The document discusses the legal and tax issues faced by businesses operating in the cannabis industry. Despite some states legalizing marijuana, it remains illegal under federal law. This creates challenges for such businesses in obtaining banking services and deducting business expenses when filing taxes. The IRS uses Section 280E to deny deductions for marijuana businesses. Recent cases and IRS guidance are discussed but provide no clear solution, leaving businesses at risk of penalties or higher tax burdens. The document also provides examples of representation opportunities that could arise involving a marijuana dispensary and delivery business under audit.

1. Smoking Out the Money:
Current Tax Issues Related to
Medical Cannabis
Wednesday, June 17, 2015
William E. Taggart, Jr.
William E. Taggart, Jr. P.C.
Josh P. Davis
William E. Taggart, Jr. P.C.

2. The Risks in Providing Financial Services
to the Marijuana Industry
Under the Controlled Substances Act (“CSA”), it is
illegal under federal law to manufacture, distribute,
or dispense marijuana.
There are many states that impose and enforce
similar laws.

3. Financial Services and
the Marijuana Industry
• Despite more and more states passing laws that legalize
marijuana in various forms, the federal government still
lists marijuana as a Schedule I controlled substance
under the CSA
• As such, financial institutions who provide services to
marijuana-related businesses face pressure from federal
agencies.

4. The Cole Memorandum
• On August 29, 2013, Deputy Attorney General James Cole issued a
memorandum to all United States Attorneys providing updated guidance on
marijuana enforcement and priorties under the CSA.
• Outside of the below enforcement priorities, the federal government has
traditionally relied on states and local law enforcement agencies to address
marijuana activity through enforcement of their own narcotics laws.
• The Enforcement Priorities include:
• Preventing the distribution of marijuana to minors;
• Preventing revenue from the sale of marijuana from going to criminal enterprises, gangs, and cartels;
• Preventing the diversion of marijuana from states where it is legal under state law in some form to
other states;
• Preventing state-authorized marijuana activity from being used as a cover or pretext for the trafficking
of other illegal drugs or other illegal activity;
• Preventing violence and the use of firearms in the cultivation and distribution of marijuana;
• Preventing drugged driving and the exacerbation of other adverse public health consequences
associated with marijuana use;
• Preventing the growing of marijuana on public lands and the attendant public safety and
environmental dangers posed by marijuana production on public lands; and
• Preventing marijuana possession or use on federal property.

5. The Risks in Providing Financial Services
to the Marijuana Industry
• Following the August 29, 2013 Memorandum, the Financial Crimes
Enforcement Network (“FinCEN”) issued guidance to clarify Bank
Secrecy Act (“BSA”) expectations for financial institutions that elect
to provide financial services to marijuana-related businesses.
• The purpose of the FinCEN guidance is to facilitate marijuana-
related businesses’ access to financial services, while ensuring that
the activity is transparent and the funds are going into regulated
financial institutions.
• Notwithstanding the FinCEN guidance, financial institutions remain
at risk for money laundering, unlicensed money transmitting, and
BSA offenses based on participation in violations of the CSA
through the provision of financial services to marijuana-related
businesses.

6. The Risks in Providing Financial Services
to the Marijuana Industry
• Processing money from marijuana sales puts federally
insured banks at risk of drug racketeering charges.
• Because of the threat of criminal prosecution, most
financial institutions decline to allow marijuana-related
businesses to open accounts.
• The bulk of the FinCEN guidance is devoted to the
handling of cash on which the marijuana business has
almost exclusively relied until quite recently.
• A business operating on a cash-only basis is a
prescription for tax evasion problems.

7. FinCEN Risk Assessment
• FinCEN stated that as part of its customer due diligence,
a financial institution should consider whether a
marijuana-related business implicates one of the Cole
Memorandum priorities or violates state law.
• A financial institution that declines to provide financial
services to a marijuana-related business is also required
to file Suspicious Activity Reports (SARs).
• As a consequence of the burden and risks associated
with the FinCEN guidance, most banks continue to
decline to knowingly handle marijuana related
businesses.

8. Filing Suspicious Activity Reports on
Marijuana-Related Businesses
• The obligation to file a SAR is not affected by any state
law that legalizes marijuana-related activity.
• A financial institution must file a SAR if it knows,
suspects, or has reason to suspect that a transaction
conducted or attempted by, at, or through it:
 Involves funds derived from illegal activity or is an
attempt to disguise funds derived from illegal activity;
 Is designed to evade BSA regulations; or
 Lacks a business or apparent lawful purpose.

9. “Marijuana Limited” SAR Filings
If it is reasonably believed that a financial transaction does
not implicate one of the Cole Memo priorities or violate
state law, the memorandum directs the financial institution
to file a “MARIJUANA LIMITED” SAR that contains:
Identifying information of the subject and related parties;
Addresses of the subject and related parties;
The fact that the institution is filing the SAR solely
because the subject is engaged in a marijuana-related
business; and
The fact that no additional suspicious activity has been
identified.

10. FedEx Indictment
• Most marijuana related businesses in California appear
to have established banking relationships, but consider:
• In July 2014, a San Francisco federal grand jury indicted
FedEx with conspiracies to traffic in controlled
substances and misbranded prescription drugs for its
role in distributing them for illegal Internet pharmacies.
• In August 2014, DOJ added additional charges, including
conspiracy to launder money.

11. FedEx Indictment
• The case is a key test for how much legal responsibility
delivery companies bear for the contents of the
packages they deliver.
• If FedEx is found guilty, the U.S. Attorney’s Office says
FedEx faces a potential maximum fine of twice the
revenues it made on the business, or about $1.6 billion.

