10.0 CLE Hours, Including 2.0 Ethics Hours in Missouri 10.0 CLE Hours, including 2.0 Ethics in Kansas

2300 Main Street, St. 100 ■ KC, MO 64108 ■ phone 816-474-4322 ■ fax 816-474-0103

46th Annual Bench-Bar & Boardroom Conference

Thursday, May 16, 2018

12:50 – 1:40 PM

Legal Issues Unique to Medical

Marijuana, CBD Oil and Cultivation of Cannabis

Jennifer R. Johnson, Hinkle Law Firm LLC Ms. Johnson practices in litigation and risk management, with a focus on commercial disputes, including construction and employment matters. She also assists clients with risk management strategies, advising clients on best practices to avoid claims, handling claims after they are asserted, and ensuring clients use best practices to put themselves in the most favorable position available if it becomes necessary to defend a lawsuit. Ms. Johnson also has extensive experience in matters involving internet defamation, including litigation involving application of Anti-SLAPP legislation like Kansas’ Public Speech Protection Act. Practicing in the Kansas City area, Ms. Johnson also assists clients in the emerging cannabis industry, and advises businesses working with cannabis industry participants related to unique issues that develop in the context of providing ancillary services to cannabis industries operating in compliance with state law. Ms. Johnson also provides advice to employers as to best practices, including modification of policies and procedures to address patients who are qualified patients under Missouri’s medical cannabis law. Jennifer’s litigation experience is diverse, and includes the defense of claims made pursuant to federal and state employment laws and regulations; prosecuting and defending claims for breach of contract; defending claims for violation of consumer protection statutes; prosecuting and defending claims for misappropriation of trade secrets and/or breach of fiduciary duty; and defending premises liability, construction defect, product liability, and professional liability claims. Jennifer joined Hinkle Law Firm after earning her Juris Doctorate from the University of Kansas School of Law, where she graduated in the top 10% of her class. Following law school, Jennifer began her practice in the Wichita office. She moved to Overland Park in 2010 to help the firm open Hinkle’s Kansas City Office, returning to Johnson County where she was raised.

Rebecca D. Martin, McDowell, Rice, Smith & Buchanan, P.C. Rebecca D. Martin is a Kansas City attorney experienced for over 30 years in tax law, taxpayer representation and business transactions. She represents individual taxpayers and businesses in income and employment tax matters before the IRS, and the Kansas and Missouri Departments of Revenue. Rebecca handles matters involving civil tax controversies, audits, appeals, and civil tax litigation including in the U.S. Tax Court. She also handles tax collection matters, including installment agreements, offers in compromise, levy releases, penalty abatements, collection due process hearing requests, innocent spouse relief, applications for tax lien discharges, withdrawals and subordinations and negotiations to avoid seizures. She also provides representation for business transactions, business entity formations and acquisitions including restaurants with liquor licenses and nonprofits, estate planning, premarital agreements and probate proceedings. Real estate professionals refer to her sales of real property encumbered by federal and state tax liens, and she represents either the buyer or seller in these transactions on all levels of the transaction to enable the transaction to be closed regardless of whether proceeds are available to fully pay the liens. Ms. Martin further assists business owners on the sales of business assets encumbered by tax liens. Ms. Martin advises individuals in divorce proceedings or immediately after the divorce decree is entered with respect to interpretation of financial statements and entity returns, effectively resolving joint income tax liabilities and defending against potential personal penalties for the nonpayment of business trust fund taxes, and, in general, advises on tax planning associated with property settlements and alimony or maintenance payments associated with divorces. She also assists personal representatives and probate counsel on estates involving unpaid taxes, tax liens and unfiled returns.

