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Bad dreamer, what’s your name?
Looks like we’re riding on the same train
Looks as though there’ll be more pain
There’s gonna be a showdown

I have always thought that the August 29, 2013 “Cole Memo” is an amazing legal document. In case you’ve never read it, or in case you haven’t read it in a while, here’s a link: https://www.justice.gov/iso/opa/resources/3052013829132756857467.pdf

The Cole Memo was released by the U.S. Department of Justice (the “US DOJ”) in response to the fine people of Colorado and Washington passing ballot measures in November 2012 that legalized the commercial production and sale of marijuana for all persons 21 years of age and older. The Cole Memo summarizes the enforcement policies of the US DOJ concerning marijuana, and somehow concludes that federal US attorneys should just sit back and let commercial marijuana businesses sell marijuana to non-patient consumers right out in the open. On Main Street. In the middle of town. Smack dab in front of everyone driving down the road or walking down the sidewalk. When it’s clear as a crystal that every single person involved is violating federal law all day long.

How could this happen? Is the Cole Memo an enlightened piece of political pragmatism? A bold action by the Executive Branch in response to inaction by the Legislative Branch and a realization that the War on Drugs was a complete failure? A lazy cop-out by the Executive Branch because it didn’t have the stomach to either enforce or change the law? A nonsensical mish-mash of pretzel logic by the liberal elites in the Obama Administration? The Cole Memo is probably all of these things, and that’s what makes it so great. And without it, thousands of marijuana businesses and probably millions of marijuana consumers across the country would not be doing what they are doing today.

Under a different U.S. President and a different U.S. Attorney General, there might have been an entirely opposite version of the Cole Memo, which could have resulted in SWAT teams descending on medical marijuana businesses and in the federal government threatening state employees with imprisonment should they dare to implement the ballot measures. If that had happened back in 2013, I am quite certain that Oregon Ballot Measure 91 would not have passed in 2014, at least not in the form it took.

But I digress. What is President-elect Trump going to do once he affirms to the TV cameras that he will preserve, protect and defend the Constitution of the United States? I have read many articles discussing the possibilities, and most everyone’s conclusion, including mine, can be boiled down to: “Who the hell knows?” Things could get worse, for sure. On the other hand, maybe things get better and then it’s truly game over for federal prohibition in Oregon and other States that have legalized marijuana. Either way though, I suspect that the Cole Memo won’t survive the first six months of calendar year 2017.

From a business perspective, what is one to do with such uncertainty? Keep on keepin’ on seems like a logical choice at the moment. The industry was never for the faint-hearted, and there are enough other real day-to-day problems to deal with. So what’s the point of getting bogged down thinking about an unanswerable question when we’ll all know the answer soon enough. But what about those tip-toeing around the industry at the moment, like . . . uh . . . investors? If they’re not already in the game, they don’t need to do anything. They can sit on the sidelines and wait for more certainty. Or maybe they see an advantage in the uncertainty, and think they should move in now. Market inefficiencies lead to opportunities and all of that.

In any event, here’s why I’m writing this. If you are a client who engaged our firm to assist you in raising money at any time during the past few years, or if you are an investor who has invested in one of our clients, you have probably seen the following securities law risk factor in one of the investment documents:

Our business is illegal under federal law. Producing, manufacturing, processing, possessing, distributing, selling, and using marijuana is a federal crime. Under the Federal Controlled Substances Act of 1970 (the “Federal CSA”), marijuana is classified as a Schedule I drug, which is defined as having a high potential for abuse and no currently accepted medical use. Your investment in the Company may: (a) expose you personally to criminal liability under federal law, resulting in monetary fines and jail time; and (b) expose any real and personal property used in connection with our business to seizure and forfeiture to the federal government. We encourage you to carefully review the U.S. Department of Justice Memorandum for All United States Attorneys dated August 29, 2013 from James M. Cole (the “Cole Memo”), which summarizes the current enforcement policies of the U.S. Department of Justice (the “US DOJ”) concerning marijuana.

