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Oregon’s 25% Sales Tax on Early Sales

* * * Updated January 21, 2016 * * *
Oregon’s the new sales tax is applicable to medical dispensaries that have so-called “early” or “recreational” sales to non-medical customers under SB460 from January 4, 2016.  The Oregon Department of Revenue (“ODR”) released temporary tax regulations that medical dispensaries with such sales need to be aware of as they move into the new year.
A pdf of the regulations can be dowloaded from ODR’s marijuana tax page.
General Requirements of the Sales Tax
1.  The tax starts January 4 on rec. sales to dispensary customers;
2.  The tax is 25% of the retail price of the seed, flower, leaf, or nonflowering plant;
3.  The amount of the tax must rounded up to the next whole cent;
4.  The tax should be separately itemized on customers’ receipts and must be disclosed to the customer;
5.  The tax should be collected from customers;
6.  The tax must be deposited with ODR using the payment voucher in the month after the sale;
Some “To-Do” Items for January 4
Register for the new tax, if applicable.  ODR has provided a form for this purpose.
Dispensary POS systems should be set up to calculate sales tax on “early” sales, rounding up to the next whole cent, and to generate receipts that separately state the amount of the tax.
Internal accounting folks will need to track early sales from January 4, 2016.
Prepare to make a deposit, using the newly released ODR voucher, in February for January sales.  A prior appointment is required if you will pay in cash.  Interestingly, ODR felt it necessary to communicate it is not interested in cash that was removed from a body cavity, corpse, or animal.
Happy holidays and new year!
Update
Under the current OLCC regulations, which will be applicable to recreational sales, there are a range of rules that appear intended to prevent tax motivated “bundling.” In a previous version of this blog post, I wrote that those rules would apply to early sales. Based on public comments, it appears the Oregon Department of Revenue does not consider those rules to apply. Note that care should be taken to document the retail sales price and the amount of the tax collected in each transaction to which the sales tax applies.
“Bundling” is selling items subject to a sales tax for a low price, so long as the customer also purchases a high-priced item that is not subject to a sales tax.
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The Ninth Circuit Applies 280E

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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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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 “I tell ya I don’t get no respect. No respect at all.”

 rodney

If Sections 42 and 58 of Ballot Measure 91 were able to talk during the 2014 political campaign, this is what they might have said. These Rodney Dangerfield-like provisions were not merely ignored by dozens of city councils who “preemptively” adopted ordinances that taxed recreational marijuana. The provisions were expressly acknowledged by the city councils, and then duly ignored. Ouch.

To refresh everyone’s memory, here’s what these fine provisions (which were copied verbatim from Oregon’s current liquor statutes) have to say for themselves.

Section 42. State has exclusive right to tax marijuana. No county or city of this state shall impose any fee or tax, including occupation taxes, privilege taxes and inspection fees, in connection with the purchase, sale, production, processing, transportation, and delivery of marijuana items.

Section 58. Marijuana laws supersede and repeal inconsistent charters and ordinances. Sections 3 to 70 of this Act, designed to operate uniformly throughout the state, shall be paramount and superior to and shall fully replace and supersede any and all municipal charter enactments or local ordinances inconsistent with it. Such charters and ordinances hereby are repealed.

Could these provisions be any clearer? What kind of legal analysis would cause anyone to think that a local tax might be “grandfathered in” if an ordinance was adopted before Election Day? Don’t the words “replace,” “supersede,” and “repeal” expressly contemplate preexisting ordinances?

The political analysis seemed to be just as sophisticated. As far as I could tell, it boiled down to something like this: “Well it’s probably not going to work, but everybody else is doing it, so let’s just do it too.”

But hold on. Not so fast. There are always heroes, both major and minor, to every story. And one of my favorite moments in the campaign came from the Banks City Council when they were discussing the adoption of an ordinance that would have taxed recreational marijuana. “Essentially, this is posturing?” Councilor Rob Fowler asked. “Yes,” answered city attorney Dan Kearns.

I’m a sucker for straight talk, and so that made me smile.

But all of that was yesterday. Election Day has come and gone. The campaign is over, the votes have been counted, and the time for serious thinking and implementation is here.

