How The Feds Are Going After Cannabis Businesses Now That The Cole Memo Has Been Revoked
On January 4, 2018, Attorney General Jeff Sessions rescinded previous Justice Department guidance related to enforcement of federal marijuana laws. This guidance was known as the “Cole Memo” and set at a national level the standards by which local Federal prosecutors should follow in determining who should be prosecuted for violation of Federal laws prohibiting cannabis. Now it is up to each U.S. Attorney’s District Office to determine marijuana enforcement policy in light of the specific circumstances in their individual districts.
Policy Announced By The U.S. Attorney’s Office For The State Of Oregon.
In an announcement made on May 18, 2018, the U.S. Attorney’s Office for the State of Oregon expressed how it intends to exercise its discretion in marijuana enforcement under the Federal Controlled Substances Act (“CSA”) 21 U.S.C. § 812. That Act classifies marijuana as a Schedule 1 substance with a high potential for abuse, no currently accepted medical use in treatment, and lack of accepted safety for use under medical supervision; and therefore, prohibits the cultivation, possession, and distribution of marijuana.
While Federal prosecutors are not declaring immunity of procession for those who violate this law, the U.S. Attorney’s Office in Oregon does recognize that its resources are finite and by necessity must use appropriate discretion before prosecuting any federal case.
In so doing, the United States Attorney’s Office for Oregon will focus its resources primarily on situations involving one or more of the following priorities:
- Overproduction and Interstate Trafficking – exportation of Oregon-based cannabis outside of Oregon.
- Protecting Oregon’s Children – sale or distribution of cannabis to persons under 21 years old.
- Violence, Firearms, or other Public Safety Threats – engaging in cannabis using violent means that include but not limited to firearms and explosives.
- Protecting Federal Lands, Natural Resources, & Oregon’s Environment – engaging in cannabis that is harmful to the environment or on Federal lands.
- Organized Crime – engaging in cannabis that serves to fuel other criminal activity, especially through racketeering and the involvement of organized crime. This includes not only violent crimes, but also non-violent criminal activity, such as federal income tax evasion or systematic money laundering to evade detection of illegal proceeds.
While businesses should be able to easily avoid the first four priorities, it is the fifth that I find most cannabis businesses having exposure given the restrictions placed on banking and the unfavorable tax law in place.
18 U.S.C. §1956 – Laundering Of Monetary Instruments
18 U.S.C. § 1956(a) defines three types of criminal conduct: domestic money laundering transactions (§ 1956(a)(1)); international money laundering transactions (§ 1956(a)(2)); and undercover “sting” money laundering transactions (§ 1956(a)(3)). Marijuana-related businesses need to be aware of domestic money laundering transactions (§ 1956(a)(1)).
To be criminally culpable under 18 U.S.C. § 1956(a)(1), a defendant must conduct or attempt to conduct a financial transaction, knowing that the property involved in the financial transaction represents the proceeds of some unlawful activity, and the property must in fact be derived from a specified unlawful activity.
Violations of § 1956 have a maximum potential 20-year prison sentence and a $500,000 fine or twice the amount involved in the transaction, whichever is greater. There is also a civil penalty provision in § 1956(b) which may be pursued as a civil cause of action. Under this provision, persons who engage in violations of any of the subsections of 1956(a) are liable to the United States for a civil penalty of not more than the greater of $10,000 or the value of the funds involved in the transaction.
Penalties For Filing A False Income Tax Return Or Under-reporting Income
Failure to report all the money you make is a main reason folks end up facing an IRS auditor. Carelessness on your tax return might get you whacked with a 20% penalty. But that’s nothing compared to the 75% civil penalty for willful tax fraud and possibly facing criminal charges of tax evasion that if convicted could land you in jail.
Criminal Fraud – The law defines that any person who willfully attempts in any manner to evade or defeat any tax under the Internal Revenue Code or the payment thereof is, in addition to other penalties provided by law, guilty of a felony and, upon conviction thereof, can be fined not more than $100,000 ($500,000 in the case of a corporation), or imprisoned not more than five years, or both, together with the costs of prosecution (Code Sec. 7201).
