Cannabis Business Blog

Come tax time, taxpayers in the marijuana industry in Oregon may want to proceed with caution.  Since Oregon is tied to the Internal Revenue Code—specifically IRC § 280E—for purposes of income taxation, deductions relating to the trade or business of selling medical or recreational marijuana will be disallowed, and therefore taxpayers in this industry seeking to capitalize expenses and add them to the cost of goods should keep in mind that the taxing authorities will likely be monitoring this area closely.  For more information on this issue, please read the latest post on our firm's sister blog Larry's Tax Law.

Radio talk show host Ross Reynolds, from KUOW's The Record interviews Hal Snow, member of Garvey Schubert Barer's Cannabis practice group, on the tricky landscape of the marijuana industry. Hal gives his thoughts on topical issues related to current states compliance with federal laws under the Obama administration, banking issues, rise of medicinal and recreational marijuana, and the outlook on marijuana legalization and regulation under a new president and Congress in January 2017.

Listen here: http://kuow.org/post/current-legal-landscape-marijuana-still-tricky

In the July 9, 2015 Olive¹ decision, the Federal 9^th Circuit Court of Appeals upheld a Tax Court decision that a medical marijuana dispensary was precluded from deducting any amount of ordinary and necessary business expenses associated with the operation of the business because the Vapor Room (the “business”) is a “trade or business…consist[ing] of trafficking in controlled substances…prohibited by Federal law.” I.R.C. § 280E. Deductions were limited to the “costs of goods sold.”

The Vapor Room sold only medical marijuana. It provided many other services but didn’t charge for them. The appellate court distinguished Olive¹ from the 2007 CHAMP² decision where the Tax Court determined that the taxpayer was engaged in two income generating businesses including the sale of medical marijuana and extensive counseling and caregiving services. In CHAMP², the ordinary and necessary business expenses related to the counseling and caregiving services were deductible. See I.R.C. § 162(a).

Participants in the marijuana industry should review the facts of the Olive¹ and CHAMP² decisions carefully, and consult with their tax attorneys and accountants on the most tax efficient way to structure their marijuana businesses.

If the marijuana business owner also obtains revenue from the sale of non-marijuana goods and services then the ordinary and necessary business expenses related to the non-marijuana activity should be deductible.

Finally, on Aug. 10, 2015, the U.S. Tax Court published the Beck³ decision which, in line with the Olive¹ decision, held that a marijuana business that only sold marijuana products, could not deduct any of the ordinary and necessary business expenses related to the marijuana business. Deductions were limited to “cost of goods sold” I.R.C. § 280E. The Beck³ decision discussed the CHAMP² decision and upheld its holding that a business may have two or more businesses and that the ordinary and necessary business expenses relating to the non-marijuana businesses were deductible.

¹ Martin Olive v. C.I.R. 139 T.C. 19

²Californians Helping to Alleviate Medical Problems, Inc. – CIR (CHAMP), 128 T.C. 173 (2007)

³Beck-v-C.I.R., T.C. Memo 2015-149 (08/10/2015)

Under Section 162(a) of the Internal Revenue Code, a business can deduct from its gross income “all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.” According to the United States Court of Appeals for the Ninth Circuit, however, this deduction is not extended to marijuana related businesses. Olive v. Commissioner of Internal Revenue, No. 13-70510 (9^th Cir. July 9, 2015).

In 2012, the United States Tax Court assessed penalties and interest against Vapor Room Herbal Center, a California medical marijuana dispensary owned by Martin Olive, for its deduction of $654,071 as business expenses on its 2004 and 2005 income tax returns. Although IRC Section 162(a) allows businesses to deduct “ordinary and necessary expenses,” IRC Section 280E prohibits a business from deducting for any “trade or business [that] consists of trafficking in controlled substances … prohibited by Federal law.” Citing Section 280E, the Tax Court held that operating a medical marijuana dispensary constituted trafficking in controlled substances in violation of federal law, even though it was legal under California law.