Benjamin L. Tompkins, Kennyhertz Perry Ben Tompkins works closely with individuals and companies, providing guidance and counsel in all aspects of civil and criminal litigation, as well as providing counsel to exempt organizations and individuals concerning formation, operation and other entity governance issues. Ben focuses on tax controversies, white collar criminal defense, internal investigations and corporate compliance and has extensive experience successfully defending clients in all types of complex litigation in federal and state courts. As a former Assistant U.S. Attorney in Los Angeles and Department of Justice Tax Division Trial Attorney, Ben offers clients a unique depth and breadth of experience in civil and criminal tax matters involving a range of issues, including those involving (i) unreported income, (ii) nonfiler enforcement, (iii) undisclosed foreign bank accounts, (iv) tax return preparers, (v) employment taxes and related trust fund recovery penalties, as well as worker classifications, (vi) excise taxes, (vii) taxpayer, tax promoter and tax preparer penalties, (viii) IRS administrative procedures (i.e., examinations, collection efforts and summons enforcement proceedings), (ix) IRS bankruptcy claims and related bankruptcy fraud issues, (x) valuation disputes, including family limited partnerships, conservation easements and other property interests, (xi) wrongful disclosures, (xii) cryptocurrency, and (xiii) identify theft. Prior to joining Kennyhertz Perry, Ben worked most recently at a Kansas City litigation boutique where he represented individuals and businesses in complex litigation and other government enforcement proceedings involving the Internal Revenue Service, Department of Justice, Federal Bureau of Investigation, Federal Trade Commission, and Missouri Attorney General, along with advising individuals and businesses with issues related to exempt organizations, corporate governance and other legal issues. Prior to returning to Kansas City, Ben served for more than three years at the U.S. Attorney’s office in Los Angeles and then prior to that he served almost eight years as a trial attorney for the U.S. Department of Justice Tax Division in Washington, D.C. During his more than a decade of government service, Ben has served as first chair in numerous bench and jury trials, conducted extensive civil and criminal investigations (including Grand Jury proceedings), negotiated significant settlements and plea agreements, taken and defended fact and expert depositions, and handled all aspects of motion practice, trial practice, and criminal sentencing proceedings. In this regard, Ben has successfully litigated cases in U.S. District, Bankruptcy, and state Courts in California, throughout the South (Alabama, Florida, Georgia, Mississippi, South Carolina), as well as Delaware, Kentucky, Nevada, North Carolina and Virginia. While at the Tax Division, he litigated more than 100 civil tax cases, made several of the largest

recoveries in Tax Division, and earned the high honor of Department of Justice Outstanding Attorney for six consecutive years (2008-2013). During his time with the Department of Justice, Ben served as an instructor in the National Advocacy Center’s Civil Trial Advocacy Course and served as the United States Attorney’s Office Point of Contact for bankruptcy tax fraud matters and substantive tax issues. Ben draws on his comprehensive experience leading criminal and civil tax prosecutions and investigations for the U.S. Attorney’s office and Department of Justice Tax Division to provide clients with valuable insights and practical strategies to effectively navigate and resolve their civil and criminal legal issues. Ben’s previous experience also includes working as an associate for five years at a law firm in Washington, D.C., where he defended financial services companies in nationwide consumer fraud class actions and other complex litigation and regulatory matters, as well as assisted with internal investigations. After law school, he served as a judicial law clerk for the Hon. Stephen H. Glickman of the District of Columbia Court of Appeals. Ben graduated with high honors from The George Washington University Law School in Washington, D.C. He was an editor on The George Washington Law Review, a member of the Order of the Coif, and an executive board member of the Trial Court Board. He earned undergraduate degrees in history and political science, cum laude, at Pepperdine University in Malibu, California. As a recognized leader in the field, Ben regularly speaks and writes articles on criminal and civil tax issues. Ben is a member of the Missouri, Kansas, District of Columbia, Virginia and California bars, as well as the Western District of Missouri, the District of Kansas and the Central District of California. He is an active member of the American Bar Association (Tax and Litigation Sections and various subcommittees), Federal Bar Association (Litigation and Criminal Law Sections) and Kansas City Metro Bar Association (various sections, current Vice-Chair of the Tax Committee). He resides in the Kansas City area with his wife and family.

Andrew D. Wimmer, Jack Henry & Associates Corporate Counsel: Jack Henry & Associates 2012-Present, Corporate Counsel: Liberty Mutual, 2005-2012 Adjunct Professor: UMKC Corporate Law and In-House Counsel

LEGAL ISSUES UNIQUE TO MEDICAL MARIJUANA, CBD OIL AND CULTIVATION OF

CANNABIS

Presentation at KCMBA’s 46th Annual Bench-Bar & Boardroom Conference

Jennifer R. Johnson

Hinkle Law Firm LLC

Andrew D. Wimmer

Benjamin L. Tompkins Kennyhertz Perry LLC

Medical Marijuana Jennifer Johnson

Hinkle Law Firm, LLC

jjohnson@hinklaw.com

Showmelegalmarijuana.com

AMENDMENT TWO – RIGHT OF ACCESS

ARTICLE XIV. MEDICAL MARIJUANA

Primary Purpose: Right of Access – Qualifying Patients

Mechanism: Creation of Regulatory Framework for Licensing and Regulation of New Industry Dispensaries, Minimum 192 (24/congressional district)

As of April 25, 2019, DHSS has received application fees from 269 would-be applicants.

Cultivators, Minimum (statewide)

As of April 25, 2019, DHSS has received applications fees from 151 would-be applicants (60 available licenses)

Infused Products Manufacturers (statewide)

As of April 25, 2019, DHSS has received application fees from 79 would-be applicants (86 avail licenses).

AMENDMENT TWO - TIMELINE

JUNE 4TH – ALL APPLICATION FORMS AVAILABLE

JULY 4TH – DHSS ACCEPTING PATIENT/CAREGIVER APPLICATIONS

AUGUST 3RD – DHSS ACCEPTING LICENSE APPLICATIONS (ALL)

DECEMBER 31ST – DEADLINE FOR APPROVAL OF LICENSE APPLICATIONS

EXPECT PRODUCT AVAILABILITY IN THE LATE SPRING 2020

FEDERALISM

MARIJUANA STILL A SCHEDULE I DRUG UNDER THE CONTROLLED SUBSTANCES ACT.

