ASK THE CALIFORNIA EMPLOYMENT TAX AND PAYROLL TAX ATTORNEY – HAS THE US TAX COURT DEALT A FATAL BLOW TO CALIFORNIA’S MARIJUANA INDUSTRY
By Robert S. Schriebman
The Tax Equity and Fiscal Responsibility Act of 1982 enacted IRC § 280E. This section said, in substance, that no tax breaks will be allowed for any business engaging in drug trafficking or for the sale of controlled substances prohibited by Federal law. This included the sales of marijuana and related products. We are all aware that many states have now legalized the use of marijuana including California. This state legalization may have given birth to “the worst of times.” States that have an income tax system, such as California, allow deductions and credits against business income in order to determine net taxable income. A tax is then paid on this net income either by the entity or a pass-through to the entity’s shareholders. However, under § 280E, the IRS may disallow all deductions and credits at the Federal level.
On November 29, 2018 the US Tax Court decided the case of Harborside Health Center. Harborside Health Center v. Commissioner, 151 T.C. No. 11. In this case a medical-marijuana dispensary , operating legally, under California law, was refused Federal level deductions and credits. Harborside, in addition to marijuana sales, also offered various services and argued that the offering of services should allow it to by-pass § 280E and use IRC §§ 162 and 274 for deductions, etc. – the same code sections used by every other legally operated enterprise. The Tax Court held that Harborside could not deduct such things as cost of goods sold, cost of labor, utilities, etc.
In this article I will take a brief overview of the Harborside case and discuss the other related nightmares that go along with the decision. Somewhere in all of this may also be some advice for those looking to invest in the California marijuana industry.
The Harborside Case – An Overview
The Harborside case is long and detailed – some 21 pages. However, one need not read too much further after reading Judge Holmes introductory paragraph.
“Holmes, Judge: Patients Mutual (Harborside) owns what may well be the largest marijuana dispensary in America. To the Commissioner that just makes it a giant drug trafficker, unentitled to the usual deductions that legitimate businesses can claim, unable even to capitalize its indirect costs into its inventory, and subject to penalties for taking contrary positions on its tax returns for the tax years ending July 31, 2007 through 2012. Patients Mutual (Harborside) was to be treated like any other business because it follows California Law, it does more than distribute marijuana, and the Federal government already decided not to pursue a civil-forfeiture action against it.” (Harborside added)
I leave it to you to read the rest of the decision, but it seems to me that everything goes downhill from the beginning.
What May Be In Store For Marijuana Stores
These thoughts are not about how California regards its legal marijuana industry; it’s about potential IRS disasters – a Titanic voyage waiting to happen. At the end of its calendar or fiscal year, the legal California business prepares its State and Federal income tax returns. All proper deductions, credits, etc. are allowed on the California return, but none are allowed under § 280E on the Federal returns. The California taxes are paid, but where is the money going to come from to pay huge Federal taxes that are assessed solely against gross receipts?!
If the Federal taxes are not paid timely, there will be penalties and interest – about 40% more on the total liability. If the Federal liability cannot be paid in full, the taxpayer will be turned over to a revenue officer Federal tax collector who will demand immediate payment or perhaps run the risk of the IRS closing down the business, seizing the business assets and selling them at public sale. The shareholders, behind the corporation or LLC may be held personally liable if they have taken out income and distributions that the IRS deems excessive. Their personal assets, including bank accounts, homes, and other investments could be subject to enforced collection.
If the business decides not to file Federal income tax returns, that’s a crime under Federal law. How are investors going to receive a decent return on their legal investment here in California?
The above may appear to be an overreaction, a Twilight Zone fantasy, but I have been at this business of tax collections close to 50 years, and I have learned a thing or two. The IRS appears to be getting more aggressive and the days of a kinder and gentler IRS have become the ‘good old days.’
Robert Schriebman has a successful practice in the Rolling Hills Estates area of Los Angeles County serving clients throughout California and the United States. He has successfully dedicated more than 40 years to helping individual taxpayers, business owners, CPAs, Enrolled Agents, and tax attorneys navigate the complicated tax systems of the federal and state governments. Mr. Schriebman is in private practice. He is not affiliated in any way with the EDD and he is not employed by the EDD or any other agency of the State of California.
Robert Schriebman has written the only 2 books ever published dealing with how California Employment Development Department (EDD) operates. See “California Tax Collection Practice and Procedures” and “California Taxation Practice and Procedure,” both published by Commerce Clearing House.
Robert Schriebman has written over 20 books including the major manual used nationally by practitioners and the IRS, “IRS Tax Collection Procedures – A Manual for Practitioners” published by Commerce Clearing House.
Robert Schriebman has written over 20 books including the major manual used nationally by practitioners and the IRS, “IRS Tax Collection Procedures – A Manual for Practitioners” published by Commerce Clearing House in addition to the only 2 books ever published dealing with how California Employment Development Department (EDD) operates. See “California Tax Collection Practice and Procedures” and “California Taxation Practice and Procedure,” both published by Commerce Clearing House.
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