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April 8, 2015
Tax Professionals and IRS Grapple With Changing Pot Laws
by David van den Berg

Full Text Published by Tax Analysts®

This article first appeared in the April 8, 2015 edition of Tax Notes Today.

The IRS recently settled a case in which it agreed to refund penalties assessed on a marijuana dispensary for paying its taxes in cash -- a potential sign, if a small one, that tax representatives for the industry will be facing fewer risks and less stigma than they did even a few years ago.

Allgreens, a Denver medical marijuana dispensary, settled with the IRS in March, according to Allgreens' attorney. The dispensary challenged the penalty in a Tax Court petition filed in June 2014, arguing that federal banking regulations prevented all licensed marijuana businesses in Colorado from openly holding bank accounts, leaving it with no alternative but to pay its taxes in cash. (Allgreens v. Commissioner of Internal Revenue (Docket No. 028012-14).)

In a January 29 response to Allgreens' petition, the IRS admitted that its settlement officer determined that the business was making every effort to comply with the law but the officer still denied an abatement request -- encapsulating the challenges facing an industry considered legal under some laws but not others.

Nevertheless, Colorado attorney Rachel Gillette, who represents Allgreens, told Tax Analysts that she considers the settlement one of the higher-profile successes of her career. In addition to the IRS concession, the agency will abate outstanding penalties and refund those already paid, she said, adding that the case will be moot and Allgreens will move for dismissal.

Industry tax representatives are split on what the Allgreens case means for their practice and the industry generally.

Scott Levy, an Arizona CPA who started working with clients in the marijuana industry in 2013, said it's always promising when the government backs down from an argument. "One has to wonder if the IRS knew they were going to lose the case and settled, so that a precedent could not be set," Levy said. "We will see moving forward how strict they remain in assessing that cash-only penalty and how they will respond to future abatement requests."

William Taggart, an Oakland, California, lawyer who works with clients in the medical marijuana community, downplayed the IRS's action. "The decision in the Allgreens case is simply a pragmatic decision over how the IRS should spend money," he said. "It would cost the IRS more to litigate than it [would] collect."

When asked for a response, the IRS said federal law prevents the agency from commenting on pending litigation.

The Denver Post first reported on the resolution of the case March 19.

Whatever the legal significance of the Allgreens case, for Gillette at least, the climate has changed dramatically for practitioners working with the marijuana industry since 2010, which is when she started her practice upon leaving a tax position at a larger firm.

Gillette, who is also executive director of the Colorado chapter of the National Organization for the Reform of Marijuana Laws, said that she enjoys working in an ever-changing area of law and that she believes marijuana laws need reform.

Gillette, Taggart, and Levy are part of a community of lawyers and accountants who at least occasionally work with marijuana businesses. Those businesses are part of an industry gaining legal acceptance at the state level as the drug remains illegal under federal law and as IRC section 280E bars anyone trafficking in marijuana and other controlled substances from receiving any deductions or credits for activities related to that drug trafficking.

Since 2012 voters in four states and the District of Columbia have passed ballot measures allowing for at least some recreational marijuana use, while more than 20 states and the district permit marijuana use for medical needs. Oregon and Alaska passed their ballot measures in 2014, when the industry grew 74 percent to reach nearly $3 billion in sales, according to a report from the ArcView Group, which calls itself the largest cannabis investor network.

Lawyers who work with clients in the marijuana industry tend to have "an affinity" for it and know people working in it, said Sam Kamin, a University of Denver law professor. They also are disproportionately younger and less experienced, he said, and smaller or more specialized firms are generally the ones working with the industry.

"If the industry becomes more stable (and more explicitly legal), this will certainly change," he said.


Feds Still Lurking

Edward Roche, a University of Denver law professor, said he guesses that practitioners working with the industry won't get in trouble for representing a business that's illegal under some laws, and they can actually make a lot of money. But he said it's risky, and he's turned down requests for help.

"It's probably not going to cost my license, but I don't feel comfortable with doing something that probably is not going to cost me my license," he said. "The people who are doing this business I think are legit lawyers and accountants, providing necessary professional services to a business the people of Colorado have decided should be legal," he added. "I mean it's not like they're the mob lawyers."

For investors and practitioners, working with ancillary businesses is less risky, Kamin said. Working exclusively on the medical side of the marijuana industry is a little safer, but there isn't a true safe harbor there, he said.

Gillette said that she never thought twice about accepting Allgreens as a client and that she does not offer advice on breaking the law. When she started her practice, she was aware of the legal risks of representing marijuana businesses, she said.

"I've always taken the position that these laws are complex and these businesses should have the benefit of legal counsel when it comes to state and local laws," Gillette said.

In a 2013 article, Roche noted that the Maine Professional Ethics Commission ruled that lawyers cannot aid clients working in the medical marijuana business. However, he also wrote that the Arizona State Bar Association ruled that lawyers could ethically assist clients in conduct allowed by Arizona's medical marijuana law, so long as they advised clients regarding the potential implications of their actions under federal law. (Roche article available for download: http://goo.gl/sEy844.)

The IRS Advisory Council, in its 2014 public report, called for prompt guidance to clarify that tax professionals won't be considered unethical, be targeted for an audit, or be deemed in violation of Circular 230 just for representing or preparing a return for a business considered illegal under federal law but permitted to operate under state law.

The Colorado Supreme Court in 2014 also adopted a comment to the state rules of professional conduct stating that lawyers may ethically assist marijuana businesses in conduct that state law allows but they must inform their clients about federal laws and enforcement policies. To Roche, the comment says it's permissible not only to advise marijuana businesses on state law but to help them get leases, work on collective bargaining agreements, and engage in similar business activities.