PATIENTS AND LICENSEES ARE IN VIOLATION OF FEDERAL LAW

GONZALES V. RAICH

Two CA patients in compliance with CA Compassionate Use Act – DEA raid in 2002.

Suit to enjoin Federal Government from prosecuting them under the CSA.

HELD: Cultivation for personal use within single state still within scope of proper federal control under the Commerce Clause.

FEDERAL POLICY RE: PROSECUTION

COLE MEMORANDUM

Issued in 2013, Identified DOJ Guidance re: Enforcement Priorities.

Priorities: preventing distribution to minors, preventing revenue from sales from going to criminal enterprises, preventing diversion of marijuana from legal states to prohibition states, preventing state authorized marijuana activity from being used as a cover or pretext for trafficking other illegal drugs/activity.

Jurisdictions with legal marijuana: If a state has a strong, effective regulatory and enforcements system, conduct in compliance with state law not likely to fall under enforcement priorities.

January 2018: Jeff Sessions rescinded the Cole Memo, leading to uncertainty.

Since January 2018

No notable change in Federal enforcement practices.

In part due to Budget Rider Amendment in place since 2015 – Rohrabacher-Blumenaur Amendment.

No funds made available to the DOJ by the appropriation may be used to prevent states from implementing their own laws that authorize the use, distribution, possession or cultivation of medical marijuana .

Renewed in 2019.

No protection for recreational use states.

After original enactment, US Attorneys previously actively prosecuting state businesses under CSA dismissed cases; 9th Circuit held in 2016 prosecutors were spending federal funds in violation of the Amendment, and prosecutors only permitted to pursue defendants if evidence of non-compliance with state law. (United States v. McIntosh).

AMENDMENT TWO BASICS FOR LAWYERS

Representing Doctors:

“Physicians shall not be subject to criminal or civil liability or sanctions under Missouri law or discipline by the Missouri state board of registration for the healing arts… for owning, operating, investing in, being employed by, or contracting with any entity licensed or certified pursuant to this section or issuing a physician certification to a patient diagnosed with a qualifying medical condition…”

Other health care providers also protected from criminal/civil liability, sanctions and discipline for owning, operating, investing in, being employed by or contracting with a licensee.

Major Health Systems prohibiting doctors from certifying patients; clinics opening throughout the state to provide certifications.

CONTRACTING WITH LICENSEES

Ancillary Services Businesses – Transportation, Security, Real Estate, Banking

No concern re: contract defenses involving illegality.

“It is the public policy of the state of Missouri that contracts related to marijuana for medical use that are entered into with qualifying patients, primary caregivers, medical marijuana testing facilities, medical marijuana cultivation facilities, or medical marijuana dispensary facilities and those who allow property to be used by those entities should be enforceable.”

Advising Clients

“An attorney shall not be subject to disciplinary action by the state bar association or other professional licensing body for owning, operating, investing in, being employed by, contracting with, or providing legal assistance to prospective or licensed medical marijuana testing facilities, medical marijuana cultivation facilities, medical marijuana dispensary facilities, medical marijuana-infused products manufacturing facilities, qualifying patients, primary caregivers, physicians, health care providers or others related to activity that is no longer subject to criminal penalties under state law pursuant to this section.”

Real Estate

Landlords be cautious.

If you have a mortgage, check the terms.

Leasing to Cultivators: Make sure you know what the operation entails.

Protect the structure – moisture issues/damage, ventilation, consider neighboring properties, account for potential legal action by neighboring property owners, tenants.

Include protections in lease that encompass regulatory compliance by tenant, consider having cannabis practitioner review.

Leasing in Advance of Licensing, consider contingencies, be aware of licensees aptitude when evaluating risk/reward.

EMPLOYERS – NOT SO SIMPLE

QUALIFYING PATIENTS – No claims for working, or attempting to work, under the influence of marijuana. No requirement to allow on-duty use.

THE PROBLEM – TESTING FOR MARIJUANA INTOXICATION

THC metabolites: No clear indicator of current intoxication, time of last consumption.

Variants:

Frequency of Use, Quantity of Use, Timing of Use

Biological factors.

EMPLOYERS: DRUG TESTING AND THE MHRA

Unlawful to discriminate because of disability.

Definition of Disability: “a physical or mental impairment which substantially limits one or more of a person’s major life activities, being regarded as having such an impairment, or a record of having such an impairment, which with or without reasonable accommodation does not interfere with performing the job.”

So, what if the use of medical marijuana off the clock is the reasonable accommodation that prevents the physical or mental impairment from interfering with the employee’s ability to perform his job?

