California Cannabis Operators Warn of Possible Industry Collapse

Leaders of California cannabis companies warned Gov. Gavin Newson and lawmakers last week that the state’s regulated marijuana industry is in danger of collapse, calling for tax relief and an improved retail market to support ailing businesses.

In a letter sent to Newsom, Senate President Pro Tempore Toni Atkins, and Speaker of the Assembly Anthony Rendon, more than two dozen cannabis advocates and industry executives noted that the goals of cannabis legalization in California included ending the illicit marijuana market and protecting public safety while creating an accountable regulated industry. But four years after the start of legal sales, the “industry is collapsing.”

“We need you to understand that we have been pushed to a breaking point,” the cannabis industry leaders wrote in the letter to Newsom and legislative leaders.

The Shortcomings of California Cannabis Legalization

The letter cites several shortcomings of cannabis legalization in California, including high taxation for legal operators that results in dispensary prices that are 50% more than the illicit market. Industry leaders also faulted the ability of local governments to ban cannabis businesses from locating in their jurisdictions, a situation that leaves only one-third of municipalities with local access to regulated cannabis products. The result is a market ripe for unregulated operators, with 75% of the cannabis in California coming from the illicit market, all of it untested and potentially unsafe.

Industry executives also noted the failure to adequately address the harms caused to communities of color by the failed War on Drugs. Taken together, cannabis legalization has led to a regulatory environment that threatens the viability of cannabis businesses, particularly legacy operators making the transition from California’s traditional unregulated market.

“It is critical to recognize that an unwillingness to effectively legislate, implement, and oversee a functional regulated cannabis industry has brought us to our knees,” they wrote. “The California cannabis system is a nation-wide mockery; a public policy lesson in what not to do.”

“Despite decades of persecution by the government, we have been willing and adaptable partners in the struggle to regulate cannabis,” the letter continues. “We have asked tirelessly for change, with countless appeals to lawmakers that have gone unheard. We have collectively reached a point of intolerable tension, and we will no longer support a system that perpetuates a failed and regressive War on Drugs.”

Businesses and groups signing the letter to Newsom include California Cannabis Industry Association, the California chapter of the National Organization for the Reform of Marijuana Laws, the Los Angeles-based United Cannabis Business Association, Papa & Barkley, Flow Kana Inc., Harborside Inc., and CannaCraft.

Cannabis Industry Pleads for Tax Relief

Those signing the letter asked for the elimination of California’s cultivation tax, which they say makes cannabis the only agricultural product that is taxed at the farm. Noting the state’s $31 billion budget surplus, they also requested a three-holiday from collecting the cannabis excise tax, followed by a graduated return of the tax over subsequent years.

“We are looking for an immediate suspension of the cultivation tax, which is an incredibly burdensome tax that compounds throughout the legal supply chain,” Lindsay Robinson, executive director of the California Cannabis Industry Association, told reporters at a virtual press conference on Friday. “So that’s one avenue that we are pursuing. We’d also like the lawmakers through the legislative process or the budget process. Consider suspending the excise tax or reducing the excise tax for the foreseeable future until the legal market can really start to grow and thrive.”

The industry executives also called for an expansion of retail access to support floundering operators, noting that 68% of local governments have failed to allow for regulated cannabis in their jurisdictions. They propose legislation that would force every city and county where a majority of voters approved Proposition 64, the landmark cannabis legalization initiative passed by voters in 2016, to adopt measures to regulate cannabis by July 1, 2022. Jurisdictions that failed to act would default to the state’s rules for regulated cannabis.

CannaCraft chief of government and consumer affairs Tiffany Devitt says that California has not lived up to the goals of cannabis legalization and is putting the health of the industry in jeopardy.

“The Newsom administration is failing the majority of California voters who support legal recreational marijuana by perpetuating wrong-headed tax, licensing and enforcement policies that are decimating a once vibrant industry,” Devitt wrote in an email to Cannabis Now. “Inaction is costing our state jobs, strengthening the already dominant illicit market, and ensuring that one of California’s great heritage industries will be non-competitive when federal legalization occurs.”

Erin Mellon, a spokeswoman for the governor, said in a statement that Newsom supports cannabis tax reform and recognizes the system needs reform, including increased efforts to stem the unregulated market.

“It’s clear that the current tax construct is presenting unintended but serious challenges,” Mellon said. “Any tax-reform effort in this space will require action from two-thirds of the Legislature and the Governor is open to working with them on a solution.”

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IRS Commissioner Shares Recommendations for Cannabis Businesses

A longtime Internal Revenue Service (IRS) official participated in a recent webinar where he made recommendations on how cannabis businesses can stay tax compliant.

