Blockchain, Cryptocurrency, Cannabis - and Taxes

"Since cryptocurrencies are decentralized and unregulated for the most part, they enable cannabis businesses to accept secure, cashless, and fast payments that can be converted into greenbacks or sent anywhere around the world at competitive speeds."*

I like to research and write about emerging technologies and trends in how we live and work. A long time ago, that is how I gov involved in tax policy and technical matters related to the Internet and e-commerce.  For almost ten years now, it has led me into interesting topics of marijuana (cannabis if that sounds better), virtual currency (or cryptocurrency), and the blockchain. And there is overlap in all of these topics.

Here is a *recent article from Made by Hemp - Utilizing Blockchain Technology in the Cannabis Industry by Alex Moskov, Editor-in-Chief of CoinCentral. He notes the benefit of greater transparency in connecting transactions and payments via blockchain technology. It can also help with payment processing.

Congress sometimes gets involved with these topics as well. Hearings usually either look at problems with marijuana and crytocurrency, but some look at the opportunities in these fields. On 2/13/19, the House Committee on Financial Services held a hearing - Challenges and Solutions: Access to Banking Services for Cannabis-Related Businesses. Legislation called The Secure and Fair Enforcement Banking Act of 2019 (SAFE banking) has been re-introduced in the 116th Congress. One of the witnesses was California State Treasurer Fiona Ma, also a CPA. She noted data on continued growth in the cannabis industry and challenges of businesses not being able have bank accounts. She also noted that she and her predecessor had engaged studies for solutions including a state-run bank. However, the conclusions reached was that "the only effective long-term solution that would produce acceptable results for the financial services sector was to change federal laws and regulations related to offering basic banking services to this growing industry."

Taxes - there are certainly many tax matters in these topics. For the cash in the cannabis industry, it makes non-reporting easier as there may not be a sufficient paper or digital trail. There are safety issues of having large piles of cash around and of taking it to the local, state and IRS offices to make tax payments.

What do you think?

Guest Post - California Cannabis Businesses Need to Prepare for Possibility of IRS Audit

I'm please to present a guest post on a hot topic by Bruce Braverman, Braverman & Epstein, APC, and David Frankel.*  They share their expertise in assisting clients operating businesses in the cannabis space.

Cannabis Tax Enforcement Comes Full Circle

The federal marijuana prohibition and enforcement program now comes full circle with front line lawfare being focused on the tax front.  History buffs may remember that the entire Cannabis prohibition started with the Marihuana Tax Act of 1937 (Pub.L. 75–238, 50 Stat. 551) which imposed a “Marihuana stamp tax” and reporting requirement.  The Marihuana Tax Act of 1937 was invalidated by the U.S. Supreme Court in Leary v. United States, 395 U.S. 6 (1969).

“The Colorado Experience”: Coming Soon to California

On January 1, 2018, California launched its own licensing of recreational cannabis businesses.  Since legalizing recreational cannabis in 2012, Colorado’s cannabis businesses have seen a sharp increase in IRS audits.   See, e.g., https://mjbizdaily.com/new-irs-audits-colorado-worry-cannabis-companies/.

The thrust of IRS audits of Colorado’s cannabis-related businesses has been two-fold:

1. Internal Revenue Code §280E (banning expense deductions by drug traffickers) 26 U.S.C. §280E, and
2. IRS Form 8300 (a form prescribed by the IRS for reporting certain cash transactions) – see 26 U.S.C. § 6050I – ‘Returns relating to cash received in trade or business, etc.’

Internal Revenue Code §280E

IRC §280E forbids businesses from deducting certain business costs associated with the trafficking of Schedule I or Schedule II controlled substances.  Because Cannabis is a Schedule I controlled substance, Cannabis-related businesses must comply with Section 280E.  ^[1]Those Cannabis businesses that claim ordinary business deductions and credits should anticipate an audit by the IRS.

The IRS’s current stance on what cannabis-related businesses are permitted to deduct is summarized in Chief Counsel Advice201504011.  It allows for cannabis businesses to deduct some of their cost of goods sold (COGS).  However, taxpayers must follow pre- section 263A guidance under Reg. 1.471-1 and 1.471-11.