EMPLOYERS: What’s Happened Elsewhere?

Generally – Drug testing policies, applied uniformly, enforced without issue in many states.

Recently – Employees have had success in discrimination claims in states where the statute/constitution includes an anti-discrimination clause.

Exercise Caution when advising clients it is appropriate to take action based on positive drug test for marijuana, if the patient has been issued a qualifying patient card by the state.

Employers: Look to Functional Impairment Employees: Advise Prior to Results

______

Employers: Do not rely on drug testing to determine on the job use for qualifying patients.

Employers: Evaluate on duty use with functional limitations, indicators.

______

Employees: Do not use marijuana at work, prior to work.

Employees: If required to submit to drug testing, advise employer (or prospective employer) of status as qualifying patient prior to testing.

Cannabis and Banking

As a result of the differing viewpoints between state and federal law, the Treasury Department and Justice Department have issued separate advisories intended to give battles confidence that if they are compliant with the guidance, they will not be prosecuted for providing services to legitimate state-licensed marijuana businesses.

The memorandum issued by the DOJ does not grant a safe harbor from prosecution but directs prosecutors and regulators to give priority to cases where financial institutions have failed to adhere to the memorandum.

Cannabis and Banking (cont)

The guidance allows access to financial services for marijuana-related businesses while ensuring their activity is transparent and there are appropriate AML safeguards implemented. Safeguards may include, but are not limited to, adequate customer due diligence (CDD), ongoing monitoring, enhanced due diligence (EDD), and proper suspicious activity report (SAR) reporting. SAR reporting has been enhanced to include a new classification of SARs related exclusively to the marijuana industry.

Until Congress passes legislation legalizing marijuana, ultimately financial institutions will remain concerned about violating federal law risking the potential of grave consequences from regulatory agencies imposing various civil monetary penalties, cease and desist orders, fines and banishment of bankers from their careers for life. Regardless of what (the DOJ says, regulators can still bring down harsh penalties on financial institutions .

FinCEN Guidance

Perform EDD to ensure appropriate licensing and registration. This would include requesting and verifying with the appropriate state authorities whether the business is appropriately licensed and registered.

Develop an understanding of the normal and expected activity for the business. The key is whether the business is serving medicinal or recreational customers and taking into consideration the products sold.

Implement ongoing monitoring of publicly available sources for adverse information about the businesses and related parties.

FinCEN Guidance (cont)

Monitor for suspicious activity including the red flags described in the guidance.

Maintain current due diligence on the customer by performing periodic reviews.

Assess whether the marijuana-related businesses violates one of the Cole Memo priorities or state law.

FinCEN Guidance (cont)

File SARs on marijuana-related businesses (including those licensed under state law) in accordance with suspicious activity reporting requirements and the provisions addressed in the FinCEN guidance.

Report currency transactions in connection with marijuana-related businesses consistent with existing regulations and thresholds. Marijuana-related activity may not be treated as non-listed businesses and therefore is not eligible for exemption with respect to the financial institution's currency transaction report (CTR) obligations.

Marijuana Termination

FinCEN also imposed a new and unprecedented obligation on financial institutions . If a FI learns that after terminating its relationship as a result of filing a "Marijuana Termination" SAR, and subsequently the marijuana-related company seeks out a new financial institution, it is strongly urged to alert the second bank of the potential illegal activity. This should be executed through the 314(b) Voluntary Information Sharing.

State Law Considerations

Financial institutions should perform an assessment of state's marijuana-related laws. The documented assessment will provide an understanding of the approval requirements to open or service a marijuana related business.

State Law Considerations (cont)

The application and approval process and criteria to grant identification cards, business and transportation licenses

Oversight, monitoring and enforcement of marijuana-related businesses

Laws and regulations surrounding the cultivation, manufacturing, sale and distribution of cannabis

Restrictions in which individuals or businesses will not be granted a license or identification card.

For example: Does the state disqualify an individual(s) from obtaining or possessing a license because the individual has previously committed a felony and/or been sentenced for a violation state or federal law related to controlled substances?

Best Practices to Consider

Banks who maintain account relationships with marijuana-related businesses should enhance policies, procedures and monitoring controls to:

Identify marijuana-related relationships at account opening.

Evaluate and document the potential risks posed by marijuana dispensaries.

Revise their AML program to address marijuana related businesses, including SAR policies and procedures addressing a three-tiered marijuana-specific reporting approach-"Marijuana Limited," "Marijuana Priority," and "Marijuana Termination." financial institutions that have policies or procedures surrounding account closures as a result of multiple SAR filings will need to update their policies to address exceptions for marijuana limited SARs.

