by Levy Barr Group, LLP

With all the recent publicity about audits by the Internal Revenue Service (IRS), we are getting many calls regarding the fear that all expenses of medical cannabis dispensaries and cultivators may be disallowed. We want to reassure everyone that we feel this fear is not warranted.

First, it is well established by a Senate Committee, the United States Court of Appeals and the U.S. Tax Court (many times) that at least Cost of the Goods Sold are certainly allowable as a deductible expense against the gross receipts.

Second, the definitions of Cost of Goods Sold from both an accounting and tax viewpoints is relatively complex, and includes the allocation of many indirect costs as well.  Therefore, what becomes deductible will likely be decided case-by-case.  For every single one of our clients, we have presented some non-deductible expenses based on specific analyses based on their specific situations.  Of our hundreds of clients, no one yet is being audited on this issue.

Third, many dispensaries which are being audited – all of whom are not our clients – have had returns prepared which have not attempted to present any expenses which are non-deductible.  We feel these clients have tax preparers who are either unaware of the law, or who are simply choosing to ignore its implications.  At this time, as long as the law exists, we feel this is an unreasonable position and is likely to draw attention by the IRS.

Fourth, read what our friend, Henry Wykowski has told the press last week regarding his representation of clients.

Fifth, please be aware that some dispensary operators who are being audited may be using their audit in a political way, in order to more dramatically make the point of the Federal government’s opposition to the legal nature of medical marijuana.  In our opinion, this is a legitimate position, but out of context it is creating undue anxiety.

Sixth, be aware that some of the recent news about taxes is about Sales Taxes, not Income Taxes. In this regard, we feel that some dispensaries have consciously decided that sales taxes in California should not be paid, and are therefore not paying or collecting them. We feel this position is not reasonable.

Seventh—and this is the most important thing—YOU MUST KEEP GOOD RECORDS.  If there is anything to be concerned about, we feel this is it.  We will be communicating with all of our clients and friends as soon as our busy tax season is over regarding what policies and procedures we feel you should have to help you through an audit, if it should come.

In the meantime, please feel free to reach out to any of us.

Contacts:

Hank Levy, hank@hanklevycpa.com

Anthony Barr, anthony@hanklevycpa.com

Carrie Sheret, carrie@hanklevycpa.com

The sections of the Health and Safety Code listed include sanctions for possession (11357), cultivation (11358), possession for sale (11359), transportation or furnishing marijuana (11360), maintaining a location for unlawfully selling, giving away, or using controlled substances (11366), managing a location for the storage or distribution of any controlled substance for sale (11366.5), and nuisance caused by selling, storing, manufacturing, and distributing a controlled substance (11570).

In People v. Urziceanu (2005), the California Court of Appeal said that this section of the MMPA “indicates it contemplates the formation and operation of medicinal marijuana cooperatives that would receive reimbursement for marijuana and the services provided in conjunction with the provision of that marijuana.”

But is this the same thing as selling?

Los Angeles City Atty. Carmen Trutanich has said that state law authorizes collectives only to grow marijuana and recover their actual costs, not to sell it.

This sounds like splitting hairs to me – what is the difference between selling and recovering costs when it is clear in the MMPA that this all needs to be done without profit?

One thing that further muddies the water is that the Attorney General’s medical marijuana guidelines seem to urge collectives to pay sales tax.  But if they are not selling and just recovering their costs, why do they have to pay sales tax?  This puts collectives in a difficult position – if they pay sales tax, are they admitting they are selling which is not clearly legal?  And if they don’t pay sales tax, will the Board of Equalization come after them?

One possible solution is to pay sales tax but submit a letter to the BOE stating that the collective is paying under protest because it does not believe that a collective set up by patients to share marijuana is selling anything.

“It will not be a priority to use federal resources to prosecute patients with serious illnesses or their caregivers who are complying with state laws on medical marijuana, but we will not tolerate drug traffickers who hide behind claims of compliance with state law to mask activities that are clearly illegal,” Holder said. “This balanced policy formalizes a sensible approach that the Department has been following since January: effectively focus our resources on serious drug traffickers while taking into account state and local laws.”

To see the complete memorandum that was issued to provide “clarification and guidance to federal prosecutors,” click here.

In related news, in spite of the federal attorney general’s pledge not to prosecute state law compliant medical marijuana dispensaries, there have been several recent raids in California and Washington.  Follow this link to a New York Times Magazine article about the difficulties caused by the conflict between state and federal medical marijuana law.

A “primary caregiver” is defined as “the individual designated by the [patient] who has consistently assumed responsibility for the housing, health, or safety of that person.”

