We sat down with Nick Richards. Nick is a Partner in the Tax practice group at Greenspoon Marder LLP. He represents individuals and businesses in tax audits & trials, M&A, in managing tax debt, and he advises cannabis companies, owners, and investors regarding tax and regulatory compliance matters. For more than twenty years, Mr. Richards has been a tax attorney, beginning his career with the IRS. He was a leading trial attorney, a Chief Counsel advisor, and a Special Assistant United States Attorney.
With his broad experience and understanding of all phases of the tax system, from reporting and assessment through appeals, court, and tax debt resolution, Mr. Richards achieves successful legal solutions tailored to his individual client’s needs. Mr. Richards also teaches tax attorneys and CPAs throughout the US. In addition, he is an Adjunct Professor of Law at the University of Denver, Graduate Tax Program, where he teaches State and Local Tax and Civil and Criminal Tax.
Taxes can be stressful, and Mr. Richards’ clients find relief in his broad experience in the IRS and represent taxpayers largely and small. He understands the tax system, provides informed advice, and protects taxpayers from the mistakes and missteps of those less experienced. For example, several years after leaving the IRS, he represented a Colorado cannabis company in one of the first IRS audits in the legalized industry. Since that ground-breaking case, he has successfully represented companies in many cities, states, courts, and before the federal government.
In addition to tax audits, trials, and collections, he is widely recognized as a leading cannabis industry attorney and has extensive experience in IRC Section 280E and BSA cash reporting requirements. His knowledge of the tax system is essential when advising business owners and investors, particularly in mergers, acquisitions, and entity formation.
Good afternoon and welcome to CannaList Conversations. Today, we are here with nick Richards. he is a partner at the tax practice group at Greenspoon Marder in Denver.
Thank you very much.
I recently read an article that you produced about taxation – 280E is a political weapon targeting marijuana companies, but there may be a fix – can you tell us a bit of that?
That was an article that was an op-ed piece. It’s the first op-ed piece I’ve ever had to write or chosen to write. I was involved in helping a company understand some IRS materials that they had received. We did a series of articles revealing the key elements of more than 200 pages of internal IRS documents obtained by MJBizDaily. They asked me to do an op-ed as part of that series.
To tell you the truth, I started writing about all the social issues and all the problems we have here in the united states. I am here in Denver, and it was right about the time of the shooting in boulder. My office looks out on the boulder flat irons, and I was pretty upset about that. So I started writing about that, and they said, “Nick, you’re a tax attorney; we think you should stick to the topic.”
There is a lot of injustice in the cannabis industry, so I focused on that aspect of the taxation of the cannabis industry. There is a code section called section 280e – that code section denies deductions for ordinary and necessary business expenses.
If you were living here in Colorado – it’s 420 today, by the way, which is our celebration day for marijuana – and you went in, and you wanted to get some party favors to celebrate with. So you walk into a dispensary. Everything you see in that dispensary – the bud tender’s salary, the insurance, the rent for the dispensary, the cash register, the point-of-sale system – all that stuff is all non-deductible.
The company that’s there selling that marijuana cannot deduct any of those expenses at all. So my article uh centered on that dynamic and the fact that the code section, which says no deductions for the cannabis industry or any company trafficking in a schedule one or schedule two controlled substance.
If I may interrupt for a second to sort of put this all in context, tell us a bit of your background. I know you used to work somewhere, and it’s probably pretty relevant to what we’re discussing.
I was an IRS trial attorney. That was the first job I got right out of law school. I started in the la area, and I got involved at that point when the internet was sort of knew it was the late 90s. The internet was beginning to grow up. If you went onto the internet at that time and you started googling around, one thing you found a lot of was tax shelters.
I got involved in getting out in front of those tax shelter promoters and preventing them from promoting false claims regarding tax shelters. That was a little bit of my claim to fame in the IRS. My article was about how the IRS uses the same tactics that we use to go after tax cheats, including people who were funneling money offshore and creating structures to cheat on their taxes. Many of the tools that we developed in that war – we called it a war – are now being used against the cannabis industry to ensure that they suffer the full extent of section 280e.