The IRS memo separates cannabis businesses into resellers and producers.  For resellers, such as dispensaries, the only deductions they can claim are for the invoice price of purchased cannabis and the transportation costs necessary to gain possession of cannabis.  Producers, such as cultivators or manufacturers, are allowed to deduct “indirect production costs”, which has been construed broadly to allow for deductions of repairs; maintenance; indirect labor and supplies; and the costs of quality control.

On February 2, 2018, the IRS reaffirmed their authority to “…investigate and determine whether a business is engaged in illegal drug trafficking activity for the purposes of applying 26 USC 280E…” in a legal brief filed with the U.S. Supreme Court.

Section 280E compliance requires a taxpayer to file tax returns that do not show any ‘below-the-line’ expenses.  Allocations to ‘cost of goods’ should be precise, documented and in accordance with inventory-costing regulations under IRC Section 471 as they existed when Section 280E was enacted in 1982.  The IRS has taken the position that IRC Section 263A should not be used to determine inventory costing for Cannabis businesses (see CCA 201504011 above).

CA State 280E Treatment

California corporation tax law does not conform to IRC Section 280E.  According to a representative of the CA Franchise Tax Board, the corporation tax law does not conform to IRC Section 280E but the personal income tax law does conform to IRC Section 280E.   

Any business entity operating under the California corporation tax law (including S-corps at the corporate level, and LLCs that have elected to be treated as a corporation under the “check-the-box” rules) is not affected by IRC Section 280E. 

Any entity operating under the personal income tax law is impacted.  This includes sole proprietorships, shareholders of S-corporations, LLCs (that have not elected corporate treatment), and partnerships.

Any change to this would require legislative action. 

IRS Form 8300

IRS auditors are further focusing on Form 8300, which is the form used to report cash transactions over $10,000.  It is common knowledge in the cannabis industry that banks and other financial institutions are required to report to the IRS cash deposits over $10,000.  Form 8300 requires reporting to the IRS of identifying information about the person from whom the cash was received, the business that received the cash, the person on whose behalf the transaction was conducted, and a description of the transaction.

However, it is less commonly known that all businesses, including those engaged in the cannabis industry, that receive over $10,000 in cash for a single transaction or related transactions are required to file IRS Form 8300.   Failing to do so for each such transaction can result in substantial fines and interest owed to the IRS, as well as civil and criminal penalties.

The IRS also investigates these large cash transactions for evidence of money laundering or other drug related criminal activities that would invoke the application of §280E, as well as under reporting of income.

Here’s some helpful information concerning the risks of civil and criminal penalties related to Form 8300 -

1. Statute of Limitations for failure to file Form 8300 – 3 years
2. Failure to File – IRC 6721(a)(1) provides a $100 penalty for failure to file a timely and correct Form 8300. The annual limitation for businesses with gross receipts exceeding $5 million is $1,500,000. For businesses with gross receipts not exceeding $5 million the aggregate annual limitation is to $500,000.
3. Failure to File Intentional Disregard - IRC 6721(e)(2)(C) provides for a penalty equal to the greater of $25,000 or the amount of cash received in such transaction not to exceed $100,000 for the intentional disregard for a failure to file a timely and correct Form 8300. There is no aggregate annual limitation for intentional disregard of Form 8300.
4. Criminal Prosecution - violations of an obligation to file an IRS Form 8300 can create criminal liability.  A person required to file Form 8300 who willfully fails to file, fails to file timely, or fails to include complete and correct information is subject to criminal sanctions as a felony under IRC 7203. Sanctions include a fine up to $25,000 ($100,000 in the case of a corporation), and/or imprisonment up to five years, plus the costs of prosecution.  Any person who willfully files a Form 8300 which is false with regard to a material matter may be fined up to $100,000 ($500,000 in the case of a corporation), and/or imprisoned up to three years, plus the costs of prosecution. IRC 7206(1).

Tightening the Noose

There is an interesting interplay between the following dynamics:

•       Exclusion of Cannabis business from banking leads to practical result that Cannabis business do business primarily in cash[2]

•       Cash based businesses are required to disclose information on Form 8300 that implicates criminal liability by such businesses and their vendors for violations of the Controlled Substances Act

•        Failure to file the required information subjects such businesses and individuals related thereto to criminal liability

•       Conflict with Right Against Self-Incrimination - US 5th Amendment; CA Const. Art. I, Section 24.

In Leary v. United States, 395 U.S. 6 (1969), the Court held that the Fifth Amendment privilege against compelled self-incrimination barred a criminal prosecution for failing to notify the IRS of taxable marijuana transactions that were themselves illegal.