Best Practices to Consider (cont)

Maintain a "Marijuana Termination" SAR log and/or include as part of the 314(b) information sharing log documenting notification of the potential illegal activity to the second bank, as reasonably able, through secure 314(b) information sharing. The Fl should maintain the date of notification, name of FI notified, contact person for the respective Fl, customer name, nature of notification (i.e., marijuana termination SAR on potential new customer) and response date. If the bank does not participate in 3 I 4(b) sharing, documentation addressing the limitation of notifying the second bank should be noted on the log. Similar documentation process should be included for a FI that receives notification of a termination SAR though 314(b) information sharing; however, in addition the FI should document verification of the 3 I 4(b) participation and action taken on the information received. Ensure marijuana-related business relationships are appropriately considered within the bank's suspicious activity monitoring and other applicable reporting systems.

Best Practices to Consider (cont)

Review and update the manual and/or automated transaction monitoring systems to ensure the thresholds or parameters have been set to assist in identifying or analyzing the red flags outlined in FIN-2014-G00J.

Treat marijuana dispensaries as an ineligible customer type for CTR exemptions, similar to ineligible businesses identified under (31 CFR I 03.22(d) (5) (viii).

Best Practices to Consider (cont)

Periodically scrub customer base names and addresses against a listing of approved marijuana dispensaries' names, owners and addresses to identify any potential unknown marijuana-related business accounts. This may be an effective control to implement regardless of the financial institutions ' exposure to marijuana-related businesses.

Perform a transaction volume and dollar comparison of all marijuana dispensary accounts in relation to other marijuana-related business accounts to identify any significant variances in business activity. This will also assist in establishing an understanding of normal and expected activity for marijuana dispensaries. The frequency can be established based on the bank's overall risk profile.

Best Practices to Consider (cont)

Documented executive and board acknowledgment that they understand the risks associated with banking marijuana-related businesses and recognize that banking marijuana-related businesses currently violates federal law.

The risk committee or board of directors should be made aware of key risk indicators related to the marijuana business-related accounts. Accounts or related partiers should exceptions/violations, CTRs filed, 314(a) requests.

Best Practices to Consider (cont)

Consider allocating a compliance officer responsible for monitoring the marijuana-related businesses. The individual should have a thorough understanding of the specific state laws surrounding the legalization of marijuana and the federal law. The individual should be knowledgeable in AML/BSA laws, regulations and guidance, and privy to emerging trends and risks of illicit activity resulting from the legalization of marijuana.

Update the AML/BSA training program to incorporate adequate coverage to address the bank's procedures and due diligence for servicing the marijuana industry, associated red flags and risks. The training should be tailored to the specific business lines.

Continuously perform an Office of Foreign Asset Control (OFAC) scrub on the business and activity level.

LEGAL ISSUES UNIQUE TO MEDICAL MARIJUANA, CBD OIL AND CULTIVATION OF

CANNABIS

Presentation at KCMBA’s 46th Annual Bench-Bar & Boardroom Conference Benjamin L. Tompkins Kennyhertz Perry LLC

TAX CONSIDERATIONS

Federal Tax Considerations

State Tax Considerations

Other Considerations

U.S. LAWS ON CANNABIS

• Recreational use began being banned in 1911.

• 1930s began crackdown on all uses of cannabis • Term “marijuana” became popular

• Harry Anslinger, first director of Bureau of Narcotics

• Reefer Madness

• 1937- Marihuana Tax Act passed

• 1942 - Dropped from Pharmacopeia • 1970 - Controlled Substances Act

classifies it as schedule 1 as temp measure…still there

• 1982 – Section 280E Added to the Internal Revenue Code prohibiting deductions or credits for any trade or business trafficking in controlled substances. Section 280E limits deductions available under §162(a).

OVERVIEW OF STATES

• While cannabis is illegal at the federal level, numerous states have made recreational cannabis legal under various regulatory regimes.

• Furthermore, more than half of states have legalized cannabis for medical purposes.

• Under both regimes, cannabis remains heavily taxed, regulated and scrutinized.

• State and local excise tax collections on retail cannabis sales surpassed $1 billion in 2018. This is data from California, Alaska, Colorado, Nevada, Oregon and Washington. See Taxing Cannabis, Institute on Taxation and Economic Policy (Jan. 2019).

TODAY

• Marijuana remains federally illegal, and on Schedule 1 under the CSA • However, federal enforcement in states where marijuana has been legalized remains

restricted by both (1) Rohrabacher–Farr and (2) the Trump DOJ’s unofficial commitment to the Cole Memo.

• 33 states have legalized medical marijuana, and 10 have legalized recreational use.

• 10 states and Washington D.C. have legalized recreational marijuana use

• 33 states, including

Missouri, have legalized medical marijuana use

TAXES

Players that may be subject to taxes (1) Growers/Cultivators (2) Manufacturers (3) Testers (4) Distributors (5) Retailers (6) Others including landlords, real estate owners, etc.

• Types of Taxes (1) Income (2) Excise (price or weight-based) (3) Sales (4) Cultivation (5) Any exemptions for resale (if so then the purchaser may ultimately pay the tax) (6) No sales or excise tax (9 states)

IRS’s Position

• Marijuana-Related Businesses need to understand the IRS’s position as it pertains to their operations.