"And the problem is that that's still a federal crime -- aiding and abetting a continuing criminal enterprise," Roche said. A new federal administration less accommodating to the marijuana industry could order prosecutions of businesses in it, he said, citing New Jersey Gov. Chris Christie (R), who has been discussed as a potential presidential candidate, as an example.

"And so maybe they prosecute their lawyers, too," Roche said. "So we'd have a lawyer who has committed a federal crime, is convicted of it, is serving time, but I think -- in my opinion -- can't be disbarred because he was operating within a Supreme Court opinion that said it was ethical to do it."

Gillette, however, said the court opinion made her more comfortable with representing clients in the marijuana business. She also said it's led more large firms to assist marijuana businesses, "which I don't necessarily think is a bad thing."


IRS Budget Crunch Opening Doors?

Despite the risks, lawyers and accountants are slowly opening up to the idea of joining those already working with the marijuana industry, said Kris Fowlkes of Pinnacle Consultation in Colorado Springs, which helps marijuana firms get started. One reason, he said, is fewer IRS audits of businesses in the cannabis industry.

"The last time I got a figure from our accountant it dropped like 600 percent in the past two years," Fowlkes said of the audit rate.

The IRS's budget crunch is proving beneficial for clients, Levy agreed. So far, none of his clients have run into major problems with the IRS -- just an occasional minor notice or information request, he said.

"While the IRS has remained stalwart in seeking to audit these businesses and apply [section] 280E, the fact that so many more of them have opened in recent years means [its] reach is not as great as it once was," he said. "More of these businesses are opening all the time, but the IRS's manpower and budget remain static. So that has caused many of my clients to feel more comfortable in taking slightly more aggressive stances on their tax returns than they might have a few years ago."

While Levy said his clients are taking slightly more aggressive tax planning approaches, he added that businesses lacking access to the banking system who do that put themselves at greater risk with the IRS.

"Obviously, not having banking creates a situation where there is not as much of an audit trail for the client to document their expenses," he said. "So without a bank account, these businesses are taking a greater risk with aggressive tax stances, since it may be more difficult for them to properly document all of their expenses to begin with."


Being Kept Out of Banks Invites Trouble

According to Fowlkes, that lack of a paper trail leaves room for exploitation. "Keeping our industry out of banks only makes it easier for the very few bad apples to do the wrong thing, such as the obvious tax evasion," he said, adding that section 280E reform would not only make more tax breaks available to marijuana businesses but would also lead to greater compliance.

Jim Marty, a Denver CPA who has both a marijuana practice and a separate practice for non-cannabis clients, said businesses growing or selling marijuana can find ways to isolate those activities from other parts of their operation, and that how cannabis firms structure their operations is important.

Marty said that marijuana businesses that take aggressive tax planning approaches are dealing with the law. "Well, you know, they're trying to find ways to avoid getting totally clobbered by 280E," he said.

Marty wasn't alone in invoking the importance of 280E for marijuana businesses. Levy did, too, and said he offers his marijuana industry clients tax planning and return preparation services.

"In my view, tax planning and preparation go hand in hand as part of the service I provide my clients," he said. "Given the crucial role planning can play in the basic survival of these businesses, as a result of 280E, I view that as the most vital part of what I do for them."

When it comes to return preparation for marijuana businesses, Roche said, "I'm not so sure that it's not OK because they do have a legal obligation to comply with the tax law and maybe you're just helping them comply with the law on past facts."

But Fowlkes maintains that ancillary businesses not directly growing or selling marijuana actually do shoulder the same risks as those who are. He spoke with a Tax Analysts reporter at a marijuana industry trade show in Washington and said that merely attending that event could be considered a conspiracy to commit a federal felony.

"That's the reality of what we live every single day," he said.


No Fears of Imminent Federal Prosecution

But despite living in that world, none of the practitioners who spoke with Tax Analysts expressed any immediate fears of being prosecuted for working with clients in the marijuana industry. And Kamin said there's not much reason for them to. The fear of prosecution for otherwise ethical conduct is fairly remote, he said. Concerns about professional sanction or loss of other business are more realistic, he said.

Fowlkes, from his experience, seemed to back that up. While he said there is more fear of prosecution on the East Coast than in other parts of the country, in general, when lawyers and accountants turn down his firm's overtures, it's not out of fear of jail time.

"Normally the people that say no are doing it on a personal basis, not so much on a fear basis or any logical reason. . . . We definitely carry a stigma with us," he said, adding that stigma may be easing.

For now, Fowlkes said, marijuana firms tend to choose the same accountants to represent them, and those professionals aren't afraid of working with the business. But he said they're not advertising their cannabis work and don't want to be known as "cannabis tax guys," he said.

"I could name three accountants, and I would say at least 70 percent of the licensees in Colorado use those three accountants," he said.

Fowlkes also echoed Roche's comment that those professionals can make a lot of money from working with marijuana firms. They may be able to charge a marijuana business double or triple what they charge a non-cannabis firm because of a lack of availability, he said.

"We don't really have a big market to shop, so the first guy that says yes, we're normally not even asking him what his fees are," Fowlkes said.

For Gillette, representation in the small marijuana community is more about trust, especially as businesses come out of the shadows and into the state-regulated market. "A lot of the people know each other, and people do talk," she said. "Reputation means a lot, and you want to know that there's somebody you can trust."

Marty said clients pulled him into working with marijuana businesses. Now, in addition to his cannabis and non-cannabis practices, he travels the country teaching accountants about how to work with marijuana clients and runs a network of accountants and lawyers working in the industry.

There is, Marty said, "certainly plenty of room for accountants to work in this industry," calling his peers in the industry colleagues, not competitors.

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