“Since the effect of the Act's terms were such that.… compliance with the transfer tax provisions would have required petitioner, as one not registered but obliged to obtain an order form, unmistakably to identify himself as a member of a "selective group inherently suspect of criminal activities," and thus those provisions created a "real and appreciable" hazard of incrimination within the meaning of Marchetti, Grosso, and Haynes. pp. 395 U. S. 16-18.” Leary v. United States, 395 U.S. 6 (1969) at 7.

Proposed Solution

The solution lies in de-scheduling Cannabis under the Controlled Substances Act.

What do you think?

*Author Biographies

Bruce Braverman is President of Braverman & Epstein, APC., a law firm with offices in Sacramento and Irvine, California, which provides tax law and consulting services to cannabis businesses.  Bruce Braverman is a retired California Deputy Attorney General with over thirty years of public service.   He has provided legal advice to cannabis cultivators, manufacturers, and dispensaries on state and local licensing matters over the past 5 years.

David Frankel has over 20 years’ experience representing parties in cannabis related activities.  Mr. Frankel focuses his practice on business formations, LLC and corporate transactions, startups, negotiations, contracts, venture capital, and cannabis licensing and compliance. 

---

[1] See Californians Helping to Alleviate Medical Problems, Inc., v.

Commissioner, 128 T.C. 173 (2007); Tax Court held that taxpayer trafficked in medical marijuana, which is a Schedule I controlled substance, and that §280E disallows all deductions attributable to that trade or business. Tax Court also held that §280E does not disallow the deductions attributable to the taxpayer’s separate and lawful trade or business.

[2] See Department of the Treasury Financial Crimes Enforcement Network Guidance FIN-2014-G001

Guest Post - Tax Practitioners and Marijuana Business Clients

Here is a guest post from Brett A. Podolsky, an attorney who is also a Criminal Legal Specialist certified by the Texas Board of Legal Specialization. He is the former Assistant Criminal District Attorney for the State of Texas. As a criminal defense attorney in Houston, Texas, Mr. Podolsky dedicates his entire practice to litigation. He handles a wide variety of cases, including drug charges, federal crimes, white-collar crimes, and sex crimes. Brett offers some suggestions for practitioners on what you need to know about taxation and marijuana.

Unanswered questions remain concerning whether tax practitioners, e.g. CPAs and attorneys, can aid a marijuana business entity with its tax issues, including tax planning and/or compliance, since the sale of marijuana is still considered a federal crime. Practitioners ask, “Is assisting a marijuana business an ethical violation?” as well. All businesses, including those that sell cannabis, require tax, legal, and accounting assistance. Businesses need answers regarding business structure, taxes, and future financial planning. This post addresses what business owners and advisers should know and contemplate before agreeing to take on a client engaged in the sale, production, or use of marijuana.

State Laws and Marijuana

Today, in many states and the District of Columbia, commercial entities may form under state laws to grow and/or sell cannabis. The laws are strict concerning who may grow (produce) or sell to consumers and who may purchase. Each state’s regulations, statute, and guidelines may also interact with additional laws, e.g. employment or zoning laws. All the while—and despite the fact that states’ laws allow for cannabis production, sales, and use—these actions remain crimes under the Controlled Substances Act of the federal government. Like other businesses seeking advice about the newly passed tax laws, marijuana businesses are likely to want assistance from a tax adviser as well. Certified public accountants and attorneys may be cautious about whether they wish to, or should, assist these businesses. If CPAs and attorneys decide to assist the marijuana business, they will want to ensure that their actions won’t lead to licensure or rules of conduct violations to which they’re subject.

Attorneys and Professional Conduct

The Bar Association of San Francisco (2015) issued Ethics Opinion 2015-1 to discuss whether an attorney in California may ethically represent clients engaged in a medical marijuana business. The opinion concludes that “a lawyer may ethically represent a client on the facts presented consistent with California Rule of Professional Conduct 3-210…provided that (the attorney’s) legal advice and assistance is limited to activities permissible under state law and the lawyer advises the client regarding the possible liability under federal law and other potential adverse consequences under state and federal laws.”

Marijuana Business Overview

Most states and the District of Columbia have passed laws that allow some forms of growing, selling, and using medical marijuana. 