Olive appealed the Tax Court’s decision to the Ninth Circuit Court of Appeals. His first claim was that for a “trade or business” to “consist of trafficking in controlled substances,” the business must consist solely of trafficking in controlled substances. Olive argued that in addition to dispensing medical marijuana, the Vapor Room also offered free caregiving services such as yoga, massage therapy, discussion of illnesses, counselling on various personal, legal or political matters related to medical marijuana and education on how to consume medical marijuana responsibly. The Ninth Circuit agreed with the Tax Court that the Vapor Room’s only “trade or business” was the sale of marijuana. It noted that the test for determining if an activity is “trade or business” is whether the activity was entered into with the intent of making a profit. As the Vapor Room’s other services were offered for free, the only activity that could raise a profit was the sale of marijuana.

Olive’s second claim was that IRC Section 280E should not apply to him because it was enacted before medical marijuana dispensaries existed, therefore Congress could not have intended for medical marijuana dispensaries to fall within the category of “items not deductible.” The Ninth Circuit stated that this argument had no bearing on its analysis.

Olive’s last claim was that Section 538 of the Consolidated and Further Continuing Appropriations Act 2015, PL 113-235 prohibits the IRS from defending his appeal as it provides that federal funds may not be used to prevent states that at the time of the Act had legalized medical marijuana, from implementing their state laws authorizing the use, distribution, possession or cultivation of medical marijuana. The Ninth Circuit held that Section 538 does not apply because the IRS is not preventing California from implementing its laws that authorize the use, distribution, possession or cultivation of marijuana. Instead, the IRS is simply enforcing a tax, which does not prevent people from using, distributing, possessing or cultivating marijuana in California.

This ruling is an obvious and a troubling set-back for the marijuana business community. It is just another example of how the inconsistencies between federal and state laws can be challenging for marijuana users, growers, processors and regulators. This problem could be resolved by revising the Internal Revenue Code to provide a further exception under 280E to allow state-sanctioned marijuana enterprises. Until then, marijuana business owners should caution taking business deductions or – alternately, consider whether other business activities are entered into with the intent of making a profit for the business.

This article was first posted on GSB's Northwest Land Law Forum blog, May, 29, 2015. 

Cities and counties don’t always have the power to regulate on anything they please.  Sometimes local action is pre-empted by state or federal law, but determining when local government action is pre-empted is often tricky business.

The general rule in Washington (and Oregon) is that local governments are authorized to make and enforce all laws necessary to further its police power, including zoning laws, so long as they do not directly conflict with state or federal laws.  The Medical Use of Cannabis Act (MUCA), enacted in 2010, codified at RCW 69.51A.085(2), authorized patients to establish collective gardens for growing medical marijuana.  “Collective gardens” are defined by state law to include group efforts to pool resources and grow medical marijuana for patients’ own use.  The MUCA further clarified that local governments retain authority to regulate the production, processing or dispensing of medical marijuana through zoning, business, licensing, health and safety requirements, and business taxes.  RCW 69.51A.140.  Relying on this zoning authority, the City of Kent, Washington enacted an ordinance that prohibited “collective gardens” in every zoning district within the city.

In the recent case, Cannabis Action Coalition (CAC) v. City of Kent, the Washington Supreme Court was asked whether the MUCA authorization for “collective gardens” preempts the Kent ordinance banning them. A statute preempts the field and invalidates a local ordinance “if there is express legislative intent to preempt the field or if such intent is necessarily implied…from the purpose of the statute and facts and circumstances under which it was intended to operate.”  The Court found no express preemption clause, leaving the question of whether preemption is implied.  CAC argued that the express authorization allows cities to zone only commercial production and processing of marijuana and not non-commercial collective gardens.  The court rejected that argument, finding nothing in the express language that distinguished between a profit or the shared use collective garden activities.  The Court went on to find that, although state law prohibits local governments from opting out of medical marijuana altogether, the local ordinance concerned a particular land use, collective gardens, and did not address the personal use of medical marijuana.  Accordingly, the Court found that the City’s ordinance was not pre-empted.