The IRS Commissioner of Small Business/Self-Employment (SB/SE) Examination, De Lon Harris, participated in a PBC webinar on Wednesday, alongside PBC CEO and co-founder, Josh Radbod. There, he discussed the topic of how cannabis businesses can continue to be compliant, despite cannabis’ federal status.

“It’s really our mission at the IRS, not just with marijuana and cannabis industries, but with all taxpayers, to promote voluntary compliance,” Harris said during the webinar. “And that can happen in different ways. When most people think of the IRS, they think of examinations or audits and they think that’s the only way that we interact or try to promote voluntary compliance with taxpayers, but we do our fair share of outreach and education as well. Just like what we’re doing today.” 

The PBC Conference is a B2B event for “payments, banking and compliance in the cannabis industry.” Harris was also a keynote speaker at the PBC Conference in 2021, held on September 9-10, 2021. 

Harris also spoke of the IRS’ goal of reducing audits for the cannabis industry. “Regarding the cannabis marijuana industry, we developed a strategy that we hope will increase voluntary compliance and identify and address non-compliance when it’s there,” Harris said.

“Our focus is to positively impact filing and paying and reporting compliance on the part of all cannabis businesses to keep audits to a minimum.” On the IRS’ side, Harris noted that they seek to properly educate their examiners so they can conduct a quality examination, that the different sects of the IRS communicate properly with each other, and that they continue to partner with groups like the PBC to promote education.

As Radbod proceeded to ask Harris key questions during the webinar, he shared that cannabis statis as a Schedule I controlled substance doesn’t mean that taxes shouldn’t be paid. “As I’m sure you’re aware, and everybody listening, that a business engaged in the sale or production of marijuana or cannabis is considered illegal under federal law but nevertheless, it’s a business in every sense of the word, whether its categorized under federal statute as legal or illegal, it still remains to be obligated to pay federal income tax on the taxable income that it earns.”

The Internal Revenue Code 280E complicates matters, preventing businesses who sell cannabis from receiving tax deductions, even if those businesses operate legally in states that have legalized cannabis sales. However, that section does allow cannabis “to reduce their gross receipts by properly calculating a cost of goods sold to determine its income.” While a cannabis business can’t deduct advertising or selling expenses, it can reduce gross receipts, according to internal revenue code 471. 

Harris highly recommended that cannabis businesses strive to keep records of their receipts, canceled checks and any other documents that support evidence of income. “Well-organized records make it much easier to prepare the tax return, and to help provide answers if your return is selected by the IRS for an audit.”

Harris explained that all of this and more is available on the IRS website; however, users must search for “marijuana” in order to find information, rather than using the keyword “cannabis” for the time being. 

“So we’re making that change, but for now, you would type in ‘marijuana industry,’ and it would pull up the page that we give you information about, not only general information that would help you understand and meet tax responsibilities required by the cannabis industry, but the page which includes links to pages of more specific information,” he concluded.

The post IRS Commissioner Shares Recommendations for Cannabis Businesses appeared first on High Times.

The Latest IRS Initiative Could Positively Impact Cannabis

The tax man is extending a helpful hand to marijuana business owners, not something we would normally see for the cannabis industry. 

In an announcement posted on its website late last month, the Internal Revenue Service unveiled its new “Cannabis/Marijuana Initiative,” billed as a “groundbreaking effort” by the agency to assist such business owners as they navigate the often confounding U.S. tax code.

The goal of the initiative, the agency said, “is to implement a strategy to increase voluntary compliance with the tax law while also identifying and addressing non-compliance,” a move the IRS believes “will positively impact filing, payment and reporting compliance on the part of all businesses involved in the growing, distribution and sales of cannabis/marijuana.”

The agency said it has a number of “strategic activities” planned as part of the initiative, which include ensuring that “training and job aids are available to IRS examiners working cases so they can conduct quality examinations (audits) consistently throughout the country,” making sure “there is coordination and a consistent approach by the IRS to the cannabis/marijuana industry,” finding “ways to identify non-compliant taxpayers,” collaborating “with external stakeholders to increase an awareness of tax responsibilities to improve compliance” and giving “taxpayers access to information on how to properly comply with the filing requirements.”

Even as dozens of states have legalized marijuana for either medical or recreational marijuana use, and even as polls consistently show that majorities of Americans support legalizing marijuana outright, there remains a stubborn elephant in the room—cannabis is still listed on the Controlled Substances Act and is thus still illegal on the federal level. That makes things very difficult when it comes to tax breaks.

De Lon Harris, a commissioner at the IRS who authored the post on the initiative last month, alluded to that discrepancy as a motivation behind the new program.

Rather than just providing information on the IRS’ website, Harris said he intends to “engage with the cannabis/marijuana industry through speaking events and other outreach.” He said that he has hosted three such outreach events in the last year.