And so, I thought, it might be helpful if everyone fully understood the two main themes of Ballot Measure 91.

The first theme is an adherence to the eight federal enforcement priorities regarding marijuana that are specified in the US Department of Justice Memorandum dated August 29, 2013 by Deputy Attorney General James M. Cole. These eight priorities, which are set forth in Section 1 of Ballot Measure 91, are as follows: (1) preventing the distribution of marijuana to minors; (2) preventing revenue from the sale of marijuana from going to criminal enterprises, gangs, and cartels; (3) preventing the diversion of marijuana from states where it is legal under state law to other states; (4) preventing state-authorized marijuana activity from being used as a cover or pretext for the trafficking of other illegal drugs or other illegal

activity; (5) preventing violence and the use of firearms in the cultivation and distribution of marijuana; (6) preventing drugged driving and the exacerbation of other adverse public health consequences associated with marijuana use; (7) preventing the growing of marijuana on public lands and the attendant public safety and environmental dangers posed by marijuana production on public lands; and (8) preventing marijuana possession or use on federal property.

All Oregonians, regardless of how they voted on Ballot Measure 91, should be in favor of these priorities. In that sense, and with respect to those priorities, we are all on the same side.

The second theme of Ballot Measure 91 is to minimize the illegal marijuana market to the greatest extent possible. This is perhaps implied by the Cole Memo, but I think it deserves its own special emphasis, as minimizing the illegal market is, in my opinion, one of the primary means by which Oregon can accomplish the goals in the Cole Memo. (Note that it could be that said that Washington’s Initiative 502 adheres to the enforcement priorities in the Cole Memo. However, I think few would say that Initiative 502 was drafted in a way to minimize the illegal market to the greatest extent possible.)

To minimize the illegal market, private businesses should be incentivized to enter, and remain in, the regulated market. Likewise, adult consumers should be incentivized to purchase marijuana from licensed retailers rather than from an illegal non-taxpaying dealer.

Now, it should go without saying that the tax structure in any marijuana regulatory scheme will play a vital role in minimizing the illegal market. After consulting with national tax policy experts, and after examining different hypothetical tax models for marijuana, we adopted five tax philosophies for Ballot Measure 91: (A) tax as early as possible in the distribution channel; (B) tax by weight rather than by price; (C) remain watchful with respect to how the illegal market responds to the legal market; (D) remain flexible in responding to the illegal market; and (E) ensure that the State is the sole taxing authority.

A cohesive tax policy that can compete with and respond to the illegal market will be virtually impossible if dozens of local jurisdictions are able to continually and sporadically impose different and uneven taxes.

There may come a time at some point in the future when matters stabilize to such a degree that the illegal market is no longer of any practical consequence. However, until then, the Oregon legislature and the various city councils that adopted marijuana tax ordinances should respect the will of the majority of Oregon voters by not amending, and by following, the clear language and intent of Sections 42 and 58 of Ballot Measure 91.

Specifically, the Oregon legislature should resist amending these sections during the 2015 and 2016 legislative sessions. The city councils that adopted the ordinances should repeal them, or at least suspend them while Ballot Measure 91 is given a chance to be implemented in accordance with its terms. A city council that seeks to impose a marijuana tax in clear violation of Sections 42 and 58 of Ballot Measure 91 will collect nothing and will simply waste time, money, and energy defending a lawsuit that cannot be won.

Naturally, the desire to raise tax revenues from a new source is tempting. However, Ballot Measure 91 already distributes tax revenues to cities, counties, schools, law enforcement, and mental health, alcoholism, and drug services. Let’s call that good enough for now. Because in the long run, minimizing the illegal market sooner rather than later will result in more tax revenues for everyone.

Ballot Measure 91 provides the State of Oregon and every local government with a unique opportunity to implement a new policy and to create something of lasting value, while at the same time promoting public safety and a more sophisticated dialogue concerning the subject of marijuana. Imagine the pleasant surprise and pride that current and future Oregonians might feel if all areas of state and local government are able to cooperate, execute, and perform in a constructive manner and successfully implement Ballot Measure 91. If such a thing were to happen, more than one future Oregon voter might have reason to say: “I gotta tell ya. You earned my respect.”

You can read the published version in the Oregonian.

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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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