At first pass, the sexiest aspect of the marijuana industry is probably 3-foot-tall plants that grow psychoactive flowers. But it gets hotter (not): wonky tax code experts who are fighting the federal government over an obscure tax code that is crippling small businesses across the legal industry.
The Internal Revenue Service has written specific rules for every profession and activity, legal and illegal. For political bribes, see tax code 162(c) and for trafficking illegal drugs see tax code 280e. Legal marijuana businesses have to pay taxes under the same category of illegal drug traffickers because cannabis is still a federally illegal drug and is categorized as a Schedule I substance under the Controlled Substances Act.
But there are tax attorneys and accountants waging battle against these rules, and they may just be the industry’s biggest allies. They include attorney Henry Wykowski of Wykowski & Associates, attorney James Thorburn of Thorburn Walker LLC, and Hank Levy, a CPA of the Henry Levy Group in Oakland, California, who have been serving marijuana businesses and representing marijuana entrepreneurs in court battling the IRS to change tax code 280e.
If you’re unfamiliar with tax code 280e, you probably are not in the marijuana industry. Marijuana businesses that are operating legally under state licenses across 25 states and Washington, D.C., pay effective tax rates of 70 percent under the tax code. Under 280e, entrepreneurs can deduct costs associated with growing the plant, but nothing related to the retail business. (Some businesses, due to poor financial structuring, pay tax rates of 100 percent or more on their profits, Levy explains.) While the marijuana industry has accomplished a lot by reforming state laws, the road to profitability and sustainability is still far away and requires changing federal law, which has been resilient to the legalization movement.
During a panel on taxes at the National Cannabis Industry Association business summit and expo in Oakland last week, Wykowski, Thorburn, and Levy said that marijuana businesses might want to just pay their high taxes and continue with their business, but more companies need to stand up against the IRS. Currently, Wykowski is representing Harborside, one of the nation’s largest dispensaries, in its current battle with the IRS to get 280e repealed.
“We have to fight back by taking more and more of these cases to trial,” says Wykowski. “If we are not going to get the concession from the IRS, we’re going to get them from the tax court. Every trial we’ve done for cannabis companies, the judges ask the U.S. attorneys prosecuting the cases, ’Don't you guys read the paper? Why is the government spending our money arguing these cases?’ ”
One of Wykowski’s biggest wins in the battle between the IRS and the cannabis industry was the tax court case of Californians Helping to Alleviate Medical Problems Inc. v. The Commissioner in 2007. CHAMP, a medical marijuana dispensary, was on the hook for a tax deficit, but Wykowski successfully convinced the court to allow medical marijuana companies to deduct expenses that could reasonably be separated from the trafficking of marijuana (CHAMPS offered caregiving services, education, and support for patients in addition to selling marijuana). This win set an important precedent: Marijuana businesses can now differentiate the cannabis retail, production, and manufacturing aspects of their business from the (federally) lawful business aspects of the company and claim deductions attributable to the taxpayer’s separate and lawful trade or business.
Wykowski says that cannabis companies want to be structured as corporations and create separate businesses to handle cannabis and another corporation to handle everything else, this way one business can deduct employee salaries, rent, and other normal business costs.
“We are getting a lot of support, but it’s only coming if we fight for it,” says Wykowski. “It's better to go down fighting for something you believe in instead of giving in.”
Earlier this month, Harborside Health Center spent a week in tax court over a $2.4 million bill from the IRS. Harborside has been filing taxes with deductions open to regular businesses, but the IRS is saying Harborside, which is owned by activist-entrepreneur Steve DeAngelo, cannot take normal business deductions. Wykowski, who is the lead attorney, believes the Harborside case will be able to overturn the IRS bill.
During the tax panel at NCIA, Wykowski said that 280e was created to prevent drug dealers from pulling one over the government and writing off their yachts. Today, as 25 states and Washington, D.C., have some form of legal marijuana and state-licensed businesses like Harborside have helped reduce the black market and crime associated with prohibition, the IRS is ignoring Congress’ intent with 280e. “280e was meant for drug dealers,” says Wykowski, not for legal and legitimate businesses bringing jobs to the community.
Tax code 280e was created in 1982 after Jeffrey Edmondson, a Minneapolis-based man who dealt amphetamines, cocaine, and marijuana, won a lawsuit against the IRS to claim business expenses.
During the taxable year of 1974, Edmondson received 1.1 million amphetamine pills, 100 pounds of marijuana, and 13 ounces of cocaine from a supplier on consignment. Edmondson reported on his 1974 return that his cost of goods sold for these products was $105,300, itemizing deductions, which included a couple thousand miles he put on his automobile, the cost of a scale to weigh his product, packaging costs, a couple hundred dollars in long-distance and local business calls, and a portion of his rent for his home office.
The court decided that he was entitled to “both ordinary and necessary” business expenses in 1981. The next year, however, Congress passed tax code 280e, banning businesses that trafficked Schedule I or Schedule II substances from taking business expenses besides the cost of goods sold.
State-legal cannabis businesses are only allowed to deduct the cost of goods sold on their taxes and after the CHAMP case in 2007, cannabis businesses have been able to make deductions on their noncannabis business activities. Cannabis companies are also allowed to use section 263A of the Internal Revenue Code, which allows businesses to capitalize on indirect costs like inventory and administrative costs, and state excise taxes to be deducted under cost of goods sold.
All of this helps, but Wykowski, Levy and Thorburn know they still need to fight.
“We’re winning the war, but the federal government is still trying to win battles,” says Thorburn. “They are still using the tax code to destroy companies.”
Thorburn explained that his partner Richard Walker was lobbying in Washington, D.C., with NCIA to meet with a few members of Congress last week and learned something infuriating:
“What Walker was told was that if there could be a secret vote where Congress didn’t have to reveal who voted which way, that marijuana would be de-scheduled today and 280e would go away,” says Thorburn. “The problem is that a number of the states where marijuana is still illegal, they cannot get those members of Congress to support it publicly.”
So how do Wykowski, Levy, and Thorburn suggest entrepreneurs can help repeal 280e?
“The bottom line is this: If you want 280e to go away, we need the states where cannabis is still illegal to legalize it,” says Thorburn. “That way the people of Congress will be willing to vote to de-schedule and get rid of 280e and institute banking.”