ASK THE EDD ATTORNEY – THINKING ABOUT GOING INTO THE LEGALIZED MARIJUANA BUSINESS? THINK AGAIN!
By Robert S. Schriebman
December 1, 2016
I don’t usually open spam email, this one caught my attention. I was asked to make a small investment into the “The $50 Marijuana Investment Jackpot.” The ad went on promising to turn a $50 bill into an absolute fortune. The same day I was alerted to the US District Court ruling in the case of U.S. v. The Green Solution, Retail, Inc. DC Colo. 2016 USTC 50,487 (Nov. 30, 2016). (Green Solution).
Green Solution tried unsuccessfully to obtain an injunction to stop an IRS audit from investigating and determining whether it trafficked in illegal controlled substances. The Court ruled that the Anti-Injunction Act prevented Green Solution from stopping an IRS audit.
Green Solution is a Colorado based company. The retail sale of marijuana is legal in Colorado, just as it will soon be legal in California. So, the decision of the Colorado Federal District Court is absolutely relevant for us Californians.
The Green Solution case got me thinking about the pros and cons of going into the retail marijuana business. Don’t be blinded by dollars. It’s a very hazardous and complex undertaking where the ramifications of the marijuana retail sales industry will not be fully known for a long time. However, I wanted to give you my thoughts, as a tax attorney, in light of the Green Solution case.
Late Night Thoughts About Legal Marijuana Retail Sales In California
Green Solution tried to stop an IRS audit. What was the IRS looking for? If you operate an illegal drug business, you are not allowed to deduct business related expenses. IRC § 280E denies the deduction of any expenses incurred in connection with the sale of illegal drugs. While the retail sale of marijuana and related by-products may be legal in states such as Colorado, and soon in California, it remains an illegal drug under federal law. Because of this “Catch 22” paradox, I can think of nothing but potential nightmares for law-abiding people who just want to make an honest living under the law. Let’s look at a few examples.
Any business, legal or illegal, has expenses. No business has 100% profit. When an illegal business becomes legal under state law, ordinary, necessary, and reasonable business expenses are deductible in computing net profit and taxable income. Is anyone willing to go into business and pay income taxes solely based upon gross receipts? Of course not! The business person wants to pay the lowest possible tax under the law. Many years ago a famous judge by the name of Learned Hand, stated that no one is legally obligated to pay one dime more in taxes than absolutely necessary. Everything should be done to take advantage of every legally allowable tax deduction and credit.
But, what if your business, being legal in California, is not legal to the IRS? What does this mean tax wise? On your California income tax return you will be allowed to deduct all ordinary, necessary, and reasonable business expenses. According to the Green Solution case, as well as the IRC, you are not allowed any business related deductions at all! This means that for FTB purposes you pay income taxes on your net income. You get deductions for the cost of goods sold, rent, utilities, insurance, salaries and wages, etc. You pay taxes only on the bottom line. Under the IRC the IRS will not allow any of these deductions; however, the IRS will tax you on gross receipts, at rates as high as 70%! You cannot economically survive against the IRS!
No one wants to suffer the payment of a 70% IRC tax rate. Do you file an IRS return or not? Failure to file a tax return, especially when you have taxable income, can lead to federal felony charges and jail time. This is true illegal tax evasion! Failure to file both an FTB and IRS income tax return can lead to compounding of state and federal criminal charges. Therefore, not filing tax returns is not the solution to your problems. Just think of the attorney fees necessary for your defense – there goes your profits!
If it is legal to sell marijuana in California, but it’s a crime under federal law, filing a federal income tax return and signing it is an admission to illegal criminal activities. The requirement of filing a federal tax return may violate your Fifth Amendment right against self-incrimination. If you sign a federal tax return, you admit you are engaging in illegal drug trafficking. Suppose you file only an FTB return because you are engaging legal marijuana sales in California; therefore, you are filing a legal state return. However, California shares information with the IRS. So are you indirectly incriminating yourself through your legal California return? What a mess!
The above scenarios are only the tip of the iceberg. We have no way of knowing at this time all your exposure to the federal government. But, from where I sit, these are disturbing questions that can keep one up at night. Until the federal government recognizes and legalizes the retail sales of marijuana, I do not know why anyone would want to engage in this business. All I can see is economic disaster for anyone trying to operate within the law. It looks like there will continue to be an ever expanding black market in marijuana. The black market is a serious competitor for anyone trying to operate a legal retail marijuana sales business.
You cannot stop a legal IRS, FTB, or EDD audit. Green Solution was not successful in trying to stop an IRS audit. You will not be successful either.
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.
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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