Tax and calculator buttonsToday, the Tax Court issued its opinion in Feinberg v. Commissioner, a case involving an ongoing and hard fought battle between the IRS and a medical marijuana dispensary, Total Health Concepts, LLC.  The IRS examined THC’s 2009 through 2011 tax returns.  As a result of the examination, the IRS adjusted the member taxpayers’ returns to reflect a cost of goods sold allowance in excess of the amount originally claimed on the return by reclassifying expenses that were originally claimed as below-the-line expenses.  However, the IRS also disallowed expenses not reclassified as cost of goods sold.  Accordingly, the IRS computed deficiencies on the member’s individual tax returns.

During earlier phases of this case, the taxpayer argued that the Commissioner did not have jurisdiction to administratively determine whether petitioners committed a federal crime outside of the U.S. tax code, that section 280E as applied by the Commissioner is unconstitutional as it violates petitioners rights against self-incrimination under the Fifth Amendment of the Constitution, and that section 280E exceeds the authority granted to Congress under the Sixteenth Amendment of the Constitution.  The Tax Court denied the taxpayer’s request for summary judgment and compelled them to respond to IRS discovery requests.  The taxpayer’s sought a writ of mandamus, seeking review of the Tax Court’s order compelling them to produce documents.  The Tenth Circuit determined that if the discovery request harmed them, the proper time to address that harm would be after the Tax Court case was fully resolved.  As a result, the taxpayer’s case proceeded to trial.

At trial, the taxpayer did not submit documentation to substantiate the cost of goods sold allowance or the ordinary and necessary business expenses.  Instead, an expert report was submitted to substantiate a cost of goods sold allowance in excess of what the IRS allowed during the examination.  The Tax Court ruled that the expert report was unreliable because it contained statements which failed to refer to underlying source information, failed to include underlying source information which the expert relied upon, and failed to include sufficient information and data to support the report’s conclusions.  As a result, the expert report was inadmissible.

Next, the court looked to evidence which would support a higher cost of goods sold allowance than the allowance determined in the IRS report.  Without documentation, the court concluded that the IRS determination of cost of goods sold would stand.  Further, because there was no substantiation of ordinary and necessary business expenses claimed under Section 162, the court determined that it did not need to address the application of Section 280E (the code section which disallows ordinary and necessary business deductions for businesses trafficking in controlled substances).

What is the lesson here?  This case provides no guidance on the limits that will be applied to cannabis companies in determining cost of goods sold.  Rather, this case tells us that a cannabis company should prepare for an IRS examination the same way any other taxpayer should, by maintaining documentation to support the deductions claimed on the return and by provided that documentation when the IRS requests it.  This is especially true in this case, where the court determined that “there was not enough evidence in the record to make a finding of fact that THC sold medical marijuana.”  Based on this statement, if the taxpayer would have substantiated its below-the-line expenses, they would not have been subject to Section 280E, which would have been a huge win for the taxpayer.

In advance of a Senate Judiciary Committee hearing held June 19, 2017, New Jersey State Senator Nick Scutari released the text of Senate, No. 3195, or SB 3195, the long-awaited bill legalizing cannabis in New Jersey. In a statement announcing the bill in mid-May, Senator Scutari, the bill’s sponsor, stated, “Now is the time to begin shaping New Jersey’s recreational marijuana program. We will have a new governor next year and we should be prepared to move forward with a program that ends the prohibition on marijuana and that treats our residents fairly and humanely.”

New Jersey map outline
Copyright: adamgolabek / 123RF Stock Photo

Governor Chris Christie, an ardent opponent of legalization, once famously remarked that tax revenue generated by legalization of marijuana should be considered “blood money.” As a result, the legislature is not expected to vote on the bill until 2018, when Governor Christie is out of office.

Senator Scutari and other New Jersey legislators took trips to Colorado to see their legalization framework firsthand. The effect is a bill that closely resembles Colorado’s version. SB 3195 proposes the following:

  • Legalizing the possession of one ounce of marijuana flower, seven ounces of concentrate, 16 ounces of edible products infused with cannabis, seven grams of cannabis concentrate, and 72 ounces of infused liquid for adults over 21 years of age
  • Elimination of sales tax on medical cannabis purchases and installing a staggered sales tax schedule on recreational purchases. The tax rate the first year is proposed to be 7%, 10% in year two, and then increase by 5% each year after that until reaching 25%
  • Expunging criminal charges related to possession of marijuana
  • Creating a new division within the Office of the Attorney General that would be specifically charged with overseeing the legalization program

As drafted, SB 3195 prohibits home cultivation of cannabis. While stating that he would be open to negotiating that element of the bill, Senator Scutari noted the difficulties that Colorado and other states have experienced in regulating and controlling home cultivation. Those states impose limits on home cultivation, but enforcement of those limits has proven challenging.