Can you think of any other industry where this is being applied like that?
No. not a one. Even in the tax shelter world, the IRS has provided what are called voluntary disclosure programs for people who blatantly cheat on their taxes – feel like they’re going to get caught – but before they do get caught, they can come forward and voluntarily disclose. The IRS will give them a break.
Nothing like that exists for the cannabis industry. At every turn of the road, the IRS will impose 280e to the fullest extent possible, even if they have to bend the law to do it. It would seem at this point the real genesis of 280E was to punish people who sold marijuana and other drugs. And when marijuana was legalized first in California, it was the primary tool identified to shut down the industry before it got going.
What is the ramification of this on mom-and-pop type dispensaries who are trying to survive, and now they’re burdened with this type of penalty along with a whole bunch of other taxes – luxury taxes? This speaks to why it’s so difficult to launch these types of businesses.
I would say the cannabis industry pays a 70 percent tax effective tax rate, maybe higher. I have clients that pay over a hundred percent effective tax rate. That seems impossible, but let me give you an example if I’m a dispensary and I buy a joint from you for five bucks, and I pay, let’s say Sally five bucks to sell it, and she sells it for 12 bucks, then I’ve got 20 profit margin. I just made two dollars, right?
I had to spend ten dollars to make two dollars. 280E, the five dollars that I paid to sally to sell the marijuana is non-deductible. So, I would pay tax on seven dollars, and if I’m in a 30 or so tax rate, I could be paying more in tax than the two dollars that I made. that happens more often than not.
I have plenty of clients that incur millions of dollars of what’s called phantom tax. Phantom income tax because you don’t get that money, but you have to pay tax on it. I have plenty of clients that incur million-dollar phantom tax liabilities every year that they can’t pay.
And this runs completely counter to what we see in the press. Schumer recently came out and said, “We’re going to legalize.” Everything that we see in the press from the politicians would suggest they’re supportive, and yet when you look at the actual agencies that are regulating this – they’re making it next to impossible to function.
And nobody cares about that. There’s no way that a standalone fix for the tax is going to go anywhere. Nobody cares if the marijuana industry has to pay unfair taxes.
The good thing is that with full legalization, 280E goes away, but it has to come from something else; that simple problem is one that probably won’t be resolved on its own.
Because with legalization, it’ll be reclassified, so then it won’t be subject to 208E.
Correct, it only applies to a schedule one or two controlled substances, and so as long as they don’t move it to two, if they move it to three or deschedule it completely, then 280E goes away.
OK, so that would be one of the potential solutions to this problem.
Yes, for sure. Then the other solution is a partial solution. Still, the answer that I proposed in my op-ed of allowing the disallowed expenses as a basis in the business is also a solution. It means that you cannot get back the costs you pay to build your business until you sell it. This isn’t a great solution for everybody, but I think it does fit into the way taxes work. Taxes are expenses assigned to assets, such as when you build an asset when you sell it, you deduct your costs, and you pay tax on what remains.
In our system, we have a code section that says that the expenses that are really for building your business, the day-to-day ordinary and necessary business expenses – our code says, “you can take those as a deduction now. you don’t have to wait till you sell your business.” that is the code section that is being denied to the cannabis industry.
But nobody is talking about then what do we now do with those expenses, and I’ll bet there’s not a CPA accountant person out there in the world that would say that an expense that’s ordinary and necessary can just disappear. For financial purposes, it has to go somewhere. It has to go either to a deduction such as the cost of goods sold, or it has to be capitalized. Just because we don’t allow them in the cannabis industry doesn’t mean that the other items aren’t available.
