The IRS Has a New Weapon in Its War on Weed

It should go without saying that the federal government is no friend to legal cannabis.

Since the late 1970s, when the nation’s first medical cannabis law was passed by the New Mexico state legislature, the feds have been pushing back against state-level decriminalization through every government agency available, from the DOJ and FBI to the NIDA and FDA. Then of course, there’s that crucial but often overlooked ingredient in the scalding hot alphabet soup the feds force feed state-level decriminalization efforts: the IRS.

Nobody loves the IRS — this isn’t exactly a cannabis industry thing — but most industries see the agency’s existence as a necessary evil. Then again, for most industries, it represents little more than a regularly scheduled fiscal inconvenience. For legal cannabis companies, the IRS is more than just an expensive annoyance; it’s a major obstacle that can make operating a business prohibitively expensive.

There are numerous ways the federal government uses the tax code to undercut legal cannabis, chief among them Section 280E of the tax code, which bans the deduction of basic business expenses by companies involved in business connected to the sale of Schedule I or II substances, which the IRS considers “trafficking.”

As a result, many cannabis enterprises, particularly those dealing directly with the plant, end up carrying effective tax burdens upwards of 70 percent — more than double the average corporate rate of 30 percent. This has had a pronounced chilling effect on legal cannabis, causing many businesses to scale back initial plans or pull out of the industry completely when they discover how expensive it would be to pay these astronomical federal tax rates in addition to whatever taxes and fees they pay to their state government.

But at the start of 2018, the IRS escalated its war on the legal cannabis industry by expanding to a new front: nonprofit organizations and lobbying groups formed to promote cannabis legalization. The policy change was announced in an agency bulletin outlining several recent revisions to agency procedures.

From the IRS bulletin:

Section 3.02 was amended to include that the Service will not issue a determination letter when the request concerns an organization whose purpose is directed to the improvement of business conditions of one or more lines of business relating to an activity involving controlled substances (within the meaning of Schedule I and II of the Controlled Substances Act) which is prohibited by Federal law regardless of its legality under the law of the state in which such activity is conducted.

It remains to be seen if this new policy will result in long-standing industry advocacy nonprofits having their nonprofit tax status revoked, but Jerry Chin, an accountant from California, told Marijuana Business Daily that the broad scope of the language makes it a “distinct possibility.”

“What the IRS is saying is, if your trade association’s main purpose is the advocacy of a Schedule I substance, then we’re going to deny your application for that fact alone,” Chin said. “The IRS does have the ability to say, ‘Hey, we’re going to review your status and perhaps revoke it based on this.’”

Chin and other observers fear that the vague language of the agency’s restrictive standard presents a potentially disastrous possibility, not just for trade organizations like the National Cannabis Industry Association — which became the first federal cannabis industry lobby group when it registered as a 501(c)6 nonprofit in 2010 — but also for groups not directly advocating on behalf of businesses but pushing for decriminalization policies.

In this worst-case scenario, the IRS would revisit the nonprofit status of trade associations as well as policy advocacy organizations and their state-level chapters, meaning hundreds of individual groups could be affected.

The immediate practical impact of losing nonprofit status is obviously financial — trade associations without 501(c)6 status have to pay 21 percent in taxes on profits, reducing their organizational efficacy. And even if the new policy is only applied to new groups applying for nonprofit status, it could still have a pronounced chilling effect on the growth of the legal cannabis industry — which is sort of the point.

Other industry experts, like the NCIA’s general counsel Henry Wykowski, say that doomsday scenario is unlikely: The new policy doesn’t give the IRS free reign when it comes to revoking nonprofit status, so it would still have to show cause for doing so. Even then, the organization facing revocation would have legal recourse by challenging the action in tax court.

From MJBIZ Daily:

“You would have to run afoul of your obligations as a tax-exempt organization before they could just take it away,” he said. “It’s not like it’s completely discretionary.”

However, because the policy is new, nobody knows for certain how broadly or aggressively the IRS will apply it. But, as is often the case where it concerns national policy on state-legal cannabis, the deep uncertainty is part and parcel of the federal government’s overarching mission to destabilize and undermine legal cannabis.

TELL US, have you faced tax challenges because of your cannabis business?