Justice Gonzalez provided an interesting dissent explaining that, although a city may regulate consistent with the MUCA, it may not completely ban what the state permits.  The majority failed to acknowledge that participation in collective gardens is legal under state law and, as a result, Gonzalez asserts, the city may not enact regulations, zoning or not, that prohibit this lawful activity.

It is also important to note that while this appeal was pending, the legislature enacted comprehensive reform concerning the regulation of medical marijuana in Washington including repeal of the statutory provisions authorizing collective gardens.  Laws of 2015, ch. 70.  That said, this case provides an interesting commentary as the Washington Supreme Court prepares to decide whether to hear a case challenging cities’ and counties’ authority to ban licensed recreational marijuana retailers and the legislatures of both Oregon and Washington work to fashion regulations surrounding the production, processing and distribution of both medical and recreational marijuana that focus on standards controlling activities and revenue rather than land use.

During our April 10 event, “Moving Forward Under Measure 91,” in Portland, Ore., we addressed a number of complex issues regarding the developing marijuana industry. This blog series will answer questions that we may not have been able to get to during the Q&A portion of our event. Make sure to keep checking back here, or subscribe to our blog for updates!

“Is the Process of Bankruptcy Different for Marijuana Businesses?”

Some marijuana businesses and their owners have actually been denied the protection of bankruptcy in several U.S. courts. A bankruptcy trustee is an officer of the federal courts, and must uphold federal law. Because marijuana is a Schedule I drug under the federal Controlled Substances Act, some courts have deemed bankruptcy trustees unable to take possession of marijuana businesses and their assets. The trustees are therefore unable to perform their duties, and those bankruptcy cases have been dismissed. See, e.g., In re Arenas, 514 B.R. 887 (Bankr. D. Colo. 2014).

While federal bankruptcy protection may be unavailable to marijuana businesses until a change is made to federal law, it is possible that some state-level remedies will be available to insolvent marijuana businesses or their creditors. For more detailed information about marijuana businesses and bankruptcy, and recommendations for how to begin considering state-level approaches, see our article in Marijuana Venture magazine: “Marijuana business denied protection by bankruptcy court.”

On Friday, Governor Jay Inslee signed Senate Bill 5052, reshaping Washington’s medical marijuana law and largely merging commercial medical marijuana production and sale into the regulated I-502 recreational system.  This law will have a significant impact on medical marijuana providers and patients. In this brief update, however, I will highlight some of the changes that will impact current participants in the recreational marijuana market or those who wish to join the merged recreational/medical system.

Retailers and Medical Endorsements

Under the new law, medical marijuana will be sold by licensed retailers who obtain a medical marijuana endorsement from the renamed Washington State Liquor and Cannabis Board (mercifully preserving the Board’s useful acronym).  Any retailer who acquires an endorsement must carry products that are identified by the Department of Health as beneficial to medical marijuana patients and comply with what will likely be a host of additional regulations adopted by the Department and the WSLCB.

By July 1, 2016, the law will bring to an end unregulated collective gardens.  Although individual and collective growing by no more than four medical marijuana patients (or designated providers) for their own use will remain lawful (subject to WSLCB regulation), the retail sale of recreational and medical marijuana will be limited to licensed stores with medical endorsements.  Current recreational retailers will need to assess the pros and cons of serving the medical marijuana market and begin to take steps to prepare for applying for a medical marijuana endorsement.

New Retail Licenses

Under regulations to be adopted, the WSLCB will reopen the licensing process for retail stores and issue new recreational licenses to meet the needs of the medical marijuana market.  The law directs the WSLCB to increase the maximum number of retail outlets authorized to operate in each county to accommodate the needs of medical patients.  Unlike the prior I-502 lottery, however, this round of licensing will be merit-based and intended to identify retailers who have a demonstrated history of legal compliance, qualifications and experience in the marijuana industry, and familiarity with the needs of medical marijuana patients.  The specific merit factors, timing, and licensing process will be determined by WSLCB regulation and interested applicants must take measures to stay abreast of this process and react quickly.

