The tea party has company. For the past several years, the Internal Revenue Service has been systematically targeting medical marijuana establishments, relying on an obscure statute that gives the taxing agency unintended power. The IRS has been functioning as an arm of justice, employing the U.S. tax code as a weapon in the federal government's ongoing war against legal cannabis.
The majority of Americans favor legalization of marijuana, while 18 states and the District of Columbia have already legalized medical marijuana. But pot businesses in those states are vulnerable to the federal government's strategic application of IRS Code Section 280E, a law enacted in 1982 after a drug dealer claimed his yacht and weapons purchases as legitimate business expenses -- and long before medical marijuana was first legalized in California in 1996.
Now the IRS is applying a rule originally aimed at illegal (and often violent) drug trafficking to businesses that are entirely legal under their states' laws. Medical marijuana dispensaries are facing audits and heavy tax bills that could force them out of business.
"Whether or not this is a coordinated tactic to try and shut down the industry, or send a chill through the industry, or if it's just the IRS trying to collect as much revenue as they can from easy targets, it's clearly outside the spirit and intent of the law," said Kris Krane, a former executive director of Students for Sensible Drug Policy who now serves as principal of 4Front Advisors, a medical marijuana dispensary consulting firm.
According to the Treasury Department, Section 280E disallows "deductions incurred in the trade or business of trafficking in controlled substances." Individuals involved in the sale of controlled substances -- including marijuana -- may not deduct standard business expenses from their federal taxes. That means, unlike other small businesses, medical marijuana dispensaries can't write off the cost of rent, payroll, product or advertising. As a result, stores that might not even be profitable can end up being taxed out of business.
"Section 280E was passed by Congress to deprive drug dealers on corners from deducting their expenses," said Henry Wykowski, a defense lawyer who represents dozens of dispensaries under audit in California. "The IRS is using this law in a way it was never intended to be used."
When asked about the agency's application of 280E to and auditing of medical marijuana dispensaries, IRS spokesman Bruce Friedland referred to a 2010 memo the IRS sent to members of Congress, which states that "neither section 280E nor the Controlled Substances Act makes exception for medically necessary marijuana."
In California, Harborside Health Center is currently fighting the IRS' claim that the Oakland dispensary owes more than $2 million in back taxes from 2007 to 2008. Other dispensaries, like the Vapor Room in San Francisco, which was also asked to cough up millions in back taxes, have shuttered as a result. In 2012, the federal government's raid of Oaksterdam University, a cannabis trade school in Northern California, was carried out by the IRS along with the Drug Enforcement Administration.
While the Obama administration has made headlines with high-profile raids on dispensaries in California, Washington, Montana and other states, its financial attacks on the medical marijuana industry are taking place largely out of public view.
"It's not as shocking as a SWAT team raiding the [medical cannabis] facilities," said Aaron Smith, executive director of the National Cannabis Industry Association, a trade group comprising marijuana business professionals that works to reform business regulations and legitimize the country's marijuana industry. He said IRS audits, in comparison to clamorous DEA raids, have become a silent killer for the industry.
"Attacking state-legal businesses is extremely unpopular, but in doing so through financial means, they're able to undermine state medical marijuana laws without drawing as much ire from the voters," Smith said.
Dona Frank, who owns multiple medical marijuana facilities in California, said that while the IRS audits may spare the public the sight of masked law enforcement officers carrying assault weapons, the scrutiny is no less intimidating to the business owners being targeted.
"Who doesn't get scared when they get a letter from the IRS?" she said. "They've audited every business that I've had." Frank said her most recent IRS audits began this past September and that the IRS informed her recently that the agency was applying 280E.
The irony, Wykowski said, is that the IRS has only focused on the dispensaries filing federal tax returns. In other words, state-legal businesses trying to follow the law end up being punished for doing so. "The result is, unfortunately, you're better off not filing," Wykowski said.
The IRS' pursuit of medical marijuana dispensaries began during the Bush administration. In 2007, Wykowski represented Californians Helping to Alleviate Medical Problems, a San Francisco dispensary, in its appeal of a 2005 IRS audit. That case established that the federal government could apply 280E to medical cannabis businesses.
In subsequent cases, marijuana dispensaries have sought to carve out exceptions for the parts of their businesses, like caregiving services, that are not covered by the Controlled Substances Act. By and large, the courts have sided with the federal government.
So medical marijuana advocates are looking to Congress to change the law. In 2011, legislation to amend 280E was introduced in the House but died in committee. Now, as medical marijuana has gained even greater acceptance -- and after two states, Colorado and Washington, have legalized recreational pot -- supporters are trying again.
The National Cannabis Industry Association is pushing Congress to carve out exemptions for marijuana businesses so they can take deductions like anybody else operating in compliance with state and local law. The group is hosting an industry lobby day in Washington, D.C., next month, during which marijuana business owners from across the country will meet with lawmakers and press their case.
The 280E Reform Campaign, an association ally, was also recently formed to spearhead a focused effort against IRS targeting of marijuana businesses and offer guidance for dispensaries on the process of filing federal income tax returns. The group hosts seminars around the country to educate dispensary owners and other cannabis industry professionals about 280E and to teach strategies for navigating IRS audits.
Wykowski said that the IRS hides behind the argument, "If you want to change it, go to Congress, not to us," arguing that the IRS has the power to promulgate industry guidelines that could mitigate the situation.
But unless the IRS changes its stance on medical marijuana, or Congress or the president forces a change, individual dispensary owners are likely to continue to be targets.
"The auditing of dispensaries by the IRS is unfair and unreasonable and should be of concern to everybody," Wykowski said. "If they can do it to one group, they can do it to any group. ... A dispensary wins if they get treated like any other taxpayer."
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