Federal Law and Policy

On January 15, 2019, Fox Rothschild attorneys Josh Horn and Joseph McNelis will present Employment Compliance in the Age of Legalized Marijuana to the Greater Valley Forge HR Association in King of Prussia, PA.

Joshua Horn, Partner, Fox Rothschild LLP

Joseph A. McNelis III, Associate, Fox Rothschild LLP

The presentation will discuss the challenges Pennsylvania employers face given the dichotomy between state and federal laws governing cannabis. Josh and Joe will will provide an overview of federal and state marijuana laws (particularly the Pennsylvania Medical Marijuana Act), discuss specific aspects of the employment relationship affected by the legalization of marijuana, and offer practical guidance for employers on how to navigate this new and developing area of the law.

For more information and to attend the event, click here.

Also–don’t forget to check out our “White Paper” on the same topic, which provides a great overview and important takeaways for employers.

In the latest Tax Court opinion addressing the application of Section 280E to cannabis businesses there is no good news. However, there is some new guidance.  In Patients Mutual Assistance Collective Corp. v. Comm’r, 151 T.C. No. 11, the taxpayer made a litany of arguments to convince the court that their business, or a portion of their business was not subject to Section 280E.  These include arguments we have seen before, including (1) that the business was not trafficking in controlled substances, here, because the government had abandoned a civil forfeiture action, and (2) that because a portion of the business involved branding and the sales of non-marijuana products, deductions related to these operations should not be subject to Section 280E.  These arguments failed and only make it clear that similar arguments are likely to be unavailing.  In fact, the Court spends ten pages discussing why the entire business is integrated and subject to Section 280E.  Taxpayers hoping to establish a separate trade or business that is not subject to Section 280E now have clarity, but also an extremely high bar.

New Holdings:  Inventory Accounting Rules

The new developments addressed in this case involve the application of inventory rules to cannabis businesses.  Previous cases focused primarily on the previously discussed arguments and failed to give any detailed guidance on how to apply the inventory rules.  The Court clearly and strongly concluded that the more expansive Section 263A  inventory cost rules do not apply to businesses subject to Section 280E.  The Court reasoned that “if something wasn’t deductible before Congress enacted section 263A, taxpayers cannot use that section to capitalize it. Section 263A makes taxpayers defer the benefit of what used to be deductions-it doesn’t shower that as grace on those previously damned.”  Slip Op. at 53.

The Court’s conclusion is based on the notion that we go back in time to 1982 to determine what is includible in inventory costs.  The Court refers to Treas. Reg. section 1.263A-1(c)(2) which states:

Any cost which (but for section 263A and the regulations thereunder) may not be taken into account in computing taxable income for any taxable year is not treated as a cost properly allocable to property produced or acquired for resale under section 263A and the regulations thereunder. Thus, for example, if a business meal deduction is limited by section 274(n) to 80 percent of the cost of the meal, the amount properly allocable to property produced or acquired for resale under section 263A is also limited to 80 percent of the cost of the meal.

While this reasoning is understandable, if we turn the question on its head, we could also ask whether the section 280E disallowance is determined before or after inventory costs are calculated.  For example, even if there is a meals and entertainment expense that is clearly includible in inventory costs, no one is going to argue that 100% of meals and entertainment is includible in inventory costs.  In this case, you are determining inventory costs and deductions, and then applying Section 274.   So, it is easy to see how those provisions overlap.  However, if inventory costs are determined based on the applicable inventory rules and then Section 280E is applied, then you have a different result because Section 263A expands what can be included in inventory costs, and the remaining deductions are subject to Section 280E.  That result is not inconsistent with the notion that items such as meals and entertainment and penalties are not deducted in determining taxable income regardless of whether they are a deduction under Section 162 or an inventory cost under Section 471 or 263A.

The Harsh Result

It is important to note that the Court analyzed and concluded that the taxpayer was a reseller and not a producer.  Because the taxpayer did not itself grow marijuana, this is not surprising.  The Section 471 rules that apply to resellers do not allow for extensive indirect costs to be included in inventory.  Thus, for businesses that do not produce or manufacture, they will continue to face significant challenges by the IRS if they are including indirect costs in inventory costs.  For cultivators and producers, careful consideration should be given to how the 471 rules apply, depending on the activities of the business.