• As the 10th Circuit observed in a Colorado case -- [T]oday prosecutors will almost always overlook federal marijuana distribution crimes in Colorado but the tax man never will.” Feinberg v. C.I.R., 808 F.3d 813, 814 (10th Cir. 2015). Indeed, currently the Department of Justice is prohibited from pursuing criminal prosecutions related to medical marijuana businesses. See Green Solution Retail, Inc. v. United States, 855 F.3d 1111, 1114 (10th Cir. 2017) (discussing generally this appropriations amendment).

• These decisions do not preclude the IRS from ensuring that MB businesses are complying with § 280E of the Internal Revenue Code that prohibits credits or deductions for any trade or business “trafficking in controlled substances” prohibited by Federal law. 26 U.S.C. § 280E. See also 18 U.S.C. § 841(a)(1) (CSA makes it unlawful to knowingly or intentionally “manufacture, distribute or dispense a controlled substance”).

IRS’s Position (cont’d)

• “[M]arijuana is still a controlled substance under the [Controlled Substances Act],” so “the IRS has pursued numerous marijuana dispensaries in Colorado and elsewhere to recoup unlawful business deductions.” Green Solution Retail, Inc. v. United States, 855 F.3d 1111, 1114 (10th Cir. 2017).

• Deductions are a matter of legislative grace, and a taxpayer must prove its entitlement to deductions. INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1991); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934). To that end a taxpayer is required to substantiate each claimed deduction by maintaining records sufficient to establish the amount of the deduction and to enable the Commissioner to determine the correct tax liability. 26 U.S.C. Sec. 6001; 26 C.F.R. sec. 1.6001–1(a). Even though the state may allow marijuana related businesses, that does not mean the business is entitled to deductions.

• An understanding of these cases illustrates how marijuana businesses in other states have been unsuccessful in challenging the IRS’s actions to ensure these businesses are not taking any credits or deductions that would otherwise violate section 280E.

• What is the reach of the IRS’s position stretch? Does it reach separate businesses that purchase equipment and lease the equipment to companies that cultivate and/or manufacturer the product (whether dried leaves, cigarettes, liquid, edibles, etc.).

• Proper structuring of entity operations and accounting for trafficking and non-trafficking operations should help.

IRS’s Position (cont’d)

• While the IRS has consistently argued that taxpayers are not entitled to deductions or credits under section 280E, the IRS has advised dispensaries that the amount of income does not include any state excise taxes. See Chief Counsel Advisory Opinion 201531016 (July 31, 2015).

• Consistent with Section 164(a) of the Internal Revenue Code, the IRS provided that “a taxpayer who paid the marijuana excise tax should treat the expenditure as a reduction in the amount realized on the sale of property rather than as either a part of the inventoriable cost of that property or a deduction from gross income.”

• Without action at the federal level, the IRS will continue to enforce section 280E and may seek to expand its reach to include other businesses that own the land or buildings, lease the employees or engage in other transactions with the marijuana businesses.

Green Solution Retail v. United States , 855 F.3d 111 (10th Cir. 2017)

• Green Solution filed suit seeking to enjoin the IRS from obtaining information in support of its position that the marijuana dispensary was violating the CSA and, as a result, “ineligible for deductions under § 280E.” Id. at 1114.

• The Court found it lacked subject matter jurisdiction since Green Solution’s actions were prohibited under the Anti-Injunction Act and the Declaratory Judgment Act. See 26 U.S.C. § 7421; 28 U.S.C. § 2201.

• In reaching these conclusions, the Court rejected the Appellant’s argument that the IRS was “acting outside its authority” in investigating potential violations of criminal law and that §280E is a penalty and not a tax.

Alpenglow Botanicals, LLC, v. United States, 894 F.3d 1187 (10th Cir. 2018)

• Taxpayer LLC operated an approved medical marijuana dispensary. Taxpayer paid the assessed tax and sought a refund after the IRS denied its deductions under section 280E. The Tenth Circuit affirmed dismissal of the taxpayer’s motion to dismiss for failure to state a claim.

• The Court rejected the taxpayer’s arguments that

• The IRS exceeded its authority in disallowing the deductions;

• Disallowing the deductions violated the Eighth Amendment; and

• The IRS was precluded from denying deductions under the “dead letter rule” where there was a policy of non-enforcement by DOJ found it lacked subject matter jurisdiction since Green Solution’s actions were prohibited under the Anti-Injunction Act and the Declaratory Judgment Act. See 26 U.S.C. § 7421; 28 U.S.C. § 2201.

• In reaching these conclusions, the Court rejected the Appellant’s argument that the IRS was “acting outside its authority” in investigating potential violations of criminal law and that §280E is a penalty and not a tax.