Now, I’ve been a securities law attorney for over 20 years and I can tell you that this is one of the craziest risk factors that’s ever been written in the history of securities laws. “Invest in our company and you can go to jail.”

Despite that doomsday scenario, I’ve had the feeling for some time now that nobody’s given it two seconds’ worth of thought. “Yeah yeah yeah, it’s against federal law. Thanks for the news flash. Now where do I sign?” Why did everyone just start blowing through this risk factor like they couldn’t care less? The answer I’m guessing is a mixture of: (i) the Cole Memo, and the fact that federal US attorneys have actually adhered to it for years; and (ii) the fact that so many people are involved in the industry now that there’s a feeling of safety in sheer numbers. “What are they going to do? Arrest everyone?”

Probably not. But a big chill could set in for a while if Trump’s Attorney General nominee Jeff Sessions says or does one thing rather than another. And so for now, I am unveiling a new securities law risk factor, which will appear, along with the original, in our documents for clients who are seeking to raise money from investors. To be sure, this one won’t last as long as the original Cole Memo risk factor. And as mentioned, I am guessing that both of these risk factors will be relegated to the dustbin in the near future, almost certainly to be replaced by a new one (hopefully better, but perhaps worse). For now however, behold the following, and keep on keepin’ on:

The federal government’s enforcement policies with respect to marijuana may change. Since the release of the Cole Memo, federal United States Attorneys having jurisdiction over Oregon have not attempted to prosecute any person whose commercial marijuana operation is in compliance with Oregon law. As a result of the United States presidential election held on November 8, 2016, Donald Trump is expected to become the next United States president on January 20, 2017. Mr. Trump has announced that he intends to nominate Jeff Sessions for Attorney General of the United States. If confirmed by the United States Senate, Mr. Sessions will head the US DOJ and dictate the US DOJ’s enforcement policies concerning marijuana. Mr. Sessions has previously stated his opposition to the legalization of marijuana, and may adopt US DOJ enforcement policies consistent with his position, including but not limited to a revocation of the Cole Memo. Any change in the US DOJ’s enforcement policies likely will have a material adverse effect on us.

Tonight, the longest night

Take it away Mr. Lynne: https://www.youtube.com/watch?v=m0cuCLTnkMM

Showdown lyrics © Sony/ATV Music Publishing LLC, Warner/Chappell Music, Inc.

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Major changes to the minimum salary requirements for exempt employees originally scheduled to take effect on December 1, 2016, are now on hold as the result of a ruling by a U.S. District Court judge in Texas.

As discussed in our November 7, 2016 blog post, the new rules would significantly increase the minimum salary requirements for the executive, professional and administrative employee exemptions (from $455/week to $913/week) and the minimum compensation for the highly compensated employee exemption (from $100,000/year to $134,004/year).

Twenty states joined together to challenge the new rules. On November 22, 2016, Judge Amos L. Mazzant III of the Eastern District of Texas issued a preliminary injunction blocking the new rules from taking effect. Since it is only a preliminary injunction, the judge can change his ruling after further proceedings, but that is seen as unlikely. The Obama Administration can appeal the ruling to the Fifth Circuit Court of Appeals, if it chooses to do so, but no decision has been announced.

The ruling means employers do not have to make any changes to current salary levels, at least until the courts make a final decision. Most employers already planned for the new rules, so it will be interesting to see how employees react when employers rescind their announced changes. We also don’t know the Trump Administration’s position on the proposed changes, so stay tuned.

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payday

On December 1, 2016, big changes are coming to the minimum salary requirements for exempt employees.  The U.S. Department of Labor is significantly raising the minimum salary that an employee must receive to qualify as exempt from overtime.