The initiative also provides that “no physician in this state shall be punished, or denied any right or privilege, for having recommended marijuana to a patient for medical purposes.”

(Note that Proposition 215 does not protect patients and their caregivers from federal prosecution for possession and cultivation, though there has been some indication that Attorney General Holder has made such prosecutions a low priority.)

Proposition 215 did not address how patients are to obtain marijuana, other than cultivating it themselves.  Proposition 215 does not exempt patients from prosecution for purchasing marijuana.

Recognizing that it is not practical to expect each patient to grow his or her own marijuana and to address various other concerns, the California legislature adopted Senate Bill 420 (the Medical Marijuana Program Act) in 2003 to provide further guidance.

SB 420 contains the following provision: “Qualified patients . . . and the designated primary caregivers of qualified patients . . . who associate within the State of California in order collectively or cooperatively to cultivate marijuana for medical purposes, shall not solely on the basis of that fact be subject to state criminal sanctions.”

(A qualified patient is a person whose physician has recommended the use of marijuana to treat a serious illness.)

In August 2008, the California Attorney General issued additional guidelines.

The following are some guidelines for the formation of a cooperative or collective to cultivate medical marijuana.  Of course, this post does not include all of the information needed to form a cooperative or collective — it is advisable to consult with an attorney or expert.

Forming a Cooperative or Collective in California

Katovich Law Group has worked with many clients to form California cooperatives.  Our cooperative clients include a self-help bike repair workshop, a software developer, a biofuel provider, a group of IT consultants, a group of small businesses conducting a “shop local” campaign, a solar energy business, a grocery store, and a web developer.

While any business can operate cooperatively and democratically, in California, if a business wants to use the word “cooperative” in its name, it must form under one of the cooperative statutes.  California has statutes for electrical cooperatives, housing cooperatives, and agricultural cooperatives.  Any cooperative that does not fall into one of these categories can form under the California Consumer Cooperative Statute.  Despite its title, this statute can be used by any kind of cooperative.

A group of medical marijuana patients and their caregivers can form a cooperative under the consumer cooperative statute or the agricultural cooperative statute to cultivate marijuana.

The Medical Marijuana Program Act exempts from prosecution patients and caregivers that “collectively or cooperatively . . . cultivate marijuana for medical purposes.”  This seems to imply that a group of patients could choose to form something other than a statutory cooperative — something called a “collective.”  Unfortunately the word “collective” is not defined.

This language has been interpreted by some to mean that patients could form any type of entity they wish as long as it is operated collectively and meets the other requirements of medical marijuana law.  Unfortunately, the law and guidelines are not clear on this subject.  Some patient/caregiver groups have chosen to form a “collective” under the California Nonprofit Mutual Benefit Corporation Statute.  Forming under this statute has the benefit of qualifying the organization to receive exemption from state income tax.

While forming as a nonprofit mutual benefit corporation is not specifically authorized in the law or guidelines, a handout prepared by the California Secretary of State distributed at a meeting of the Nonprofit Organizations Committee of the State Bar states that an association of medical marijuana patients and caregivers can form as a consumer cooperative, an agricultural cooperative, or a mutual benefit corporation.

While patients and their caregivers may form a cooperative or collective, the entity itself cannot cultivate marijuana.  Only patients and their caregivers are exempt from prosecution for cultivation — the entity that they form is NOT exempt.  Therefore, individual members of the cooperative (note that only patients and their caregivers can be members) may cultivate marijuana and the cooperative may facilitate transactions between the members so that those members that cannot cultivate marijuana themselves can receive marijuana from those members that can.  In practical terms, this means that the cooperative should not hire employees or contractors who are not members of the cooperative to cultivate marijuana.

As the Attorney General puts it, “the cycle should be a closed circuit of marijuana cultivation and consumption with no purchases or sales to or from non-members.”

Additional requirements include the following:

• The cooperative shall not transact any business with non-members.
• The cooperative may not be operated for a profit (“Any monetary reimbursement that members provide to the collective or cooperative should only be an amount necessary to cover overhead costs and operating expenses . . . .  Marijuana grown at a collective or cooperative for medical purposes may be allocated based on fees that are reasonably calculated to cover overhead costs and operating expenses.”)
• Any sales conducted through the cooperative are subject to sales tax.
• Sellers of marijuana must have a state seller’s permit.
• “Collectives and cooperatives should provide adequate security to ensure that patients are safe and that the surrounding homes or businesses are not negatively impacted by nuisance activity such as loitering and crime.  Further, to maintain security, prevent fraud, and deter robberies, collectives and cooperatives should keep accurate records and follow accepted cash handling practices.”
• Cities and counties may require a business license.