taxation of oregon marijuana businesses october 26, 2015
DESCRIPTION
Regulatory ContextTRANSCRIPT
Taxation of Oregon Marijuana Businesses
October 26, 2015
Disclaimer
This communication is not tax advice or legal advice. It is provided solely for informational and educational purposes and does not fully address the considerable complexity of real-world business arrangements. If this
communication includes federal tax advice, it cannot be used for the purpose of avoiding tax penalties.
Regulatory Context
DOJ Cole Memo (8/29/13)Federal Enforcement Priorities communicated to U.S. Attorneys: • Prevent distribution to minors• Prevent revenue from going to criminal enterprises• Prevent diversion of marijuana to other states• Prevent trafficking in other illegal drugs• Prevent violence• Prevent drugged driving and other adverse public health consequences• Prevent growing of marijuana on public lands• Prevent possession and use of marijuana on federal propertyThe Cole Memo is “intended solely as a guide to the exercise of investigatory and prosecutorial discretion.” Neither the Cole Memo nor Oregon law provide a legal defense to a violation of federal law.
Key Dates in Oregon’s Marijuana History1973 – Decriminalization of small amounts of marijuana1998 – Medical Marijuana Act provides patients may possess up to three mature plans, four immature plants, and one ounce 2005 – Patients may possess up to six mature plants, 18 immature plants, and 24 ounces; growers may be reimbursed for supplies and utilities2012 – HB 3460, the Dispensary Bill expands the list of reimbursable expenses grows to include payments for services, making a legal marijuana business possible for the first time2014 – Measure 91 passes, promising legal recreational marijuana for users, a rational regulatory framework for the industry, and additional tax revenue for the the state government2015 – Potentially the end of reimbursement model, early recreational sales, residency requirements…2016 – Measure 91 businesses come online
Oregon Medical Marijuana Act1. The Oregon Medical Marijuana Act (OMMA) protects
compliant individuals from criminal prosecution for the production, possession, or delivery of marijuana
2. The Oregon Health Authority (OHA) administers the Oregon Medical Marijuana Program under OMMA
3. OMMA (and the underlying regulations) provide an extremely challenging set of rules for a business to operate under
4. There is a perception that OHA has taken a hands-off approach to enforcement of some of OMMA’s more technical provisions
Measure 91(passed November 4, 2014)
1. M91 themes include incentives for participation in legal market and regulation in manner similar to alcohol
2. Some changes in 2015 legislative session, but general approach of M91 remains intact
3. The Oregon Liquor Control Commission (OLCC) is drafting and will enforce regulations of recreational marijuana in Oregon
Measure 91 Framework
M91 contemplates licensing and regulation of four types of activities: 1. Production2. Processing3. Wholesaling4. Retail5. Potentially, nursery and laboratory licenses.
2015 Legislative Session
The 2015 legislative session saw a number of changes to Oregon’s marijuana laws passed (but not yet signed by the Governor), including: 1. Medical marijuana program
a. Cosmetic changes to the reimbursement modelb. Residency requirement
2. Measure 91a. Residency requirement
OMMP - Where are we now?
1. OMMP is technically the only game in town until M91 licenses are issued
2. The OMMA is still an affirmative defense to criminal prosecution under Oregon criminal law
3. Individuals operating a medical marijuana business must continue to fit within the categories identified in the OMMA
M91 - Where are we now?1. Recreational sales from dispensaries expected to
start October 12. First M91 producer licenses expected January
20163. First M91 processor, retailer, and wholesaler
licenses expected by Fall 2016 4. OLCC is drafting the regulations that will govern
M91 businesses5. Draft Temporary Rules released for comments
Taxation of Oregon Marijuana Businesses
§ 280E Planning Questions
1. Is the taxpayer engaged in prohibited
trafficking such that it is subject to § 280E?
2. Is the taxpayer engaged in a service business, rather than a production business, such that it may not use inventory accounting?
3. Is the taxpayer engaged in non-trafficking activities?
IRC § 280E“No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances (within the meaning of schedule I and II of the Controlled Substances Act) which is prohibited by Federal law or the law of any State in which such trade or business is conducted.” Emphasis added.
Treas. Reg.§ 1.61-3(a).
“In a manufacturing, merchandising, or mining business, “gross income” means the total sales, less the cost of goods sold, plus any income from investments and from incidental or outside operations or sources…”
280E Mechanics- Pre-Tax Profit -
Gross Receipts 500,000Less Cost of Goods Sold 250,000Gross Profit
250,000
Less Other Expenses 100,000Net Profit
150,000
280E Mechanics - After-Tax Profit (Non § 280E) -
Gross Receipts 500,000Less Cost of Goods Sold 250,000Gross Profit 250,000
Less Other Expenses 100,000Net Profit 150,000
Less Income Tax 51,650After-Tax Net Profit 98,350
280E Mechanics - After-Tax Profit (With § 280E) -
Gross Receipts 500,000Less Cost of Goods Sold 250,000Gross Profit 250,000
Less Other Expenses 100,000Net Profit 150,000
Less Income Tax 97,250After-Tax Net Profit 52,750
280E Mechanics- A Real-World Example -
Gross Receipts 1,056,083Less returns and allowances 8,802Balance 1,048,031
Cost of Goods Sold 835,312Gross Profit 212,719
Total deductions212,958Taxable Loss –239Est. taxes based on loss 0
280E Mechanics - A Real-World Example -
Estimated taxable income adjustment per CHAMP +200,000 Estimated taxes after
adjustment64,000
Est. financial loss after taxes –64,239
Facts In CHAMP v. Commissioner• Taxpayer segregated space where it provided
yoga/meetings from space where it provided marijuana
• Taxpayer provided members with regular, healthy meals; organized field trips
• Nearly half of the taxpayer’s members suffered from AIDS and paid a single membership fee for the right to receive caregiving services and medical marijuana
• Management allocated membership fee between caregiving and trafficking activities
Facts In CHAMP v. Commissioner (cont.)