• Eight states – Washington, Alaska, Oregon, California, Nevada, Colorado, Maine, Massachusetts, and the District of Columbia (about 21 percent of the country’s population) – allow recreational marijuana use. 
• Although most states allow medical marijuana usage, federal classification of marijuana (cannabis) remains a Schedule I controlled substance. This classification is somewhat at odds with the idea that marijuana may be safely used under medical supervision. 
• Colorado’s sales taxes, licenses, and fees from marijuana sales continue to show robust growth. Total revenues were about $67.6 M in 2014, $130.4 M in 2015, $193.6 M in 2016, and about $247.4 M in 2017 (Colorado Department of Revenue). 

The marijuana industry is a high growth industry. State taxation of marijuana businesses is widely discussed.

Marijuana Tax Revenues

Businesses selling marijuana have tax compliance issues to consider as well. When states sought to adopt cannabis legalization laws, taxation was an essential element of attracting political support. For that reason, tax rates were set high: 

• Washington (37 percent), Colorado (29 percent), Alaska (25 percent), and Oregon (25 percent) 
• The Tax Foundation reports robust growth of tax revenues in these states. 

California established a 15 percent excise tax and other states have pegged revenue rates at 10 – 25 percent. Lawmakers note that consumers have the option to travel to another state with lower marijuana tax rates. Competition in the free and open markets are likely to determine at what rates states tax marijuana businesses in the future.

Tax Reform and Marijuana

The Tax Cuts and Jobs Act (PL 115-97) was passed on December 22, 2017. It’s widely considered as the most notable overhaul of the United States Tax Code since the Reagan Administration.

IRC § 280E

Cannabis businesses must understand how these new laws affect them. The following are some of the significant tax issues cannabis businesses face now: 

• The Tax Cuts and Jobs Act didn’t repeal IRC § 280E. 
• This section prevents the cannabis producer, processor, or retailer from subtracting expenses from income (other than those deemed ‘Cost of Goods Sold’). 
• As a result, cannabis businesses must determine the expenses included in Cost of Goods Sold and identify deductible expenses. As of this writing, little guidance is available to assist taxpayers in making these determinations. 
• Note that, on audit of a California medical marijuana dispensary, the IRS used IRC § 280E to prohibit it from deducting any operating expenses (e.g. auto expenses and officers’ salaries). In other words, IRS sought to prevent the dispensary from earning a profit on the medical marijuana business. 

Tax experts theorize that IRC § 280E wasn’t repealed because it would’ve been considered a tax cut – which would’ve prompted the U.S. Congress to replace lost revenues. However, cannabis businesses will pay lower federal taxes starting this year. Tax rate decreases mitigate its effect.

Corporate Structure

In addition, cannabis businesses should consider corporate structure under the new tax law: 

• The Tax Cuts and Jobs Act make “C Corporations” more tax-favorable. 
• C corporations pay taxes at the corporate level. 
• Individual shareholders pay taxes on dividends paid by the corporation (at rates up to 20 percent). 
• In past years, double taxation discouraged C corporations. The Tax Cuts and Job Act effectively reduces this issue by lowering C corporate tax rates to 21 percent. (Tax rates on dividends are unchanged under the Act.) 
• C corporations also enjoy 1) shareholder audit protection as well as 2) more flexibility in employee benefits. 

The new tax law may disfavor certain Limited Liability Companies (LLCs) and Pass-Through entities: 

• To date, many new businesses automatically choose the limited liability company corporate structure. 
• LLCs assume a variety of forms but, commonly, income is passed through to the entity’s owner(s). Pass-through income is taxed at the owners’ or member’s individual tax rates: in some instances, the owners may see (20 percent) of the business’ income. 
• For instance, a single person in the 24 percent bracket earns net income from an “ancillary” cannabis enterprise that he runs as a sole member of an LLC. The LLC’s income is $100,000. His federal taxes from the enterprise are $19,200, or $100,000 net less $20,000 times 24 percent. 
• Take note of exceptions: Congress has framed the pass-through entity benefit in the IRS code as a deduction: IRC § 280E disallows the deduction from cannabis retailers, producers, distributors, and manufacturers. In this scenario, the cannabis business referenced above will pay taxes on its full net income.**
• In this way, the new tax law punishes cannabis businesses. 
• Although some ancillary businesses benefit from a 20 percent deduction, others (pass-through entities) see the 20 percent deduction minimized or disallowed because of many inter-related and/or complex rule exceptions.

