manufacturers (Reg. § 1.471-11)

This method is the closest method to section 263A and permits capitalization of both direct and indirect production costs — full absorption — to compute COGS. Production costs include direct production costs, as well as fixed and variable indirect production costs. The regulation places indirect costs into one of three buckets: (1) costs that must be included in COGS, (2) costs that are not required to be included in COGS, and (3) costs that are includable in COGS depending on the taxpayer’s book treatment. The word choice in the not required bucket is interesting. It suggests that taxpayers do not face a blanket prohibition of using those costs in COGS, and that taxpayers might in fact be able to capitalize COGS whenever doing so is consistent with industry best practices.

Query: What is the penalty risk for using section 263A?

On December 20, the Tax Court released a subsequent opinion in Harborside that is limited to discussing the application of penalties under section 6662. Harborside avoided penalties because the court determined that they acted reasonably and in good faith. However, it is interesting and noteworthy that the tax years in question were 2007 through 2012. All of those years are prior to the IRS CCA stating the IRS position that cannabis companies cannot rely on section 263A. This suggests that the Tax Court may be less forgiving for tax returns filed after the IRS published the CCA and taxpayers should consider amended returns for open tax years. The Tax Court does provide some insight into penalty relief for tax returns filed after the CCA. They note that the IRS had not promulgated regulations for section 280E, and no such regulations exist today.

The Takeaway

There are significant tax advantages to cannabis businesses that “manufacture” their inventory rather than buying it for resale. As such, cannabis businesses can better position themselves by vertically integrating — typically by producing or processing cannabis — along with retail activities. Tax policy may drive both vertical integration and consolidation within the industry.

Earlier this week the U.S. Tax Court issued its long-awaited opinion for the Harborside case, which addresses several issues that impact cannabis tax planning strategies.  Those issues include:

  • Definition of “consists of” as used in section 280E;
  • A Narrow view of CHAMP and when a business engages in two or more trades or businesses;
  • Hints that separate taxpayers may be aggregated as engaging in separate trades or businesses;
  • Holds that section 263A does not apply to a trafficking business subject to section 280E and must rely on section 471 COGS methodologies; and
  • Interprets the meaning of “produce” for purposes of the COGS method found in Reg. 1.471-11.

The opinion does not discuss whether Harborside is liable for accuracy-related penalties under section 6662(a).  Also, the Tax Court did not adopt the IRS position previously asserted in an IRS Chief Counsel Advice memorandum — that taxpayers must use the section 471 methodologies that existed when Congress enacted section 280E.  We previously questioned that IRS position.

 

The federal tax reform law that passed in December 2017 included a new incentive, the qualified opportunity zone (QOZ) regime.  The purpose of this tax incentive is to unlock and redirect trillions (yes, trillions) of capital gains into investments into new businesses, and substantial improvements to existing businesses, so long as those businesses are located in a QOZ (generally, designated  low income census tracts from the 2010 census).  The tax world has been abuzz about this enormous opportunity since the IRS issued taxpayer-friendly proposed regulations in late October.  Our summary of the QOZ regime is here, but the basic mechanics are simple: when taxpayers sell appreciated property (e.g., stocks or real estate) they can “roll” the gain into a new investment, with tax benefits for both the original “rolled” gain (deferral and up to 15 percent gain elimination) and the new investment (no tax on future gain).

In our summary, we highlighted the ability to secure QOZ benefits in urban areas, some of which are already attracting investments. QOZ benefits also are available for cannabis-business investments.  There are many QOZs in rural areas that are perfect for grow and processing operations; many urban and suburban QOZs may be good locations for retail outlets and dispensaries.

There are limitations on the types of business that can qualify for QOZ benefits, so no liquor stores, golf courses or sun tan parlors.  But Congress incorporated its “bad business” list from a Code section that has not been changed since 1986.  Accordingly, the “bad business” list does not include cannabis-related activities. (Please don’t ask us to explain why the cannabis industry is punished under one provision of the Tax Code but allowed to take advantage of another provision of the Tax Code; the best we can say is “it’s Congress.”)

So check the map before buying or building. You may find that some locations are more desirable than others, either because it will be easier to raise money from others, save taxes for yourselves, or simply turn out to be a neighborhood in which gentrification occurs more rapidly than normal.

We are proud to support Seattle University’s 6th Annual Northwest Marijuana Law Conference taking place on Friday, November 16. Josh Ashby and Sativa Rasmussen are the program’s Co-Chairs and will lead the conversation, bringing together experts from the law and the industry to provide critical focus and frameworks.

Ben Pirie will present on “Updates on Marijuana Law in Washington, Litigation, Dispute and Financial Issues” at 9:45 a.m.

Justin Hobson will present on “The Impact of Oregon, Canada and California on the Legalization of Marijuana Across the United States” at 11 a.m.

Other topics include:

  • Cannabis and the Constitution
  • The Impact of the 2017 Changes in Tax Law
  • Greening the “Green”: Sustainability in Cannabis Cultivation, Processing and Distribution
  • Growing Investments by Banks and Big Money in the Cannabis Industry
  • Ongoing Issues of Employment Law in the Cannabis Industry
  • Cannabis IP: Federal and State Protection of Trademarks and Other Intellectual Property

Date: November 16, 2018

Time: 8:30 a.m. to 5:15 p.m.

Cost: $225 General Registration | $195 Seattle U Law Alumni | $150 Non-Attorney

Credits:  Approved for 7.0 CLE Credits

(Live webcast and in-person options available.)

For more information and to register, visit the event website.

Just in case you missed it, Rep. Earl Blumenauer (D-OR) sent a memo to Democratic congressional leaders on Wednesday outlining a comprehensive plan to legalize marijuana in the United States as soon as 2019. You can read the full text here, and we couldn’t have said it better ourselves. It’s hard to overstate the importance of the comprehensive federal marijuana reforms outlined by Rep. Blumenauer (up for reelection next month — Lane Powell endorses civic engagement), which would address banking, taxation, safe access for veterans, criminal justice reform, states’ rights and scientific research. With Canada positioning itself recently as the world leader on sensible cannabis policy, the question is — why not us?

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.