Still to Come

The Court reserved its analysis of whether penalties apply for a opinion to be issued at a later date.  However, the Court hints that there might be some relief when it states that the overlap between Section 280E and 263A created a “confusing legal environment.”  One can hope that given the lack of guidance addressing the specifics of how the inventory rules apply to cannabis businesses, the IRS and the court will give taxpayers  doing their best to apply Section 280E the benefit of reprieve from penalties.

Other Notes

If you are entertained by Judge Holmes’ opinions, be sure you read the footnotes.  Footnotes 3 and 6 are my favorites.

It is not often when an employer defends a FLSA lawsuit by asserting that it is in an illegal business and therefore immune to suit. Sound funny? Well, that is precisely what a Colorado employer that furnishes security services to legal cannabis growers/sellers has pressed on the Tenth Circuit. The employer’s theory is that the workers are not entitled to allegedly unpaid overtime under the Fair Labor Standards Act because their work is illegal under federal law. The case is entitled Kenney v. Helix TCS, and was argued before the Court of Appeals for the Tenth Circuit.

The Company’s counsel argued that the collective action cannot proceed as the FLSA only applies to legal businesses. The lawyer claimed that all job functions engaged in by the workers amount to trafficking in illegal drugs. This case is fascinating because it highlights the tension between a state legalizing cannabis and its continuing illegality under federal law. The lawyer for the Company argued that this controversy entered the “legally ambiguous” sphere in which legal cannabis businesses operate.

The named plaintiff, an armed security guard who guarded growers and sellers, claimed he worked overtime many weeks and was not paid properly. He sought class certification for all such guards, going back three years. The Company moved to dismiss, arguing that the employee’s work (as he was dealing with a Schedule 1 drug under federal law) violated the federal Controlled Substances Act and was thus outside of FLSA coverage.

The district court Judge denied the motion and observed that other courts have not endorsed this concept. The Judge noted that in other cases involving businesses that violate federal laws, e.g. immigration, courts have ruled that these violations did not mean the businesses could not comply with other federal laws. However, the Judge certified the ruling for immediate appeal and thus it went (quickly) to the Tenth Circuit.

The lawyer for the plaintiff asserted that the FLSA does not have a requirement that employees subject to its jurisdiction must be engaged in “only” legal businesses. There was no outright mention of “lawfulness” in the law and there was nothing in the state statute that voided the dictates of the FLSA.

The Takeaway

Maybe Congress should make an exception to the FLSA for this industry, but it has not done so. Consider the implications of granting the employer’s motion to dismiss—it would be giving a business illegal under federal law an advantage over legal businesses by sanctioning the avoidance of paying overtime.

Hmm. Food for thought…

Fox’s own Jennifer Benda, William Bogot and Joshua Horn are paving the way in this new and rapidly developing sector.

The National Law Journal has recognized Fox’s own Jennifer Benda, William Bogot and Joshua Horn as Trailblazers in Cannabis Law. This national distinction identifies attorneys who are paving the way in this new and rapidly developing sector.

 Josh and Bill are co-chairs of Fox’s nationwide Cannabis Law Practice – one of the largest in the nation with more than 50 attorneys experienced in a range of regulatory issues. They counsel growers, distributors, processors, investors and others, including suppliers of ancillary products and services, in corporate, regulatory, mergers and acquisitions, litigation and tax matters.

 Jennifer is a seasoned tax attorney, skilled litigator and former Certified Public Accountant who forged a niche practice handling complex tax and business problems for a diverse roster of clients in the cannabis industry. By combining a decade of working experience in accounting with years of tax planning advice and tax litigation, she delivers a rare depth of business strategy, pragmatism and efficiency to emerging, regulated markets.

 The three trailblazers have also been on the forefront of thought leadership in the legalized cannabis industry. In addition to speaking at a range of events, the group has published several valuable resources including a National Survey on Marijuana Laws and Regulations – a state-by-state survey of marijuana laws; a Cannabis Industry State Tax Guide; and Employment Compliance in the Age of Legalized Marijuana, which provides information and guidance on employment relationships affected by the legalization of marijuana in certain states.

Construction siteAll employers face challenges in navigating issues surrounding legalized marijuana. For construction industry employers, the challenges are particularly difficult given the necessary emphasis on safety.