A study by New Jersey Policy Perspective and New Jersey United for Marijuana Reform estimated that legalizing cannabis could bring $300 million in new tax revenue in year one.

See my posts here, here, and here regarding the Florida Legislature’s efforts to pass laws to implement Amendment 2 (medical marijuana passed by Florida’s voters in November 2016).

Unless a special session is called, the Florida Legislature closes out this session with no agreement on medical marijuana.  Issues related to the number of grower licenses and how those licenses would be linked to storefronts created an insurmountable disagreement.

Supposedly and ironically, the pro-cannabis powers were instrumental in the demise of medical marijuana in the legislature.  The issue of  how many storefronts the current license holders (7 at present) could operate has been a large part of the debate.  The Senate wanted to cap the number of retail locations for each license holder so that these 7 license holders could not consolidate too much market power.

With the failure by the Florida Legislature, that means Florida’s Department of Health, under Governor Rick Scott, will now be responsible for creating regulations for Amendment 2.  That does not bode well for the cannabis industry or patients, since Gov. Scott is anti-medical marijuana.

24982680 - state supreme court building in tallahassee, florida.

Also expected, fierce litigation from patients, physicians and businesses now that the legislature has failed.

__________

Dori K. Stibolt is a West Palm Beach, Florida based partner with the law firm of Fox Rothschild LLP.  She focuses her practice on litigation and labor and employment issues.  You can contact Dori at 561-804-4417 or dstibolt@foxrothschild.com.

With time running out in the session, Florida’s Senate passed SB 406 (regulations to implement Amendment 2) late last night.  Now, the Florida Senate and House need to work out their differences, see my recent post on the House Bill.

Florida’s Senate and House have reached agreement on the following:

  • No smoking, but yes to vaping and edibles.
  • A House requirement that doctors must wait 90 days after meeting with a patient to issue a prescription has now been eliminated.

5904975 - the old florida state capital building in tallahassee sits in front of the new modern capital building which can be seen rising in the background. the old capital building is now a museum.

The ban on smoking remains controversial.  My own state senator, Jeff Clemens, remains critical and had this to say.

There are people out there who this is still not going to help, there are people who only get the relief that they need through smoking.

The differences that need to be worked out between the House and Senate include the big issue of the number of licenses allowed for growers/distributors.  As I noted in my earlier post, the House’s Bill included unlimited retail locations for license holders, but limited the number of licenses.  To force the House on the issue of limited licenses, and to limit any one company from becoming too dominant, the Senate put a cap on the number of retail dispensaries each license holder can operate.

Florida for Care, the group that led the campaign to pass the marijuana amendment, supports the Senate’s position on the number of licenses noting the Senate Bill:

would allow for the marijuana industry to grow alongside the patient population, providing competition and reasonable access.

The House and Senate also disagree on the tax treatment for medical marijuana, the House proposes it be tax free.

With just a couple days left in the session, we’ll see if the differences can be ironed out between the two bills.  Either way, litigation is likely.  If the Florida legislature fails to pass a bill implementing Amendment 2, any Floridian can sue.  Litigation is also likely if the Florida legislature passes a bill that bans smoking of medical marijuana or overly limits the number of licenses.

__________

Dori K. Stibolt is a West Palm Beach, Florida based partner with the law firm of Fox Rothschild LLP.  She focuses her practice on litigation and labor and employment issues.  You can contact Dori at 561-804-4417 or dstibolt@foxrothschild.com.

Tax and accounting issues you should not ignore when setting up your marijuana business:

  • The Trouble with Cash Based Businesses
    • Internal Controls – any cash based business is closely scrutinized by the IRS and other taxing authorities; having strict internal control procedures, in writing, which are strictly enforced, will go a long way in establishing credibility with taxing authorities
    • Form 8300 requirements – educate yourself or hire an accountant who can work with you to comply with this filing requirement
  • Find Good Help
    • It is very important to hire reputable CPAs and legal counsel to assist you in operating your business
    • CPAs often do not have guidance from their licensing boards re: representation of marijuana businesses and many are reluctant to advise marijuana businesses
    • Even though many state bars have given comfort to attorneys, many large law firms are still reluctant to assist marijuana businesses
    • However, sophisticated advisors are starting to work with the industry, both in house and as external advisors
  • Comply, comply, comply
    • Abide by Internal Revenue Code section 280E – this requires knowledgeable and diligent accounting advice
    • Be timely and fully pay your taxes – tax liens can create issues with licensing authorities and the IRS has very unfavorable positions regarding collections issues for the industry
    • Taxpayers have the burden of proving the proper tax liability – consider all your options before refusing to cooperate in IRS examinations