“It’s tricky from a business perspective, because even though states are legalizing marijuana and treating its sale as a legal business enterprise, it’s still considered a Schedule 1 controlled substance under federal law,” Harris wrote. “That means a cannabis/marijuana business has additional considerations under the law, creating unique challenges for members of the industry.  Specifically, these businesses are often cash intensive since many can’t use traditional banks to deposit their earnings. It also creates unique challenges for the IRS on how to support these new business owners and still promote tax compliance.”

Harris said that although IRS Code Section 280E establishes that “all the deductions and credits aren’t allowed for an illegal business,” there is a “caveat.”

“Marijuana business owners can deduct their cost of goods sold, which is basically the cost of their inventory. What isn’t deductible are the normal overhead expenses, such as advertising expenses, wages and salaries and travel expenses, to name a few,” he said. 

“I understand this nuance can be a challenge for some business owners, and I also realize small businesses don’t always have a lot of resources available to them. That’s why I’m making sure the IRS is doing what it can to help businesses with our new Cannabis/Marijuana Initiative,” Harris continued.

It may not be long before legalization goes federal. Democratic leaders on Capitol Hill like Senator Chuck Schumer have signaled that they are ready to press ahead with the reform. Earlier this year, Democratic members of the House introduced legislation that would both decriminalize and deschedule cannabis. 

The post The Latest IRS Initiative Could Positively Impact Cannabis appeared first on High Times.

Wednesday April 14, 2021 Headlines | Marijuana Today Daily News

Marijuana Today Daily Headlines
Wednesday, April 14, 2021 | Curated by host Shea Gunther

// Longtime cannabis reform activist Steve Fox dies (Marijuana Business Daily)

** GoFundMe- Support the family of Steve Fox. **

// Biden picks former New Jersey attorney general to lead DEA (Washington Post)

// Illinois Gets More Tax Revenue From Marijuana Than Alcohol State Says (Marijuana Moment)

These headlines are brought to you by Agilent, a Fortune 500 company known for providing top-notch testing solutions to cannabis and hemp testing labs worldwide. Are you considering testing your cannabis in-house for potency? Agilent is giving away a FREE 1260 HPLC system for one year! If you are a Cultivator, processor, or cannabis testing lab you may qualify for this giveaway. Open up to answer a few quick questions to enter to win!

// Medical Cannabis in Mississippi Faces Constitutional Challenge (Bloomberg Government)

// NJ Cannabis Commission Gets Going Picks Vice Chair Logo (NBC 4 New York)

// urban-gro Pre-Announces Q1 Revenue in Excess of $11.8 Million (New Cannabis Ventures)

// Aphria Stock Slammed On Dismal Third Quarter (Green Market Report)

// Organigram Q2 Revenue Slides 24% Sequentially to C$14.6 Million (New Cannabis Ventures)

// Colorado Marijuana Sales Reached $167 Million In February (Marijuana Moment (Center Square))

// Minnesota Marijuana Legalization Bill Sails Through Fifth Committee, With Floor Vote Expected Next Month (Marijuana Moment)

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Taxation’s War on Cannabis

Harborside, a California cannabis dispensary, appealed the Tax Court’s decision of tax deficiencies totaling over $29 million dollars for the periods between 2007 through 2012. Harborside’s tax liability stems from the IRS’s denial of deductions under IRC §280E and the disallowances of cost of goods sold reported on Harborside’s tax returns. Internal Revenue Code §280E prohibits tax deductions for businesses whose activities involve a federally controlled substance (within the meaning of schedule I and II of the Controlled Substances Act). Unfortunately, cannabis is still and at the time (of the facts in the case) a Schedule I Controlled Substance. 

On appeal Harborside makes two arguments: (1) whether IRC §280E violates the Sixteenth Amendment of the U.S. Constitution; (2) whether IRC §471 regulations excludes certain inventory costs for Harborside (cannabis businesses). This article will not go into the constitutionality of IRC §280E in reference to the Sixteenth Amendment but will focus on the cost of goods sold (COGS) and IRC §471 issue.

The Tax Court erred in determining that “processing costs related to inventory are not includable in Harborside’s cost of goods sold.”

The IRS did not allow Harborside to include purchasing, handling, and storage costs related to the goods it purchased for resale (“indirect costs”) — costs like testing, labeling, curing, storing, trimming, manicuring, maintaining, and packaging the [cannabis], or [cannabis] products — in its cost of goods sold.  Harborside would reject [cannabis] if it wasn’t properly cured, if it hadn’t been sufficiently trimmed, if it had an incurable safety issue such as pathogenic mold, or if it didn’t contain the right “cannabinoid profile.”