Last week, my colleague Jeff Polsky, co-chair of Fox’s Labor and Employment Department, recorded a 90-minute webinar for Lorman addressing the issues construction employers face in jurisdictions that have legalized medical or recreational marijuana. Jeff discussed developments in state law, conflicts between state and federal laws, drug testing, maintaining a drug-free workplace, and responding to employees’ requests for accommodation of marijuana-related disabilities. You can purchase the webinar here.

The Treasury Department’s Financial Crimes Enforcement Network (FinCEN) has released updated quarterly statistics showing a continuing increase in the number of depository institutions that actively bank U.S. marijuana businesses. As of March 31, 2018, a total of 411 banks and credit unions provided services to marijuana-related businesses, up from 365 one year ago. FinCEN’s data reflects a slight decrease following the Attorney General’s announcement in January 2018 that he was rescinding the Cole Memorandum, but the numbers quickly went back up, ending the quarter at their second-highest level since December 31, 2017. FinCEN’s data is based upon Suspicious Activity Reports (SARs) required to be filed by financial institutions on activity involving a marijuana-related business.

In guidance issued in February 2014, FinCEN required financial institutions providing services to marijuana businesses to file the following types of SARs depending upon the type of services being provided:

  • A “Marijuana Limited” filing, which means that the financial institution’s due diligence indicates that the marijuana-related business does not raise any of the red flags as defined in the Cole Memo and is compliant with the appropriate state’s regulations regarding marijuana businesses. In this category, the financial institution is providing banking services to the marijuana-related business.
  • A “Marijuana Priority” filing, which means the financial institution’s due diligence indicates that the marijuana-related business may raise one or more of the red flags as defined in the Cole Memo or may not be fully compliant with the appropriate state’s regulations regarding marijuana-related businesses. In this category, the financial institution is providing banking services to the marijuana-related business while further investigation is being conducted.
  • A “Marijuana Termination” filing, which means the financial institution decided to terminate its relationship with the marijuana related business for one or more of the following reasons:

– The financial institution’s due diligence indicates that the marijuana-related business raises one or more of the red flags as defined in the Cole Memo.

– The marijuana-related business is not fully compliant with the appropriate state’s regulations.

– The financial institution has decided not to have marijuana-related customers for business reasons.

Following the Attorney General’s announcement in January 2018, FinCEN announced that its 2014 guidance would remain in place. And FinCEN’s latest publication of marijuana-banking statistics contains this important note:

Note: The SAR reporting structure laid out in the 2014 guidance remains in place. FinCEN will continue to work closely with law enforcement and the financial sector to combat illicit finance, and we will notify the financial sector of any changes to FinCEN’s SAR reporting expectations.

As of April 12, 2018, FinCEN has received 51,391 SARs involving marijuana-related businesses since issuance of FinCEN’s February 2014 guidance. The vast majority of those SARs – nearly 38,000 – were “Marijuana Limited” filings, indicating that the financial institution was providing ongoing banking services to the marijuana business in question. FinCEN has received approximately 3,800 “Marijuana Priority” SARs, and over 12,000 “Marijuana Termination” SARs, during the same time period.

An analysis of FinCEN’s SAR filing data continues to show a generally positive and encouraging trend for marijuana businesses, notwithstanding the Justice Department’s policy reversal on marijuana enforcement. For the first three quarters of 2018, the number of “Marijuana Limited” SAR filings increased every month by an average of 1,401 filings. In comparison, the number of “Marijuana Priority” and “Marijuana Termination” SAR filings increased by an average of only 480 and 173, respectively.

Few things are as bi-partisan as constructing a snazzy acronym for federal legislation, and Senators Elizabeth Warren (D-MA) and Cory Gardner (R-CO) did not disappoint with the “Strengthening the Tenth Amendment Through Entrusting States Act”  (“STATES Act”). As its name suggest, the goal of the STATES Act is to protect regulated cannabis businesses and users in states where cannabis has been legalized by amending the Controlled Substances Act.

U.S. Capitol Building
Copyright: mesutdogan / 123RF

The Controlled Substances Act, 21 U.S.C. §§ 801, et seq. (“CSA”) is the federal law that makes the manufacture, distribution, and use of marijuana illegal, and is the main source for the dichotomy between state and federal law concerning cannabis. The proposed legislation seeks to amend the CSA by adding several sections which would essentially exempt state-sanctioned marijuana from the CSA. While the STATES Act would not legalize cannabis on a nationwide level, it would and give states the freedom to legalize cannabis or keep it illegal.