Olive v. Comm’r of Rev., 792 F.3d 1146 (9th Cir. 2015)

• Taxpayer challenged disallowance of deductions related to caregiving and other expenses related to the taxpayer’s medical marijuana business.

• Taxpayer operated the Vapor Room, a California-approved dispensary where customers could purchase medical marijuana (three forms – dried leaves, edibles and concentrated THC). In addition to medical marijuana, the taxpayer offered “provision of vaporizers, food and drink, yoga, games, movies, and counseling” free of charge. Id. at 1149. Because the only source of profit was from the sale of marijuana, the Court concluded that any deductions were barred undersection Section 280E.

• Rejected argument that the Court should not enforce Section 280E based upon public policy – “[i]f Congress now thinks that the policy embodied in . . . [section] 280E is unwise as applied to medical marijuana sold in conformance with state law, it can change the statute. We may not.” Id. at 1150.

Attempts to Quash IRS Summonses

• 26 U.S.C. § 7602 provides that the IRS can issue a summons to ascertain “the correctness of any return, making a return where none has been made, determining the liability of any person for any internal revenue tax ….”

• Using this authority, the IRS has issued summonses in connection with civil tax examinations of both the businesses and the individuals that own the businesses.

• Attempts to challenge the IRS’s ability to investigate any civil tax liabilities of medical marijuana dispensaries have been repeatedly rejected, because the government has been able to satisfy the four Powell factors. See United States v. Powell, 379 U.S. 48 (1964).

• As with other tax cases, courts have also rejected taxpayer arguments that the Fifth Amendment protects against the disclosure of information in the hands of third parties. See Medicinal Wellness Ctr., LLC v. United States, No. 17-MC-00170-PAB, 2019 WL 1859147, at *2 (D. Colo. Apr. 24, 2019).

Attempts to Quash IRS Summonses (cont’d)

• Courts have recently summed up why the IRS has a legitimate purpose in conducting these civil investigations:

The Tenth Circuit has rejected the argument that the IRS lacks authority to determine whether petitioners are trafficking in a controlled substance. See Green Sol. Retail, c. v. United States, 855 F.3d 1111, 1121 (10th Cir. 2017) (“But § 280E has no requirement that the Department of Justice conduct a criminal investigation or obtain a conviction before § 280E applies.” [(citation omitted)]; Alpenglow Botanicals, LLC v. United States, 894 F.3d 1187, 1197 (10th Cir. 2018) (“[I]t is within the IRS’s statutory authority to determine, as a matter of civil tax law, whether taxpayers have trafficked in controlled substances.”); High Desert Relief, Inc., 917 F. 3d 1170, 1185. While the IRS may lack authority to criminally prosecute petitioners for trafficking in controlled substances, the IRS has authority to make determinations about whether deductions are allowable under the Internal Revenue Code (“I.R.C.”), including § 280E.

Medicinal Wellness Ctr., 2019 WL 1859147, at *2 (rejecting additional attempts to investigate liabilities); see also Green Solution, LLC v. United States, Case No. 16-mc-00167-PAB, 2019 WL 1859146 (D. Col. Ap. 24, 2019).

Patients Mut. Assist. Collect. Corp. v. Comm.’r, 151 T. C. No. 11 (2018)

• Tax Court accepted the Commissioner’s argument that medical marijuana dispensary had an income tax deficiency since it could not deduct any business expenses as a result of its business being involved in the trafficking of controlled substances.

• Taxpayers may be entitled to some deductions if the taxpayer can describe the non-marijuana trade or business, substantiate the amount of income and expenses associated with each business and rebut any argument that “the sale of non-marijuana containing products had a ‘close and inseparable organizational and economic relationship’ with, and was ‘incident to’” the business of selling marijuana. Id. at 14.

• In this case, the Tax Court found that the primary business was selling marijuana and edible marijuana products and that selling non-marijuana products, offering therapeutic services and non-revenue producing activities to promote its business were not separate trades or businesses.

• Tax Court recognized that taxpayer could deduct cost of goods sold, but limited those costs to inventory and transportation costs under 26. U.S.C. § 471 for resellers and found section 263A and deductions allowed for producers inapplicable to resellers of marijuana. Id. at *17-*21

•

Alternative Healthcare Advoc. v. Comm.’r, 151 T. C. No. 13 (2018)

• This case involved a C Corp that was a medical marijuana dispensary operator, and an S Corp that handled dispensary’s daily operations.

• Tax Court found that the C Corp was engaged in trafficking and that the S Corp was also engaged in the trafficking of a controlled substance. The Court rejected Petitioners attempt to distinguish between sale of marijuana and nonmarijuana items, and that Petitioners are entitled to deduct “nontrafficking businesses.” Petitioners attempted to support their argument related to the C Corp with testimony pertaining to employee time devoted to each activity and the percentage of floor space devoted to each activity.