Employees who qualify for the professional, executive or administrative exemption will see their minimum salary rise from its current level of $455/week ($23,660/year) to $913/week ($47,476/year).  Employees who qualify for the highly compensated exemption will see their minimum compensation rise from its current level of $100,000/year to $134,004/year.

There is no phase in or grace period for the increased salary requirements.  The changes take effect immediately on December 1, so employers must be certain their salaries comply with the new rules on that date.  The consequences for not complying can be severe.  Not only will the employee be entitled to overtime for all hours worked beyond forty hours in a workweek, but the exemption may be permanently lost.

Keep in mind that in addition to the salary test, an employee must also satisfy the “duties test” to qualify as exempt from overtime.  In general terms, the employee must spend the majority of his or her time performing nonmanual, higher level duties of a professional, executive or administrative nature.  The Department is not changing the requirements of the duties test, but it makes sense for employers to take this opportunity to review the duties of employees who might qualify, to assure they satisfy the duties test.

Determining whether an employee qualifies as exempt can be very challenging.  You cannot rely on job titles or job descriptions, but must analyze the circumstances of each employee’s work.  It is not unusual to have two employees with the same job title and job description, but only one who qualifies as exempt because of differences in what they actually do on the job every day.

The penalties for misclassifying an employee as exempt and failing to pay overtime are harsh.  Of course, the employee will be entitled to back pay for the unpaid overtime.  In addition, under federal law the employee is entitled to penalty wages of double the amount of unpaid overtime and up to 30 days’ additional wages under Oregon law, plus interest in both cases.  State and federal regulators may also impose stiff civil fines for each violation.

Give us a call if you have any questions or concerns and we will work with you to assure you are in compliance.

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usda

Is there such a thing as organic marijuana? Like most things in the industry, the answer isn’t simple. Many cultivators use organic techniques. So yes, organic cannabis exists. However, can flower, concentrates, oils or edibles be marketed as organic? That answer is NO.

Federal Regulation of the Word “Organic”

Use of the word “organic” on agricultural products is regulated by the U.S. Department of Agriculture (USDA) under the Organic Food Production Act of 1990 (OFPA). Only agricultural products certified by approved agencies may be marketed as “organic”. Marijuana is considered an agricultural product under the OFPA, but the USDA will not certify marijuana as organic because the substance remains illegal under federal law.

“Organic” Marijuana Products

So where does this leave marijuana producers? Can a business name include the word “organic”? How can “organic” products be described to discerning consumers or sensitive medical patients seeking such products? Here are a few thoughts:

  • Business Name – In August 2014, the USDA issued a statement to its various certifying agencies stating that business names containing the word “organic” do not inherently constitute a false or misleading statement. Therefore, technically you can use the word “organic” in a business name BUT it may not be practical to do so (see labelling below).
  • Labelling – Remember, the key issue is to protect consumers by preventing false advertising and providing uniformity. Consequently, the USDA regulates how you can use “organic” in labeling products. There are two main product label parts: (1) the principal display panel (PDP); and (2) the information panel. The PDP portion of the package is the front, what consumers most likely see at the time of purchase. The information panel includes the list of ingredients contained in a product and other product information. We do not recommend using the term “organic” on the PDP for marijuana products. Therefore, if a business name includes “organic” it should not appear on the PDP. You may consider an assumed business name or branding product lines. However the information panel can be used to identify ingredients used in the product that have been certified organic.
  • Alternative Terms – Businesses can use other words or phrases to describe their products. Alternative terms such as “clean”, “natural”, “local”, “whole” and “sustainable” are not regulated liked the word “organic”.
  • Alternative Certification Programs – Lastly, there are alternative certification programs for the marijuana industry equivalent to organic certification. Currently two private companies have been created, Clean Green Certified and Certified Kind. Alternative certification costs approximately $1,800 to $2,000 per year. But remember, even with alternative certification, you cannot market products as “organic”.