Tax laws favor concerns committing significant capital

Generally speaking, the new tax law exceptions favor those businesses making significant capital investments, e.g. real estate, over concerns that are either labor-intensive or service-focused. For instance, many service businesses, e.g. consulting or health care concerns, don’t qualify for the new deduction (unless overall taxable income, net of several adjustments, is less than $157,500 or $315,000 for joint filers. 

However, an ancillary business, e.g. a real estate lessor, may benefit from an LLC structure.

Possible limited tax deductions for debt financing

Some investors would rather loan money to a cannabis enterprise than invest in it as an equity shareholder. Under IRC § 280E, it’s challenging for the cannabis enterprise to deduct interest expense costs. (Under old tax laws, the ancillary business could deduct 100 percent of its interest costs.) Under the Tax Cuts and Jobs Act, the total amount of interest expenses permitted for deduction can’t be a greater than interest income plus 30 percent of adjusted taxable income plus interest expenses from floor plan finance costs: Adjusted taxable income is usually taxable net (with adjustments for) expense and interest income, losses, and specific capital investments. [IRC Section 163(j)]

Fine-Tuning the Tax Cuts and Jobs Act

The new tax law passed in December 2017 became effective in 2018. It’s probable that the Internal Revenue Service will be hard-pressed to offer guidance to businesses and tax advisers. It’s also likely that the IRS will add regulations this year. If Congress seeks to fine-tune the tax bill or enact additional reforms, might IRC § 280E be repealed, or at least limited in application to state-legal marijuana operations? We'll see.

Contact a Cannabis Business Lawyer

Marijuana businesses are a robust source of tax revenues for state and local governments. Marijuana businesses must pay taxes. Most business owners want to file an accurate return and grow their business to take advantage of significant demand. However, taxes may be an especially complex task for marijuana businesses attempting to figure out their taxation obligations this year. It’s important to get legal assistance concerning your marijuana tax questions. The new cannabis industry is high-regulated at the state level and complicated for many reasons including the fact that it still involves activity illegal under federal law.


**Note from Annette Nellen (host of 21st Century Taxation blog): Brett is correct that the Section 199A Qualified Business Income provision, added by the TCJA, allows a deduction from taxable income. However, it is an odd "deduction" in that it is really a bonus deduction intended to provide some rate reduction to businesses not operating as a C corporation since C corporations got a rate reduction by the TCJA. So, this deduction is not one with a direct cash outlay. The language at Section 280E states, "No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in ..."  Query: May a marijuana business claim a deduction under Section 199A since it is not a deduction "paid or incurred"?  The provision is in Part VI on deductions (in Subchapter B of Chapter 1). But it was addeed for rate relief. If all business owners obtained rate reductions by the TCJA, even marijuana business owners would obtain that benefit. We'll see if the IRS provides any clarification on this matter.

What do you think?

Odd tax holiday in Colorado today

Several states have "sales tax holidays" where for a day or a few days specified during the year, there is no sales tax on specified items.  For example, it might be on children's clothes or school supplies close to the time when school begins. Some states have them for guns and emergency preparedness items. The Federation of Tax Administrators maintains a list of these holidays in the states.

Today, September 16, 2015, Colorado has a holiday on marijuana - but just the special 10% and 15% taxes (there are a lot of taxes on marijuana in Colorado). The reason is complicated and ties to the fact that when recreational sales became legal in Colorado and new taxes added, they raised more than allowed. HB15-1367 explains some of this (in 33 pages!).

All of this is odd and bad tax policy. For Colorado, too bad no one thought of a law modification earlier that if too much marijuana taxes were raised, it would be used to reduce other taxes or for backlog infrastructure projects, or something other than a one-day tax holiday. I'll get back to the tax issues next, but also want to note that this is also odd - isn't the state now encouraging more people to buy marijuana today due to the greatly reduced cost?  What is the purpose of that?

Tax problems include the inequity of making somethings tax exempt, but not other things. Also, everyone, regardless of need gets the tax break. For example, someone making $200,000 per year who buys school supplies for their child during a state sales tax holiday period for these items saves a few dollars of tax. Why?  If the holidays are to help low income individuals, it would be better for the state to give them gift cards for stores that sell these items (or some other way to give money for them). 

