When California voted to legalize recreational marijuana use in November, few people were as thrilled as Steve DeAngelo. Sporting his signature porkpie hat and braided hair while seated in the massive grow operation heâs building south of San Francisco, the longtime activist and weed industry entrepreneur called legalization âthe culmination of my lifeâs work.âDeAngelo has many reasons to celebrate, not least being that he has positioned himself to capitalize on what is projected to be a $7.6 billion market for legal cannabis in California within the next four years. But the founder of Oaklandâs Harborside, which claims to be the countryâs largest medical marijuana dispensary, isnât banking those billions just yet.âThe IRS,â he said, âis still trying to tax us out of existence.âMarijuana is now legal for recreational use by adults in nine states and Washington, D.C., and approved for medical purposes in 29 others. It remains illegal on the federal level, however, and the U.S. tax code â specifically Section 280E â treats state-sanctioned pot businesses like illicit drug trafficking organizations.Though President-elect Donald Trump has said heâll respect state decisions on legalization, his nomination of Alabama Sen. Jeff Sessions to lead the Department of Justice has raised concerns that the anti-weed hardliner could move to shut down the state marketplaces and prosecute those involved. Even so, the most pressing concerns center on the IRS, which would still be free to aggressively target dispensary owners â a scenario some experts suspect is likely.âThe trajectory with legalization is starting to look and feel more like booze,â said Hilary Bricken, lead attorney for the Seattle-based Canna Law Group. âIn the end days, they pinched a lot of people by going after them for tax evasion, like Al Capone. It seems like in the end we may see more IRS tax audits and prosecutions than DOJ investigations.âAn IRS spokesperson declined to comment about the agencyâs approach to the marijuana industry, but Derek Davis, a San Diego-based accountant who works with dispensaries, said that he expects the IRS to crack down on the emerging legal markets as more states join in.âItâs not a matter of if, itâs a matter of when,â Davis said. âWhat we generally see with the IRS, theyâre usually maybe two or three years behind the market trend. Itâs going to be a huge audit area, especially when youâre throwing around numbers like the market being $5-7 billion in California alone.âThe root of the weed industryâs tax problem dates back to a 1961 Supreme Court ruling that says even illicit income is taxable. That allowed a Minnesota man busted for selling weed, cocaine, and amphetamines to successfully claim in 1974 that he could write off the cost of his packaging materials, scale, and other expenses. Congress struck back in 1982 by enacting 280E, which states âno deduction or credit shall be allowedâ for any business that âconsists of trafficking in controlled substances.âWykowski already challenged 280E on a technicality in a previous case, attempting to convince the judge that the word âtraffickingâ does not apply to state-sanctioned businesses. After losing that argument, heâs now working with a linguist from the University of California, Berkeley to attack the phrase âconsists of,â claiming Harborside offers a range of services beyond trafficking marijuana, such as acupuncture, yoga, and an on-site chiropractor.âIf you apply it in its correct fashion, âconsists ofâ would not apply to Harborside or any other dispensary that does more than just sell cannabis,â Wykowski said. âIf you live in New York, you wouldnât say New York consists of Manhattan and the Bronx. It includes Manhattan and the Bronx, but it consists of all five boroughs.âWhether or not a judge will buy that argument remains to be seen, but even if Wykowski and DeAngelo lose their case, thereâs a push in Congress to overhaul the tax code to benefit legal weed businesses.Last year, Oregon Sen. Ron Wyden co-sponsored legislation with Kentucky Sen. Rand Paul that would make state-approved pot sellers exempt from 280E. The bill stalled in committee, but Wyden has vowed to continue pushing for reform.âWeâre going to be able to expand our bill pretty dramatically based on the events of the last few weeks,â Wyden told VICE News. âCalifornia has 55 members of Congress, one of out five Americans now lives in a state with medical marijuana. I think weâre on the march.âIn the meantime, California dispensaries face an especially precarious situation. The businesses are currently required to operate as non-profits under the stateâs old medical marijuana regulations, even though the IRS refuses to grant them tax-exempt status federally. Californiaâs new law, which allows for for-profit dispensaries, wonât take effect until 2018, but savvy operators like DeAngelo have built complex corporate structures to skirt existing rules and keep an eye on the future marketplace.One example of this approach: In addition to his role at Harborside, DeAngelo also serves as executive chairman of an organization called FLRish. Through this complicated arrangement, DeAngelo is able to charge his non-profit dispensary for a range of consulting services. The dispensary operations could eventually be rolled into FLRish, creating a holding company arrangement akin to Alphabet and Google. Such a move would transform what is technically a non-profit business into a for-profit one overnight.âIt is a completely novel and unusual structure thatâs been made necessary by the sort of chaotic nature of cannabis regulations,â DeAngelo said,âitâs only position that I thought would leave me in strict compliance with California cannabis laws.âBoth Davis and Bricken said itâs not unusual for California pot companies to have parallel non-profit and for-profit arms, but the accountant and attorney both warned that the arrangement can easily veer into illegality if business owners arenât careful.âItâs a way that some California companies are trying to dance around 280E,â Davis said. âWhen youâre setting up these types of structures, you donât want to do it in such a way that youâre evading taxes or money laundering, which obviously could be a huge criminal penalty.âWykowski jokes that â10 years ago the best way to avoid a 280E problem was donât file taxes,â but he bristles at mention of the phrase âmoney launderingâ when asked about Harborsideâs current corporate structure. He insists that âitâs all on the up and up.ââMoney laundering is if youâre dealing drugs and in order to get that money into the system you also have a pizza parlor that has 10 customers a day but miraculously grosses $10 million a year,â he says. âBut if a cannabis dispensary pays its accountant, pays it management, pays outside third parties to do things for them, I donât think thatâs money laundering at all. Basically, youâre paying for a service.âPolls show 60 percent of Americans now favor marijuana legalization, but pushing weed-friendly laws through the Republican-controlled Congress could still prove challenging.Regardless of whether he gets legislative reinforcements, DeAngelo says heâs prepared to keep challenging the IRS and any other federal agency that stands in his way.âThere are dyed-in-the-wool drug warriors who have been ingesting this [anti-marijuana] ideology for decades, and theyâre no sooner to go away than Steve DeAngelo is going to go away,â he said. âItâs a fight to the death.â
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The rules prohibit weed merchants from taking deductions for common expenses like rent, insurance, and electricity, which means they end up paying far more than the standard 35 percent corporate rate. These businesses can be taxed anywhere from 40 to 90 percent depending on how they operate. The IRS can also tack on stiff penalties when companies fail to comply.In DeAngeloâs case, the IRS audited his dispensaryâs tax filings for 2008 and 2009 and slapped him with a back tax bill of $2.4 million. He and his Bay Area attorney Henry Wykowski, a former Justice Department prosecutor who specialized in tax evasion, challenged the tax bill in court earlier this year. A ruling is expected in mid-2017.
The stakes of this case are far higher than DeAngeloâs hefty debt to the IRS â the ruling could introduce a new precedent to how dispensaries are treated by the IRS in the future. Specifically, Wykowski aims to exploit a potential loophole in the wording of the tax law, which could open up a path for state-approved weed vendors across the country to pay the same taxes as most other American businesses. As DeAngelo put it, âOur objective here is to kill 280E.â“The trajectory with legalization is starting to look and feel more like booze.”
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