In response to Harborside, the IRS admits in the Appellee’s brief, “if Harborside could establish that Section 471 permits it to include indirect costs in its cost of goods sold, Section 280E would not prevent that result, as that section only bars Harborside’s claim to deductions.” Section 471 states that “the use of inventories is necessary in order clearly to determine” income, and “on such basis as the Secretary may prescribe as conforming as nearly as may be to the best accounting practice in the trade or business and as most clearly reflecting the income.” 

For more clarity on §471, we look towards the regulations for guidance. Treas. Reg. §1.471-3(b) provides, in relevant part:

Cost [i.e., inventory cost] means: In the case of merchandise purchased since the beginning of the taxable year, the invoice price less trade or other discounts, except strictly cash discounts approximating a fair interest rate, which may be deducted or not at the option of the taxpayer, provided a consistent course is followed. To this net invoice, price should be added to transportation or other necessary charges incurred in acquiring possession of the goods. * * * For taxpayers acquiring merchandise for resale that are subject to the provisions of section 263A, see §§ 1.263A-1 and 1.263A-3 for additional amounts that must be included in inventory costs.

Harborside’s appeal will come down to when Harborside acquires possession of the good.

COGS is the costs of acquiring inventory, through either purchase or production. See, e.g., Reading v. Commissioner, 70 T.C. 730, 733 (1978). In support of disallowing Harborside inventory costs, the IRS states that the costs of testing, labeling, curing, storing, trimming, manicuring, maintaining, and packaging products are costs incurring after acquisition of goods. 

But when does Harborside actually acquire the “goods?” Because we cannot make the assumption that cannabis bud is a “good” if it’s still connected to the plant, not consumable because of mold, or not properly tested to determine its CBD/THC levels. At this point and before being packaged and labeled properly, the cannabis bud is a raw material. Thus, the argument could be made that Harborside has not “acquired” possession of a “good,” until the cannabis product is ready for sale and consumption that complies with state cannabis laws. 

Is Harborside a producer?

Although the argument was not brought up in the appeal, Harborside is more analogous to a producer than a reseller. This would put Harborside under Treas. Reg. §1.471-3(c) for its cost of goods sold analysis. Producers must include in COGS both the direct and indirect costs of creating their inventory. See Treas. Reg. §1.471-3(c), 1.471-11. The regulations tell producers to capitalize the “cost of raw materials,” “expenditures for direct labor,” and “indirect production costs incident to and necessary for the production of the particular article…” This would allow Harborside to include in COGS the cost of the cannabis plant, costs of testing, labeling, curing, storing, etc. However, the issue that Harborside runs into with being a producer for this regulation is the idea of control. The IRS places significant weight on whether a taxpayer has an ownership interest in the raw materials or products throughout the process. 

In Suzy’s Zoo® v. Commissioner, 273 F.3d 875 (9th Cir. 2001) the IRS stated, “[t]he only requirement for being a ‘producer’ is that the taxpayer be ‘considered an owner of the property produced.’” A taxpayer can be a “producer,” moreover, even if it uses contract manufacturers to do the actual production. Despite Harborside buying cannabis only from its members that meet its quality-control standards, Harborside does not continue to have ownership interest of the cannabis plant/products from growing to packaging, making it fail the control requirement for Treas. Reg. §1.471-3(c).  

Internal Revenue Service is being consistent with its treatment of cannabis businesses and whether they should be considered a “producer” under Sec. 1.471-3(c). In Richmond Patients Group v. Commissioner, TC Memo 2020-52, the taxpayer attempted to argue it was a producer, but to no avail. The Court concluded that taxpayer lacked the ownership interest to be a producer and even analogized taxpayer’s facts with Harborside stating that “[n]o improvements were made to [cannabis] from the time it was purchased to the time it was sold.”

Although the Court of Appeals have yet to release an opinion on Harborside’s matter, more than likely they will affirm the lower court. The rift between cannabis and the IRS extends beyond §280E and we are now dealing with more of a §471 issue. There is much to be learned and gained from Harborside. The most significant is how to qualify as a “producer” for IRC §471 regulations. If Harborside would have made exclusive rights agreements with the growers (members) to only sell to Harborside, then ownership interests may have been established significant enough to satisfy §471 regulations. However, in some states, exclusivity agreements are prohibited. Or if Harborside would have retained ownership rights to the clones or seeds given to members to grow, then Harborside would have an even better argument that they are a producer. Again, some states do not allow for retailers to have this much influence over a producer (tied house laws). There are even more scenarios that other cannabis business models could implement to avoid the Harborside predicament and allow direct and indirect costs to be included in their COGS as a producer. If nothing else, Harborside continues, as it has done for over a decade, to act as a roadmap of the shifting sands and everchanging landscape of how cannabis and tax law interact. 

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