The term “willfully” has been interpreted to require a specific intent to violate the law (U.S. v. Pomponio, 429 U.S. 10 (1976)). The term “willfulness” is defined as the voluntary, intentional violation of a known legal duty (Cheek v. U.S., 498 U.S. 192 (1991)).
And even if the IRS is not looking to put you in jail, they will be looking to hit you with a big tax bill with hefty penalties.
Civil Fraud – Normally the IRS will impose a negligence penalty of 20% of the underpayment of tax (Code Sec. 6662(b)(1) and 6662(b)(2)) but violations of the Internal Revenue Code with the intent to evade income taxes may result in a civil fraud penalty. In lieu of the 20% negligence penalty, the civil fraud penalty is 75% of the underpayment of tax (Code Sec. 6663). The imposition of the Civil Fraud Penalty essentially doubles your liability to the IRS!
Higher Taxes Still Remain
The Internal Revenue Code which businesses in the marijuana industry differently resulting in such businesses paying at least three-times as much in taxes as ordinary businesses.
Generally, businesses can deduct ordinary and necessary business expenses under I.R.C. §162. This includes wages, rent, supplies, etc. However, in 1982 Congress added I.R.C. §280E. Under §280E, taxpayers cannot deduct any amount for a trade or business where the trade or business consists of trafficking in controlled substances…which is prohibited by Federal law. Marijuana, including medical marijuana, is a controlled substance. What this means is that dispensaries and other businesses trafficking in marijuana have to report all of their income and cannot deduct rent, wages, and other expenses, making their marginal tax rate substantially higher than most other businesses.
Reporting Of Cash Payments Still Remain
The Bank Secrecy Act of 1970 (“BSA”) requires financial institutions in the United States to assist U.S. government agencies to detect and prevent money laundering. Specifically, the act requires financial institutions to keep records of cash purchases of negotiable instruments, and file reports of cash purchases of these negotiable instruments of more than $10,000 (daily aggregate amount), and to report suspicious activity that might signify money laundering, tax evasion, or other criminal activities. The BSA requires any business receiving one or more related cash payments totaling more than $10,000 to file IRS Form 8300, Report of Cash Payments Over $10,000 Received in a Trade or Business.
The minimum penalty for failing to file EACH Form 8300 is $25,000 if the failure is due to an intentional or willful disregard of the cash reporting requirements. Penalties may also be imposed for causing, or attempting to cause, a trade or business to fail to file a required report; for causing, or attempting to cause, a trade or business to file a required report containing a material omission or misstatement of fact; or for structuring, or attempting to structure, transactions to avoid the reporting requirements. These violations may also be subject to criminal prosecution which, upon conviction, may result in imprisonment of up to 5 years or fines of up to $250,000 for individuals and $500,000 for corporations or both.
Marijuana-related businesses operate in an environment of cash transactions as many banks remain reluctant to do business with many in the marijuana industry. Like any cash-based business the IRS scrutinizes the amount of gross receipts to report and it is harder to prove to the IRS expenses paid in cash. So it is of most importance that the proper facilities and procedures be set up to maintain an adequate system of books and records.
How Does This Impact Cannabis Businesses Outside Oregon?
While this position announced by the U.S. Attorney’s Office of Oregon (which is the first publicly made position of any U.S. Attorney’s Office since the revocation of the Cole Memo) only covers Federal prosecutorial discretion in the State of Oregon, this could lead to other Federal districts following the same standards. California has four federal districts so there is no telling when and to what extent each district’s office will issue a position on this matter.
What Should You Do?
Given the illegal status of cannabis under Federal law you need to protect yourself and your marijuana business from all challenges created by the U.S. government. Although cannabis is legal in California, that is not enough to protect you. It’s coming down that the biggest risk is getting taxed out of business and/or spending time in jail. So it is best to be proactive and engage an experienced board certified tax attorney-CPA in your area. Let the tax attorneys of the Law Offices Of Jeffrey B. Kahn, P.C. located in Orange County (Irvine), the San Francisco Bay Area (including San Jose and Walnut Creek) and other California locations protect you and maximize your net profits.