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 property
The 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
History
1973 – Decriminalization of small amounts of marijuana
1998 – 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
utilities
2012 – 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 time
2014 – Measure 91 passes, promising legal recreational marijuana for
users, a rational regulatory framework for the industry, and additional
tax revenue for the the state government
2015 – Potentially the end of reimbursement model, early recreational
sales, residency requirements…
2016 – Measure 91 businesses come online
Oregon Medical Marijuana Act
1. 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. Production
2. Processing
3. Wholesaling
4. Retail
5. 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 model
b. Residency requirement
2. Measure 91
a. 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 1
2. First M91 producer licenses expected January
2016
3. First M91 processor, retailer, and wholesaler
licenses expected by Fall 2016
4. OLCC is drafting the regulations that will govern
M91 businesses
5. 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
500,000
Less Cost of Goods Sold 250,000
Gross Profit
250,000
Less Other Expenses
Net Profit
100,000
150,000
280E Mechanics
- After-Tax Profit (Non § 280E) Gross Receipts
Less Cost of Goods Sold
Gross Profit
500,000
250,000
250,000
Less Other Expenses
Net Profit
100,000
150,000
Less Income Tax
After-Tax Net Profit
51,650
98,350
280E Mechanics
- After-Tax Profit (With § 280E) Gross Receipts
Less Cost of Goods Sold
Gross Profit
500,000
250,000
250,000
Less Other Expenses
Net Profit
100,000
150,000
Less Income Tax
After-Tax Net Profit
97,250
52,750
280E Mechanics
- A Real-World Example Gross Receipts
1,056,083
Less returns and allowances
8,802
Balance
1,048,031
Cost of Goods Sold
Gross Profit
835,312
212,719
Total deductions
Taxable Loss
Est. taxes based on loss
212,958
–239
0
280E Mechanics
- A Real-World Example Estimated taxable income
adjustment per CHAMP
+200,000
Estimated taxes after
adjustment
64,000
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 #1
Inventory 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 #1
Inventory 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 #1
Inventory 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. Planning
2. Compliance
3. Audit defense
4. Administrative Appeals
5. U.S. and Oregon Courts
6. Collections
Common Industry Tax Traps
1. Failure to maintain books and records
2. Pass-through tax to owner-employee
3. Pass-through tax to common owneremployee of trafficking and services entity
4. OMMA “property” issue
5. Consignment (grower)
6. Consignment (dispensary)
Common Industry Tax Issues
7. Use of street names for suppliers
8. Additional growers
9. Forms 1099 to growers
10.Barter transactions
11.Silent partners
12.Independent contractor vs. employee status
Common Industry Tax Issues
13.Mandatory tax distributions
14.Owner taxes under OMMA – are they
“normal and customary” business costs?
15.Evidence of attempts to conceal payments?
16.Traditional tax and business planning
17.Income only, or expense only, business
entities
Thank you.
Bernard Chamberlain
Emerge Law Group
(503) 241-5984
bernard@emerglawgroup.com