But it also speaks to how this will skew the cannabis market to big players because they’re the only ones going to capitalize on the losses. They can benefit from waiting ten years to sell the company and then take the offset. The mom-and-pop operation is relying on cash flow and doesn’t have that luxury. What this continues the advancement of prominent capitalized players running the industry.
For sure, it takes capital to be to just survive in the industry. But, when you add on super-high tax rates to an industry, they’re the dog that gets kicked by every official out there. If you’re a fire inspector or a city official, or a state or federal official, you’re going to show up and impose your full authority on that cannabis company. They are chasing fires constantly, and when you add 280e to the mix, it’s tough for many of them to turn a profit.
A small cannabis mom-and-pop cannabis store brings in – somewhere between three million and seven million a year – and they probably keep enough to support the owner’s family is in a good lifestyle. So they probably take home about half a million on that six million that they bring in.
If you were a convenience store owner, you take home half of that.
The other thing is this only applies to the retailers, right?
It applies to the whole industry, but because the internal revenue code works, this gets a little technical. Still, costs of goods sold are part of the business expenses allowed to be deducted each year. So if you were a grower, everything that you spent money on – right up to the final packaging – your one pound package is ready to ship – all of that is cost of goods sold, so almost all of your expenses can end up in a deductible category if you’re a grower or a producer or manufacturer.
If you’re a store, cost of goods sold stops once the product comes in your door. So you make a wholesale purchase of marijuana for resale; once you’ve paid for that product and it is in your door, your cost of gold’s good sold stops. Everything that is within the dispensary is non-deductible.
So, the overhead.
The irony is we’ll let you grow it, we’ll let you produce it, but you just can’t sell it.
It doesn’t make any sense. It makes it so only the big guys can compete. It also makes it so the black market could compete. We’ve had a hard time getting rid of the black market because it’s expensive to sell on the legal market.
You’re from Denver, which has been leading this industry for a long time. You have been very successful. We’ve seen job creation; we’ve seen an increase in the tax base, which has gone back to other social programs. What kind of advice do you have for emerging markets or something like new York, which recently passed legalization? How do they deal with this from the get-go?
Generally, you have a group that has some funding. They’ll have a person that knows something about the marijuana industry. A person who has some money, a person who has some connections and some financial that have some pro formas, that pro formas almost always have them making billions of dollars in the very first year, the very first thing I tell them is to put their pro forma away because what we hope for is to break even,
Then I start to educate them about how tough the industry is and how important it is to get started correctly.
What the 280E does is it creates phantom income, and the way our tax system works is you have two kinds of entities out there. One kind of entity is a C corporation, and that’s a taxable entity. It pays its tax. Then there are what are called flow-through entities like partnerships, S corporations, or LLCs – where the tax flows through to the individual.
If you’re getting started in the cannabis business and start as one of those flow-throughs, and you start getting a million-dollar phantom income tax, that is your tax liability. It shows up on your tax return, and you’re personally liable for it. If you can’t pay it now, there’s a lien attached to your home, and theirs is looking at your other assets to satisfy that phantom income tax.
In a C corp, that dynamic is not going on. It’s the company that’s liable for the tax, and because the IRS can’t seize the marijuana, there’s not a lot they can do. Whereas if it was an individual, there’s a lot that they can do.
So it is essential to get started in the right kind of entity. It is life or death for those in the cannabis industry.
Why does this exist?
It was in the 80s, in in the Reagan administration’s war on drugs, there was an individual who was an illegal drug dealer who deducted their cell phone, their scales, they took a home office deduction. the congress found out about it and in the height of the war on drugs they needed a scapegoat. So they uh they made a big deal out of that, and they passed section 280E to take away an individual’s ability to deduct the cost of selling a scheduled water schedule two controlled substance.
We’ve got magic mushrooms. They are almost legal here now as well; they’re also a schedule one controlled substance the same rules would apply.
Yet things like alcohol aren’t subjected to this, correct?
Tobacco, pharmaceuticals – that kind of stuff is not subject to 280E.
Right, it’s just the schedule one that’s causing this.