• The taxpayer’s primary focus was caregiving• The taxpayer provided caregiving services
regularly, extensively, and substantially independent of providing medical marijuana
• The director had significant experience in health services
• Seventy-two percent of the taxpayer’s employees worked exclusively in its caregiving business
Takeaways from CHAMP v. Commissioner
CHAMP provides the model for success, but in practice the two-business model may not not clearly apply to most marijuana businesses
Facts in Olive v. Commissioner
• Taxpayer did not incur additional expenses to provide other services
• Used same space• Used same bookkeeper and accountant• Taxpayer “would not have had any revenues at
all (and could not have operated) if none of the patrons purchased marijuana.”
Takeaways from Olive v. Commissioner
• Non-trafficking business must have substance, to be respected. Perhaps charging customers for the non-trafficking product or service is key.
• The court rejected the argument that the taxpayer “trafficked marijuana only during the short time it took for the staff members to pass the medical marijuana to the patrons in exchange for payment and that the rest of the Vapor Room’s business was providing caregiving services.”
IRC § 280E- The Big Picture -
• IRC § 280E disallows deductions for business expenses
• COGS is not a deduction (it is an adjustment to gross receipts)
• The use of inventory accounting principals under IRC §§ 471 and 263A is used by marijuana businesses to maximize COGS
• The Taxpayer in Olive was found to have a COGS equal to 75.16% of sales
Planning Focus #1Inventory Accounting
Treas. Reg. section 1.471-3 “Cost means: . . . (c) In the case of
merchandise produced by the taxpayer since the beginning of the
taxable year, (1) the cost of raw materials and supplies entering into
or consumed in connection with the product, (2) expenditures for
direct labor, and (3) indirect production costs incident to and
necessary for the production of the particular article, including in
such indirect production costs an appropriate portion of
management expenses, but not including any cost of selling . . . .”
Planning Focus #1Inventory Accounting
Caution is advised, however, as IRC § 263A(a) flush language provides the following:
“Any cost which (but for this subsection) could not be taken into account in computing taxable income for any taxable year shall not be treated as a cost described in this paragraph.”
Planning Focus #1Inventory Accounting
• “[I]f the [accounting] method used [by the Taxpayer] does not clearly reflect income, the computation of taxable income shall be made under such method as, in the opinion of the Secretary, does clearly reflect income.” IRC § 446.
• Form 3115 is generally used to request consent for a change of accounting method.
Planning Focus #2 Second “Trade or Business”
• Whether the undertakings are conducted at the same location• Whether the undertakings were originally formed as separate
activities• Whether one undertaking benefits from the other• The degree to which undertakings share management• The degree to which undertakings share employees• The degree to which one caretaker oversees the assets of both
undertakings• Whether taxpayers used the same accountant for the undertakings• Whether the undertakings maintain separate books and records
Income Duplication Example- Common Entity Structure -
Owner
Services Trafficking
Income Duplication Example- Mechanics -
• First income inclusion: Trafficking pays services income to Services. Trafficking recognizes additional income equal to the amount of the payment for which deduction was disallowed under section 280E.
• Second income inclusion: Services pays wages to its employee, who was engaged in trafficking activities for Trafficking. Services recognizes additional income equal to the full amount of its wage payment, because the entire deduction was disallowed under section 280E.
Income Duplication Example- Client Questions -
1. Whether the structure provides tax planning
benefit?
2. Does the expected tax savings justify the tax risk resulting from the use of the structure?
Tax Cycle
It’s not (just) about the audit:1. Planning2. Compliance3. Audit defense4. Administrative Appeals5. U.S. and Oregon Courts6. Collections
Common Industry Tax Traps
1. Failure to maintain books and records2. Pass-through tax to owner-employee3. Pass-through tax to common owner-
employee of trafficking and services entity4. OMMA “property” issue5. Consignment (grower)6. Consignment (dispensary)
Common Industry Tax Issues
7. Use of street names for suppliers8. Additional growers9. Forms 1099 to growers10.Barter transactions11.Silent partners12.Independent contractor vs. employee status
Common Industry Tax Issues
13.Mandatory tax distributions14.Owner taxes under OMMA – are they
“normal and customary” business costs? 15.Evidence of attempts to conceal payments?16.Traditional tax and business planning17.Income only, or expense only, business
entities