Some might be too broad. For example, what all falls under school supplies or emergency preparedness?  Time is needed by the tax agency to define the terms, if possible.  And how, for example, does the store know if someone buying paper during the holiday is doing so for school?

The compliance and administrative burdens are also high. A vendor needs to be sure it handles the holiday correctly and the state needs some way to verify that it did. 

And the effect to vendors is odd.  The holidays will cause many people to wait to buy items then causing operational challenges for stores and theirs suppliers.

What do you think?

More on marijuana businesses and tax ethics

With more states moving to allow recreational use of marijuana, we'll see more tax practitioners asked by either new or existing clients if they will help them with the accounting, tax or legal needs of their marijuana business. Despite state actions, the production, sale and use of marijuana is a crime under federal law. Thus, for licensed practitioners, there is concern about ethical violations of helping someone commit a crime.

I've got an updated article on this topic in the Massachusetts Society of CPA's Spring 2015 journal - here.  Also, more here.

I'd like to see states be more specific with these laws so far as helping attorneys and CPAs.  For example, why not add a law to specify that an attorney or CPA licensed in the state will not face any disciplinary action for assisting a marijuana client as long as done in the same manner that the practitioner serves other clients.

While it seems that the keepers/enforcers of these rules of conduct are not pursing disciplinary actions, it would still be good to have that explicit in the state statute.

What do you think?

Taxable income of a marijuana business

Despite marijuana operations at the state level being legal at the state level since 1996 in California (and now many states), tax guidance has been sparse.  A recent, non-binding Chief Counsel Advice memo sheds some light on how the UNICAP rules apply (or don't apply), but more is needed.

I've got a short article in the AICPA Tax Insider today about the CCA and its meaning - here.

A few more observations beyond the article: While the CCA basically says that the UNICAP rules do not allow a seller of a controlled substance, such as marijuana, to treat more costs as inventoriable, there seems to still be some leeway for a producer. Producers have been subject to the Reg. 1.471-11 full absorption rules since before UNICAP. These rules require treating direct materials and labor as inventoriable and then specify how to deal with indirect costs, which the regulation separates into three categories:

1. Production - expenses that are clearly part of inventory.
2. Selling - expenses that are clearly not part of production
3. Other - treat the same as you treat for books.

So, it seems that if for books, the producer leans towards treating costs as production-related, if justified and clearly not a category 2 cost, it does the same for tax and gets a better result than would a producer who treats category 3 as mostly non-production costs.  Is this the intended application of the Section 280E rule? 

If you are not familiar with Section 280E, read the article - it also has links to the tax rules cited above.

What do you think?


Photo from http://www.nlm.nih.gov/medlineplus/marijuana.html.

Marijuana businesses and ethical issues for tax practitioners

From Department of Justice website.

In a post on 1/12/14, I noted the significant tax dollars that Colorado was to generate from legalizing recreational use of marijuana. I also noted that for tax practitioners who assist these businesses (as well as those selling in other states for medicinal use), there are tax law issues (such as IRC Section 280E) and ethical considerations given that growing, cultivating, distributing and using marijuana is still a federal crime. CPAs and attorneys need to consider the rules of conduct applicable in their state.

I have a 4-page article on this topic in the Tax Talk feature of the Federal Bar's July 2014 The Federal Lawyer. It is entitled, "Ethical Considerations When Your Potential Tax Client is a Marijuana Business." [the FBA link is down, contact me and I'll send you a copy of the article (Annette.nellen@sjsu.edu); I've also got an outline on this topic] I explain the issues CPAs and attorneys face in helping these business and why, as well as some suggestions for steps to take to perhaps minimize the exposure.

This is an area in need of guidance. These businesses and non-profit entities need competent tax assistance to deal with complicated federal income tax rules, as well as sales and excise taxes that can apply at the state and local levels.  An excellent step for states that allow any use of marijuana, is to enact legislation worded something along the lines of the following.

"An attorney or CPA licensed in this state will not face disciplinary action when assisting a marijuana business in this state where the practitioner reasonably believes the business or operator is acting within state law. An attorney will likewise not face any disciplinary action in assisting a marijuana operation in this state to become compliant with the state laws or to review whether the operation is in compliance."

The ABA and AICPA and state bar and CPA associations can help by including similar statements in their rules of conduct.

What do you think? 