The WSLCB will give first priority to applicants who applied for a recreational retail license in the I-502 lottery (prior to July 1, 2014), who have operated or been employed by a medical marijuana collective before January 1, 2013, who have maintained appropriate business licenses, and who have a demonstrated history of paying applicable state taxes and fees.  Second priority will be given to applicants who have operated or been employed by a medical marijuana collective before January 1, 2013, maintained business licenses, and paid state taxes and fees, but who did not previously apply for an I-502 license.  This priority structure presents an opportunity for applicants who were unsuccessful in the I-502 licensing lottery, but have a tax and business licensing compliant history in the medical marijuana industry and are willing to incorporate medical marijuana into their retail business model.

Accordingly, participants in the medical marijuana market who did not maintain a business license or pay state taxes and fees may face a challenge in entering the new medical marijuana market structure and should take steps now to ensure compliance.

Producers and Processors

The law directs the WSLCB to reconsider the size of the total production canopy to address the need for production of medical marijuana within the regulated system.  In addition, existing licensed producers may designate production space for the production of plants determined by the Department of Health to be appropriate for medical use.  The LCB is directed to increase the production space allotted to those producers.  If current producers do not claim the total increased production canopy, the WSLCB is empowered to reopen licensing for new producers who commit to grow plants destined for medical-endorsed retailers.

Regulations

One of the chief purposes of SB 5052 is to bring medical marijuana under the regulations already adopted by the WSLCB for the I-502 recreational system, including regulations requiring seed to sale tracking, testing and product safety, product packaging, retail store locations, and more.  In general, retailers selling medical marijuana under a medical endorsement will need to comply with these WSLCB rules, and be prepared to address the rapid regulatory changes that have occurred in the past year and will likely continue to occur.  In addition, the new law will establish additional areas of regulation that have not previously existed in the recreational system or that are specific to medical marijuana.  For example, the law authorizes regulations to implement a new medical authorization database and define retailers’ responsibilities for inputting information and issuing recognition cards to patients.  In addition, the Department of Health will adopt regulations addressing beneficial medical marijuana products, safe handling requirements, a new “medical marijuana consultant certificate,” and requirements for employees of medical-endorsed retailers.  Finally, the law authorizes the WSLCB to conduct controlled purchase programs to enforce the restrictions on sales to minors and authorizes licensed retailers to conduct their own in-house controlled purchase programs to monitor compliance by employees.

We’d like to thank everyone who attended our seminar, “Moving Forward Under Measure 91,” last Friday, in Portland! It was a great event, and we were even featured as part of a KGW-TV news segment.

As promised, we’ve included links to presentations by GSB attorneys, the Oregon Liquor Control Commission, League of Oregon Cities and Association of Oregon Counties. Beginning next week we will begin our blog series addressing questions that we may not have been able to get to during the Q & A. Make sure to keep checking back here, or subscribe to our blog for updates!

OVERVIEW OF MARIJUANA BUSINESS PLANNING

• Andy Aley, Garvey Schubert Barer

• Claire Hawkins, Garvey Schubert Barer

• Jared Van Kirk, Garvey Schubert Barer

• Hal Snow, Garvey Schubert Barer

CITY AND COUNTY PERSPECTIVE

• Sean O’Day, General Counsel, League of Oregon Cities

• Rob Bovett, Legal Counsel, Association of Oregon Counties

• William Kabeiseman, Garvey Schubert Barer

OREGON LIQUOR CONTROL COMMISSION

• Tom Towslee, Acting Communication Director, Marijuana Programs, Oregon Liquor Control Commission

Garvey Schubert Barer invites you to “Moving Forward Under Measure 91” a free public event, Friday, April 10, 2015 at the World Trade Center Portland.  The half-day event (8:15 a.m.–1:00 p.m.) will address the business, legal and practical implications of Measure 91 for anyone looking to do business in the marijuana industry.