Prior to the OFPA, organic food was regulated by the states. There were substantial differences in organic farm regulations from state to state. For example, by 1990 three states operated their own organic certification programs, four states used independent certification organizations, and fifteen states defined organic techniques but did not require certification. Organic farmers found the patchwork of state regulation to be confusing to consumers and lobbied Congress to pass federal law to provide consistent and uniform information to consumers and promote fair trade practice. My prediction is that states at the forefront of marijuana legalization will begin self-regulating, similar to the food industry. In fact, Oregon passed the nation’s first organic certification law in 1973. Maybe Oregon will lead the way again by developing marijuana industry standards.

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If a tax practitioner tells you the Tax Court cases of CHAMP and Olive are singularly unfavorable to cannabis businesses, he or she is not telling you the whole story.  In both cases, the court was faced with the unfriendly language of IRC § 280E.  In both cases, the outcome would have been worse for the taxpayer if the court had not used its discretion to make favorable determinations on key issues.

The Ninth Circuit opinion in Olive v. Commissioner (link is to pdf) may indicate the Ninth Circuit is continuing this trend.  The opinion appears to provide subtle, but much needed, support for the “non-trafficking trade or business” model made famous in the CHAMP case.  Summarizing briefly, the model essentially allows a cannabis business that includes substantial non-trafficking business activities to reasonably allocate expenses to a non-trafficking trade or business, thereby permitting deduction of 100% of the allocated portion of the expense.

Right now, many CPAs are loathe to sign a tax return that respects a non-trafficking trade or business.  This may be because of an argument made by Edward Roche in his respected 2013 journal article on the taxation of cannabis businesses.  Professor Roche, in an article is of considerable breadth, laid out in detail the complex legal arguments needed for a retail cannabis business to permissibly pay federal income taxes at sustainable levels.

However, one of Professor Roche’s conclusions was that the tax law makes it difficult to establish a second trade or business and therefore difficult to treat that business as non-trafficking for purposes of IRC § 280E.  Appearing to follow the Tax Court’s lead in Olive, he applied a multi-factor analysis from the Trupp case applying the rules of IRC § 183, relating to hobby losses, to the question.  He did not, however, consider accounting method cases under IRC § 446, which also address the issue and are likely in some cases be more favorable to the taxpayer.

The Ninth Circuit’s analysis in Olive, in contrast, comes close to suggesting single factor test for identifying a second trade or business.  The court provides an analogy to a book-store that either (A) provides free coffee and cookies, etc., or (B) charges for coffee and cookies, etc.  In the first example, there is one trade or business.  In the second, there are two trades or businesses.  Although the treatment of the issue is almost cursory, and appears to be offered merely to distinguish Martin Olive’s facts from the facts in CHAMP, it is arguably more consistent with the way multiple trades or businesses are treated in the accounting method cases.

So what is the takeaway from this newest piece of IRC § 280E law?  As always in tax, facts are king.  Cannabis businesses with significant non-trafficking activities should work with a specialist in this area to determine whether those activities rise to the level of a non-trafficking trade or business.  If they do, a written plan should be put in place to reinforce that determination and, if appropriate, offer penalty protection to the business.  If they do not, it is reasonable to ask what substantive changes could be made to the way the business operates to change the determination.

If the CPA is not on board, a dialogue needs to occur with the CPA.  The question is, what will give the CPA comfort that he or she can sign a tax return consistent with the plan?  As was clear in CHAMP, and is now clear from the Ninth Circuit opinion in Olive, a decision to operate a cannabis business as a single trade or business for tax purposes can significantly reduce the amount of money the business generates for its owners on an after-tax basis.

For a cannabis business, engaged in non-trafficking business activities, it may be worth consulting with your cannabis tax attorney to determine whether the Ninth Circuit opinion in Olive, or other applicable caselaw, permits the allocation of expenses to a non-trafficking business where they may be deducted.
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Indian reservations now have the opportunity to cultivate and sell cannabis if they so choose under authority granted to them from the Department of Justice. The federal government has made it clear that if tribes approve legislation to legalize cannabis, it will not interfere with the process. Though there is some reluctance to follow through given the substance abuse problems already prevalent on reservations, Indian tribes are at least interested in learning more about the potential impacts of the cannabis industry.