The STATES Act has received so much attention not only because of the sweeping changes it proposes, but also because it has received tacit approval from President Trump, who was previously seen as a roadblock to cannabis legislation. That is due in part to a deal struck between Senator Gardner and the President, which ended with the following pronouncement from Gardner: “President Trump has assured me that he will support a federalism-based legislative solution to fix this states’ rights issue once and for all.”

The folks at Leafly have a great breakdown and explanation of the STATES Act, including the following bullet points on what the legislation proposes:

  • The act amends the Controlled Substances Act (CSA) so that as long as states and tribes comply with a few basic protections, its provisions no longer apply to any person acting in compliance with state or tribal laws relating to marijuana activities.
  • The act states that compliant transactions are not trafficking and do not result in proceeds of an unlawful transaction. This would go a long way towards ending the difficulties cannabis companies have in obtaining banking services.
  • The measure removes industrial hemp from the list of controlled substances under the CSA.
  • The following federal criminal provisions under the CSA continue to apply:
    • Prohibits endangering human life while manufacturing marijuana
    • Prohibits employment of persons under age 18 in drug operations
  • The act prohibits the distribution of marijuana at transportation safety facilities such as rest areas and truck stops.
  • The measure prohibits the distribution or sale of marijuana to persons under the age of 21 other than for medical purposes.

We will continue to monitor and provide updates on this important legislation, which has great implications for cannabis businesses throughout the country.


Joseph McNelis works in Fox Rothschild’s Blue Bell, PA office and focuses his practice on labor and employment matters. Joe also tracks legal developments in the cannabis industry in Pennsylvania and nationwide. Joe can be contacted at 610-397-2332 or jmcnelis@foxrothschild.com.

Jesse Harris writes:

Is a landlord who accepts rent from a cannabis dispensary tenant entitled to bankruptcy relief in a federal forum? In In re Olson, 2018 WL 989263 (B.A.P. 9th Cir. Feb. 5, 2018), the Bankruptcy Appellate Panel for the Ninth Circuit answered: maybe, maybe not, but either way, the bankruptcy court must make specific factual findings based on evidence in the record and explain its reasoning.

U.S. Court of Appeals for the Ninth Circuit building in San Francisco, CAIn Olson, a 92-year-old, legally blind landlord owned a shopping center in which a marijuana dispensary—operating legally under California law—was a tenant. Facing a foreclosure sale of her property, as well as ongoing litigation with the dispensary tenant, the debtor filed for Chapter 13 relief. The debtor continued to collect rent from the dispensary tenant, and ultimately proposed a Chapter 13 plan that included the sale of the shopping center within six months of plan confirmation. Before confirmation, however, the bankruptcy court sua sponte dismissed the bankruptcy case because the debtor was receiving “illegal proceeds” by “leasing property for an unlawful purpose under federal law, although lawful under state law.”

The debtor appealed, arguing that the bankruptcy court abused its discretion by dismissing the case. The Ninth Circuit agreed. In vacating the bankruptcy court’s order, the Bankruptcy Appellate Panel found that the bankruptcy court failed to articulate its legal basis for dismissing the case with “clarity and precision.” Specifically, the panel noted that the bankruptcy court did not make findings on its conclusion that the debtor violated the Controlled Substances Act by accepting the dispensary’s rent; that the debtor acted in bad faith; that the trustee would be administering the proceeds of an illegal business; or that the rents were to be used to fund the plan.

A concurring opinion written by Judge Maureen A. Tighe also pointed out that “[w]ith over twenty-five states allowing the medical or recreational use of marijuana, courts increasingly need to address the needs of litigants who are in compliance with state law while not excusing activity that violates federal law.” According to Judge Tighe, “the presence of marijuana near the [bankruptcy] case should not cause mandatory dismissal.”

The holding in Olson not only highlights the ongoing tension between the Controlled Substances Act and state marijuana programs, but it also emphasizes the need for landlords to carefully consider leasing property to cannabis businesses. Should those landlords eventually seek bankruptcy relief, such relief may be limited. That said, the panel in Olson appears to have equipped landlords who choose to lease property to cannabis businesses with certain bankruptcy options to avoid the “harsh penalty of dismissal,” such as rejecting the lease under Section 365 of the Bankruptcy Code.


Jesse M. Harris is an associate in the firm’s Financial Restructuring & Bankruptcy Department, based in its Philadelphia office.