And ... There are a variety of issues surrounding changes in state laws to allow for either medicinal or recreational use of marijuana. Recently, someone shared with me an article from a public policy professor at UCLA on issues that might arise with a patchwork of state laws and no federal intervention. See "How to Avoid 'Dumb" Marijuana Legalization." Looks like there are a variety of reasons for a federal dialogue on this topic.

Marijuana and the Tax Law

It's unlikely anyone missed the news stories about marijuana sales becoming legal in Colorado on 1/1/14. The Huffington Post reported on 1/8/14  that sales in the first week were about $5 million. That also generated a lot of tax revenue for the state because Proposition AA* that Colorado voters passed in November 2013 allows for a 15% excise tax when unprocessed retail marijuana is sold by a cultivation facility to a retailer AND a 10% sales tax (on top of the normal Colorado sales tax of 2.9%) when the retailer sells the marijuana. That proposition suggested that $70 million would be generated annually with the first $40 million to be used for public school capital construction. Additional revenues would be used to enforce regulations on the retail marijuana industry and the balance for other needs (apparently at the discretion of the legislators).

Recent guidance from the Colorado Department of Revenue (Sales 93) notes that there is a Retail Marijuana Sales Tax Return. Also, there is apparently just one possible exemption, described in "Sales 93" as follows:

"Medical marijuana is exempt from state sales tax for patients that are issued a registry card that has a tax-exempt status notation from the Colorado Department of Public Health and Environment (CDPHE). A person qualifies for the tax-exempt status if, depending on the number of people in the patient's family, their income is below a certain level. The tax-exempt patient must provide the tax-exempt registry card to the retailer at the time of purchase in order to be exempt from sales tax."  [This appears to be something new because a 2009 opinion from the Colorado Attorney General said it was subject to sales tax.] "Excise 23" explains the 15% excise tax. Medical marijuana is not subject to this tax.

Some observations:

• These are high sales tax rates on top of the normal sales tax. Depending on what additional costs the state incurs from the sales, it seems to be a significant source of revenue. A 1/9/14 story in the Wall Street Journal - "Pot Legalization Crimps Funding of Drug Task Forces," notes that states that legalize marijuana lose funding because some of the seized assets are used by law enforcement.
• Are there other items consumers are willing to pay an additional 10% sales tax on?  Perhaps the Colorado state sales tax of 2.9% is too low?
• Registry card - This card used by a low income patient to obtain a sales tax exemption on medical marijuana is interesting. Generally, it is difficult to target sales tax relief because a vendor doesn't know if a person is low-income and eligible for tax relief. This is why states typically deliver sales tax relief in overbroad ways, such as by exempting food purchases. Such broad exemptions provide significant relief to high income taxpayers who spend more on food than do lower-income individuals, and likely don't need a sales tax break. Perhaps this approach works for medicinal marijuana sales as other documentation might exist and these sales are far fewer than food.  I think the system would not work for other types of sales, such as food, due to possible abuse and added administrative costs. I think that food should be subject to sales tax with relief provided to low-income individuals via a refundable income tax credit.
• Income taxes - Since 1982, federal income tax law has denied operating deductions for a business of selling controlled substances (IRC Section 280E). The business can subtract cost of sales from its revenues, but not operating expenses such as utilities. While most businesses aim to treat expenditures as period costs rather than inventory costs, marijuana retailers would be incentivized to treat as many expenditures as possible as inventory costs so they can include them in cost of sales under the IRC Section 263A ("unicap") rules. [For more on this topic, see (1) IRC Section 280E, (2) Olive, 139 TC No. 2 (2012), and (3) "Federal Income Taxation of Medical Marijuana Businesses," by Professor Roche at the University of Denver law school, August 2013.]
  
  Query: Do the states that have legalized marijuana sales conform to this federal rule?
  
  Query: Will federal legislation pass to change 280E, such as H.R. 2240 that would make IRC 280E non-applicable in a state where sale of marijuana is legal? A problem with such legislation is that it would cause federal law to not treat all federal offenses the same given that the marijuana is a controlled substance under federal law.
  
  Query: How much will federal and Colorado income tax revenues increase due to sales by Colorado marijuana retailers?
• Practitioners - There seems to be an open question of whether a tax practitioner (particularly a licensed CPA or attorney) can assist a marijuana retailer with their tax compliance and planning, given that it is an illegal business, at least under federal law. Is there any ethical violation?

What do you think?

*For more on Prop AA, see Ballotpedia and Project Vote Smart.