Launched just over a few weeks ago at a reservation economic summit in Las Vegas, the National Indian Cannabis Coalition (“NICC”) is the nation’s first Indian trade organization focused on marijuana and Indian tribes.

The NICC seeks to educate the Indian community about the legalization and regulation of on-reservation marijuana. One of the NICC’s main goals is to help guide Indian tribal members who are interested in cannabis cultivation. Specifically, the NICC aims to provide information on cannabis medical benefits, methods of production and investments with public health and safety considerations. The NICC is also aware that proper financing and design plans are necessary for effective cannabis cultivation and it hopes to assist tribes with these issues as they decide to move forward. Furthermore, the NICC firmly believes that a united front from Indian tribal leaders will bring about more strength and power in the cannabis industry.

NICC co-chair Allyson Doctor, one partner of a licensed cannabis facility in Northern Las Vegas, hopes that the organization will help answer questions related to cannabis policy and regulation. Doctor also hopes that the NICC will help fill gaps in an area where such a resource is needed at this time. According to Doctor, though many tribal leaders are supportive in moving forward not everyone is equally as thrilled. Some tribes feel that it is not in their best interest to actively participate in this industry.

Currently, the NICC is not charging tribal members any membership fees, but hopes to cover its costs through vendor sponsorship. Doctor also hopes that such sponsors could serve as potential partners for the Indian community in the near future. This is particularly important for Indian tribes who are interested in marijuana cultivation in territories located in states where there is currently no retail or medical marijuana industry present.

In addition to the NICC’s formation, other organizations are running legal conferences directed at Indian tribal governments who are considering whether to legalize for medical, recreational, or agricultural purposes. It is likely that the NICC will be active in such future conferences as the goals of such conferences, and the NICC, will overlap substantially. These types of conferences will provide yet another arena for Indian tribal leaders to learn the ins and outs of the cannabis industry.

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Section 280E – not so simple after all

Despite what your eyes are telling you, “trade or business” is actually one word; but “trafficking,” means just that. Section 280E essentially provides that a cannabis business may not deduct its expenses. However, a close look at its language reveals surprising complexity.

If your business has anything to do with cannabis, it might be subject to Section 280E of the Internal Revenue Code. How can you tell if your business is subject to IRC § 280E? You consider whether it meets the following two elements of the statute:

Is your business a “trade or business” under the Internal Revenue Code and
Do the activities of that business include prohibited trafficking.

The term “trade or business” is a defined term under U.S. and Oregon tax law. The term essentially means any collection of activities engaged in with regularity and continuity with a profit motive. A business will not be a “trade or business” if there is not some activity engaged in with regularity and continuity. Consequently, the business of renting a warehouse to a cannabis grower would not generally be subject to Section 280E, but the business of delivering medical marijuana to patients would be.

What does that mean? It means that a landlord, even a landlord knowingly renting to a cannabis business, should be able to deduct expenses relating to his or her real property (buildings and land). Why? Because the landlord, while clearly being “in business” is not engaged in a “trade or business.”

Even if there is sufficient activity for a business to rise to the level of a “trade or business,” that business will only be subject to Section 280E if the activities of that business include prohibited trafficking. What is prohibited trafficking? That is actually a great question, and not one your tax professional is necessarily able to answer.y

A quick search of the internet under Section 280E and Oregon will reveal a range of articles, including blog posts, suggesting that “trafficking” under Section 280E is a term with vague and unspecified meaning under the Internal Revenue Code. That is not so. Rather, the Section 280E incorporates federal and state criminal law by reference.