Representatives from the Oregon Liquor Control Commission, Association of Oregon Counties and League of Oregon Cities, will speak about the important role city and county government plays in shaping and regulating the Oregon marijuana industry. In addition, Garvey Schubert Barer attorneys experienced in representing licensed marijuana growers, processors and retailers in Washington state will discuss general business planning needs unique to the emerging recreational marijuana industry.

Licensed marijuana and marijuana-related businesses in the U.S. face extraordinary legal challenges. Not only are these businesses burdened with challenges inherent in any new industry, but also must deal with complex and evolving state and local regulations, as well as uncertainty resulting from federal law.

Featured speakers and topics include:

• • Tom Burns, Director of Marijuana Programs, Oregon Liquor Control Commission, discussing OLCC’s anticipated and developing rules and regulations;

• • Sean O’Day, General Counsel, League of Oregon Cities, discussing cities’ perspectives and zoning issues;

• • Rob Bovett, Legal Counsel, Association of Oregon Counties, discussing counties’ perspectives and zoning issues;

• • William Kabeiseman, Garvey Schubert Barer, Discussing local perspectives and zoning issues;

• • Andy Aley, Garvey Schubert Barer, Discussing financing and operating a regulated marijuana business;

• • Claire Hawkins, Garvey Schubert Barer, Discussing intellectual property, trademarks and trade secrets;

• • Jared Van Kirk, Garvey Schubert Barer, Discussing labor and employment practices;

• • Hal Snow, Garvey Schubert Barer, Discussing asset protection planning.

Garvey Schubert Barer’s Cannabis Industry Group is part of its Regulated Industries Practice which serves businesses across a broad range of industries, including alcohol, radio and television broadcasting, government contracting, healthcare, and maritime.  The Cannabis Industry Group is comprised of attorneys experienced in finance, tax, real estate, intellectual property, employment, commercial litigation and criminal defense. This breadth of legal experience provides state-licensed marijuana businesses, and businesses serving the licensed marijuana industry, full-service representation.

The event is open to the public but space is limited. 

Despite some early grumbling from Congress threatening to block DC’s ballot initiative from becoming law (because of DC’s special status, DC ballot initiatives do not become law until they pass through a 30-day Congressional review period), with only a few hours to go, it appears that the review period has come and gone.

DC Mayor Muriel Bowser held a conference yesterday outlining the new DC law and how it would be enforced.  Under DC’s new law, anyone 21 years of age or older will be able to lawfully:

• • Possess two ounces or less of marijuana;

• • Use marijuana on private property;

• • Transfer one ounce or less of marijuana to another person, as long as (a) no money, goods or services are exchanged and (b) the recipient is 21 years of age or older; and

• • Cultivate within his or her primary residence up to six marijuana plants, no more than three of which are mature.

It will remain illegal in DC for anyone to:

• • Possess more than two ounces of marijuana;

• • Smoke or otherwise consume marijuana on public space or anywhere to which the public is invited; including restaurants, bars, coffee shops, and public housing;

• • Sell any amount of marijuana to another person; or

• • Operate a vehicle or boat under the influence of marijuana.

Some Members of Congress are upset about the new law and Representative Jason Chaffetz, Chairman of the House Committee on Oversight and Government Reform, has written to Mayor Bowser, warning her that implementation of the DC law is illegal because it would violate the federal spending bill passed at the end of last year barring federal funds from being used “to enact any law, rule, or regulation to legalize or reduce penalties associated with the possession, use or distribution” of marijuana.   Chairman Chaffetz has also launched an investigation, demanding that Mayor Bower provide his Committee with information about efforts related to DC’s enactment of the ballot initiative.