• With regards to the S Corp, the Tax Court also rejected arguments by the shareholders of the S Corp that they were entitled to deductions since the S Corp operated as a management company that was not engaged in the sale or purchase of marijuana. The Tax Court rejected this argument and concluded that “trafficking” does not require the S Corp to “have had title to the marijuana its employees were purchasing and selling.” Furthermore, to the extent it was involved with non-marijuana activities, the petitioners failed to introduce evidence allocating expenses to these activities. Id. at *10.

• Finally, the Court rejected the C. Corp’s argument that it was entitled to additional deductions as a producer of marijuana products as opposed to be limited to the direct costs of its inventory allowed under section 471.

Missouri

• Amendment 2 imposes a 4-percent excise tax on retail sales of medical marijuana that is paid by qualified patient and primary caregivers. This is in addition to the $25 annual fee for qualifying patients and primary care givers to obtain an id card that can be used at state-licensed dispensaries, and any applicable state and local sales taxes.

• University of Missouri released a report entitled “Missouri’s Medical Marijuana Market: An Economic Analysis of Consumers, Producers, and Sellers” that projected the State would receive between $1.2 million and $3.4 million in yearly tax revenue (possibly higher if demand is similar to Arizona) and there would be between 19,000 to 26,000 qualified patients between 2020 and 2022. The Report also projected the need for between 10 and 29 cultivators, 85 infused-product manufacturers and between 115 and 132 dispensaries during the same period.

• Given the IRS’s position and this report projecting lower demand than expected, will this be a profitable endeavor? If the direction is towards legalization of recreational use nationwide, these first steps will provide entry into a much larger market.

Legal and regulatory challenges: Exempt Organizations?

• The IRS has been blocking applications submitted by proposed 501(c)(3), 501(c)(4) and 501(c)(6) organizations.

• Rev. Proc. 20185 (Jan. 2018) - The IRS updated its procedures to provide that it would not issue determination letters concerning organizations whose “purpose is directed to the improvement of business conditions of one or more lines of business relating to an activity involving controlled substances (within the meaning of Schedule I and II of the Controlled Substances Act), which are prohibited by Federal law—regardless of its legality under the law of the state in which such activity is conducted.” While the Rev. Proc. does not mention marijuana-related businesses, it is clearly directed at them.

• Examples – PLR 201615018 and 201917008 (medical marijuana-related 501(c)(3)s).

What about hemp?

• “Hemp” is the same cannabis plant as marijuana, but is legally defined as cannabis that contains less than 0.3% THC by dry weight. If it is more than .3%, then the plant is treated as marijuana.

• Controlled Substances Act banned hemp cultivation in 1971.

• Hemp cultivation was federally legalized by the 2018 farm bill.

• Hemp is like an other agricultural commodity and can be included on a farmer’s/cultivator’s Schedule F and entitle the grower to crop insurance and other crop

• However, still subject to state regulation.

• From 2014-2018 under Missouri law, only two licenses were available state-wide for the cultivation of hemp for extract production. BeLeaf Company and Noah’s Arc Foundation are the two licensees.

• However, Missouri is launching an industrial hemp pilot program. The final rules for that program will be issued June 30, 2019, with applications available by September 3, 2019.

• Kansas also has an industrial hemp research program. Applications to participate were due by March 1.

What about CBD?

• Cannabidiol’s (“CBD’s”) legality depends on its source.

• When derived from marijuana it is a schedule 1 controlled substance under the federal Controlled Substances Act. This is because the CSA's definition of marijuana (spelled “marihuana”) includes “all parts” of the cannabis plant.

• When CBD takes the form of the investigative new drug Epidiolex it is schedule 5.

• However, when CBD is derived from hemp or some other lawful source it is not a controlled substance. Section 10113 of the Agricultural Improvement Act of 2018 defines “hemp” as “the plant Cannabis sativa L. and any part of that plant, including the seeds thereof and all derivatives, extracts, cannabinoids, isomers, acids, salts, and salts of isomers, whether growing or not, with a delta-9 tetrahydrocannabinol concentration of not more than 0.3 percent on a dry weight basis.” CBD is a cannabinoid.

What about CBD?

• Theoretically, because CBD is the active substance in an investigative drug, the FDA could regulate its sale, distribution, etc. However, it has not done so.

• In Missouri, there are still laws on the books which require you to obtain a hemp extract registration card to possess CBD. However, these laws are predicated on the federal illegality of CBD. Therefore, the legal status of CBD in Missouri is unclear, but it is widely available.

• In Kansas, CBD is fully legal as long as it contains zero THC. CBD with any THC whatsoever is considered marijuana extract.

• Subject to the qualifiers above, CBD-businesses using products directed from hemp or another lawful source should be able to operate like any other business, subject to any other applicable regulations.

THE END

Jennifer R. Johnson Hinkle Law Firm LLC

Andrew D. Wimmer

Benjamin L. Tompkins Kennyhertz Perry LLC