That is why it is important to work with experienced Oregon cannabis attorneys, familiar with principles of U.S. and Oregon income tax law, to determine whether your business is subject to Section 280E of the Internal Revenue Code.

 

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Cost of Goods Sold.  Deductible or not deductible?  That is the 280E question.
Section 280E of the Internal Revenue Code disallows many expense deductions for most Oregon cannabis businesses.  It is well known that Section 280E creates a significant handicap for a cannabis business when compared to its non-cannabis brethren.  However, a cannabis grower or a dispensary owner coming terms with their tax liabilities will eventual learn about “cost of goods sold” and its promise of deductible expenses.  
 
What is “cost of goods sold?”  
(COGS) is an accounting concept, also existing under U.S. tax law, that approximates the cost of inventory sold during the year.  Its purpose is to match the cost of inventory to the year in which the inventory is sold.  
Under generally accepted accounting principles (GAAP), the so-called “matching” of expenses to revenue is necessary to accurately reflect the income of an inventory business.  Without that matching, income of a business could vary significantly from year to year, depending on inventory levels, making it difficult to gauge the health of the business.    
 
COGS takes on greater significance in the Section 280E context because of its place in the calculation of income under U.S. and Oregon tax law. Rather than being just another deduction disallowed by Section 280E, COGS is technically an adjustment to income.  Thus, Section 61 of the Internal Revenue Code, and the Treasury regulations under that provision, state that “gross income” for tax purposes is actually gross receipts minus COGS. 
Clearly this is a complicated process and requires coordination with expert. At Emerge we are very careful to recommend and connect people in the Oregon cannabis industry with accountants who are well versed in 280E and Cost of Goods Sold. In an environment extremely unfriendly to cannabis businesses effectively tracking and reporting COGS can have a significant impact on the survival of your business.
An Oregon cannabis lawyer can provide assistance to a cannabis business and its accountants exploring the use of beneficial rules in this area.
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Support for the ongoing planning process that is managing a business is a big part of why a marijuana business can benefit from a good relationship with its CPA. If having an accountant is new to you, think of him or her as someone that can provide you with an extra set of eyes and ears for your business. The process of checking in with your accountant regularly should help you anticipate financial and tax problems before they threaten to disrupt your business or personal finances.

280E

Two potential threats to Oregon medical marijuana businesses came to mind when I saw this article published by USA Today: http://www.usatoday.com/story/news/nation/2014/11/03/irs-limits-profits-marijuana-businesses/18165033/

The first is the difficulty of managing reimbursements for a tax liability that may not be calculated until the following year. The second is the ongoing drag on a business that is struggling to pay off back taxes in its second year of operation.

Under The Oregon Medical Marijuana Act (“OMMA”), a medical marijuana business is generally permitted to accept reimbursement for its normal and customary costs of doing business. Presumably that includes taxes.

But, how is reimbursement of tax expense to occur if the taxes (1) are not paid on an ongoing basis and (2) are not even known in amount until the tax return is prepared the following year? It appears that to comply with OMMA, the tax compliance process may need to to be a year-round endeavor. An Oregon medical marijuana business should engage its accountant to help it juggle the sometimes conflicting requirements of the reimbursement model and the Internal Revenue Code.

The business owner mentioned in the USA Today article apparently operated his business at a financial loss in its first year and discovered he was deemed to be profitable under the Internal Revenue Code. As a result, he owed $20,000 of income tax for a business that lacked the cash to pay it. Given the amount owed, it is not surprising he is paying that tax over time (it appears he entered into an installment arrangement with the IRS). However, he would presumably rather use the money to pay his current year tax liability or, better yet, use it to help grow his business.

This article is a cautionary tale, for sure. An Oregon cannabis lawyer, specifically a tax attorney, can help guide you through this process. Knowing up front your tax liability and potential pitfalls can help your cannabis business in Oregon avoid outstanding liability and the ultimate failure of your cannabis business.

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