Tax requirement in co-op bill raises legal questions, IRS denies pot expenses

In Stormy Ray's proposed legislation for medical marijuana cooperatives in Oregon, there is a mandate for a new sort of "income tax." The medical marijuana cooperative bill, LC-978*, will be presented to the legislature in the coming week, according to Stormy Ray of the Stormy Ray Cardholders' Foundation.

While it makes sense to pay an income tax on net profit like any other business, LC-978 will require medical marijuana cooperatives to pay an additional "income tax" based on a flat 10% rate to the Oregon Department of Revenue.  This tax will be comprised of the following:

• 5% to the Oregon Health Authority (formerly DHS) for the purpose of administering the OMMP
• 2.5% to the Oregon General Fund
• 2.5% to the Criminal Fine and Assessment Account established under ORS 137.300

This tax will be in addition to regular income taxes required for the cooperative as a "business" entity, as well as personal income taxes for all members who may receive dividends.

While the tax itself is troubling, especially since it requires medical patients to help fund an account designated for law enforcement, there are further concerns coming to light in recent days.  A January 8 New York Times article on a raid in California highlights a recent concern regarding medical marijuana cooperatives.  Harborside, one of the largest dispensaries in California, is currently being audited by the IRS, according to Chief Executive Officer Stephen DeAngelo:

Though federal authorities have halted raids on medical marijuana dispensaries under the Obama administration, the I.R.S. has shown a new interest.

Harborside officials said the I.R.S. was raising questions about a section of the tax code known as 280E. That section, aimed at drug kingpins, prohibits companies from deducting any expenses if they are “trafficking in controlled substances.”

That section of the Federal Tax Code clearly states that expenses incurred while “trafficking in controlled substances” are not allowed to be deducted:

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.

According to DeAngelo: “Our contention is that what we’re doing is legal and not trafficking, and it’s not appropriate to apply it to us."  There are no additional taxes mandated under the California law, although some localities have attempted to implement some sort of medical marijuana tax.

If Oregon cooperatives cannot deduct their costs of operating the cooperative from their taxes, and are then mandated to pay an additional 10% tax on top of federal and state income taxes, how can Stormy Ray claim that this bill is meant to help provide an “affordable supply system?”

Even Harborside, among the largest and most successful of California’s medical marijuana dispensaries, is concerned that this tax code is so burdensome that Harborside “could be taxed out of business if the law was not changed.”  A 2007 Tax Court finding against Californians Helping to Alleviate Medical Problems Inc. solidified this interpretation of Section 280E:

Forty-seven percent of the members suffered from AIDS; the remainder had cancer, multiple sclerosis and other serious illnesses. On its final tax return for 2002, the taxpayer showed a $239 loss. The IRS denied all the nearly $213,000 in deductions because, it concluded, the taxpayer’s principal purpose was to traffic in marijuana.

Cooperatives will be paying taxes far higher than any other business in Oregon, before even accounting for the new “income tax” imposed in this bill.  This will not make medical marijuana more affordable for patients – and it could potentially set them up for criminal prosecution for tax evasion if they do not calculate the taxes correctly.

DeAngelo sums it up nicely: “This is an industrywide issue.”

*Correction: LC-978 was originally printed as LC-798 in error.