12. Marijuana Delivery Services
• A flourishing & unregulated industry of marijuana
delivery services is circumventing state bans on
storefront dispensaries and bringing medical marijuana
directly to people’s homes.
• Delivery services in Colorado and Washington, which
have legalized recreational marijuana, remain illegal -
both states specifically require in-person purchases.
• In Colorado, some delivery services have tried to get
around that law by requesting donations for deliveries,
because giving away marijuana is allowed. As many of
you may be aware this is a fiction that has been utilized
in California since 1996.

13. Deducting Illegal Payments
• Although the sale of medical marijuana is now legal in 23
states and DC, the IRS is applying the provisions of
Section 280E to businesses operating in the medical
marijuana industry to deny otherwise valid business
deductions.
• Section 280E is at the center of the conflict between
federal and state laws with respect to medical marijuana,
which is a controlled substance within the meaning of
Schedules I and II of the Controlled Substances Act.

14. Deducting Illegal Payments
• Congress added Section 280E to the IRC in response to
a decision allowing a drug dealer to deduct business
expenses.
• 280E provides that sellers of controlled substances must
pay taxes on their gross revenue instead of their net
income - producing much higher taxes - presumably
acceptable when applied only to drug dealers.
• 280E applies to state-sanctioned marijuana sellers as
well as illegal drug dealers. 280E creates a disincentive
for legitimate marijuana sellers.

15. Deducting Illegal Payments
• The two most significant cases in this area arose in
California.
• Both involve the business of providing medical marijuana
legally to patrons under the California Compassionate
Use Act of 1996 (CCUA). In both cases, the IRS used
Section 280E to deny deductions for otherwise legitimate
business expenses.

16. Californians Helping to Alleviate Medical
Problems, Inc. v. Commissioner (CHAMP)
• Section 280E does not preclude deduction of expenses
attributable to a trade or business other than that of
illegal trafficking in controlled substances simply
because the business was also involved in the trafficking
of controlled substances.
• The Tax Court found that CHAMP was involved in both
providing caregiving services & dispensing medical
marijuana, two separate & distinct businesses.
• CHAMP permitted deductions for expenses of providing
caregiving services, where the services stood on their
own merits.

17. Martin Olive v. Commissioner
• Section 280E precluded Martin Olive from deducting any
of his claimed business expenses.
• Determinations: all revenue came from the sale of
marijuana. A second business did not exist simply
because patrons also were provided with snacks, a
massage, or a movie, etc.
• Currently on appeal in the Ninth Circuit. Oral Argument
occurred in April of 2015, however no Opinion has been
issued yet.

18. CHAMP and Olive
• Both CHAMP and Olive allowed Cost of Goods Sold to
reduce gross revenue from sales to determine gross
income.
• CHAMP authorized the deduction of expenses relating to
health counseling activities, but not the expenses relating
to trafficking in a controlled substance.
• Olive should be viewed as an affirmation of the
allowance of Cost of Goods Sold, a failure of proof with
respect to a separate health counseling business
activity, and as a complete failure of proof relating to
business expenses.

19. 2015 Developments
in the Cannabis Industry

20. Office of Chief Counsel (IRS) Memorandum
• On January 23, 2015, the Office of the Chief Counsel
issued advice specifically addressing 280E to IRS
counsel lawyers throughout the United States.
• 2 Major issues
– 1. Requires the maintenance of inventory / requires
the capitalization of all costs of production of medical
cannabis products.
– 2. Treats all other costs that are not capitalized as
trafficking expenses – non-deductible under 280E.
• This CCA memorandum allows IRS lawyers to require
taxpayers to correct their accounting methods which
creates greater deficiencies.

21. June 9, 2015 Memorandum
• On June 9, 2015, the IRS issued an internal
memorandum approving the waiver or
abatement of the 10% penalty for the failure to
pay specified federal taxes by Electronic Funds
Transfer (EFT).
• This memorandum was in reaction to the
Allgreens case which arose in Colorado.
• This is not a solution as the burden will remain
on the taxpayer to prove a good cause defense
based on the inability to secure banking
services.

22. Representation Opportunities
in the Cannabis Industry

23. Vertically Integrated Dispensary
• A medical cannabis business (“Safe Harbor”) operates
as a vertically integrated indoor grow and dispensary in
San Pedro, California. A and B are partners in the
business.

24. Vertically Integrated Dispensary
• Safe Harbor was accurately denominated a “not-for-
profit” organization. Following generally accepted
record-keeping practices, Safe Harbor conducts its
business as follows:
 Allocates substantially all its costs to Cost of Goods
Sold;
 Provides health related classes and counseling to its
members to which it allocates most of its floor space and
a majority of its payroll; and
 Maintains detailed records of its cash expenditures for
bulk purchases of product.

25. Vertically Integrated Dispensary
• However, CPA has advised the owners of Safe Harbor
that the IRS has selected the most recent income tax
return of Safe Harbor for audit.

26. Internet Distribution of Medical Cannabis
• Before the owners of Safe Harbor were notified of the
IRS audit, the owners of Safe Harbor were approached
by two friends - E and F - with an idea for expanding on
the success of Safe Harbor.

27. Internet Distribution of Medical Cannabis
• E and F decided to build on the name and success of
Safe Harbor to create Safe Harbor Delivers, a state-wide
“virtual dispensary” that guarantees 24-hour delivery of
Safe Harbor’s medical cannabis products anywhere in
California.

28. Internet Distribution of Medical Cannabis
• The small dark cloud, however, has been extended to
Safe Harbor Delivers.
• CPA has advised the owners that the IRS auditor has
expanded the audit of Safe Harbor to include the prior
and subsequent year and has asked for copies of all of
the bank statements for the Safe Harbor dispensary as
well as of its owners and of any other businesses in
which the owners have interests.