It seems the quickest route to a resolution is just the legalization at the federal level.
Well, there’s a fight going on to prove that 280e is unconstitutional. The tax system we’re talking about here about income taxes; our income tax system comes from the 16th amendment to our constitution. The 16th amendment gives the u.s Congress the right to tax income, and income has been defined as gain.
So in the selling of the joint example, my gain was two bucks, but I paid tax on seven dollars. So how can that be constitutional under the 16th amendment? So there’s a fight going on right now to try to prove that section 280E is unconstitutional.
So far, the courts, if you say marijuana, they rule against you. It almost feels like they don’t care what the law is. At some point, though, somebody’s going to realize that gain is gained, and there’s no way around it. It’s very straightforward. It’s a common understanding.
The solution that I put out there, I think, is what the IRS has got in its back pocket. As soon as it’s proven that they cannot disallow the deduction forever, they’ll give it to you as a basis. So I’m saying, look, IRS get that message out now, and it makes the tax system work, and it’ll help the industry.
But this seems so counterintuitive to the need for economic development, which we want to see and what we have seen. The industry is creating jobs, the industry is creating tax revenues maybe unfairly, but clearly, they generate tax revenues. And then we’re making it as difficult as possible to succeed. It would seem that people would want us to succeed. We want to create jobs.
Yeah, I know. Interestingly the IRS doesn’t want to take those jobs away either. If they were looking to collect money from a cannabis company, they wouldn’t want to put the company out of business because they want to continue employing people. They want to take all the owner’s money; that’s what they want to do.
That may be the theory, but the reality, the practicality, is they make it so prohibitive that many people can’t operate profitably or support their staff because of the owner’s tax.
It makes it hard to do good things. For example, providing benefits to a budtender. Those are costs you can’t deduct. Likewise, making charitable contributions for good causes for the industry are costs you can’t deduct.
And so, it limits the kind of things that the cannabis industry can do and the ways that it can improve the community. There’s a slight difference, though. Those are federal taxes that we’re talking about, which go into the federal coffer. There are state taxes that are very onerous as well. Those state taxes get paid because you lose your license if you don’t pay your state taxes.
There’s a small town to the north of me here. A little tiny town in the middle of many dry counties, as we call them, has legalized marijuana in their town. I have a client there, and during the first year of adult sales, they had more tax dollars than they could spend. So they built a new library and a new fire station. The following year they built a new police station, and they paved every road in the town and repaired every sidewalk in the city. The following year they didn’t have anything to spend money on, so they created a program if you own a piece of real estate in that town, and you want to put a new roof on it or paint it or do some landscaping, they’ll match dollar for dollar with cannabis money.
We’ve also seen it go into scholarships. In another town to the south of me, if you graduate from a high school there, you get a cannabis scholarship from the money the state taxes. There are so many good things being done by the industry, but they could do a lot more if 280E weren’t such a big problem.
Why does there continue to be this disconnect? Is it politics? Why is there this disconnect?
Well, first off, nobody knows about it. It’s a little bit of the dirty secret of the cannabis industry. Everybody thinks these cannabis owners and operators are just rolling in money.
Not anybody who’s trying to do it, right?
Yeah, they don’t get how hard it can be, and you know there’s not a lot of sympathies when you say, “Hey, look, we’re struggling.” So it’s sort of “too bad, so sad.”
The industry itself I a little bit to blame. There are plenty of people that aren’t honoring 280E. So you’ve got one person on one side of the street that’s trying to pay their taxes and be compliant, but a person right across the street that’s not doing that. So it creates an unlevel playing field. It drives the price of cannabis down where it’s in many instances it’s just not high enough to cover its actual costs.
It also continues to prop up the illicit market, the black market.
Yes. Right, and that’s the other side of it. They can’t raise their prices too much because customers go back to the black markets where they don’t have the taxation issues.
Right, and you don’t know what kind of product you’re getting on the black market, but it is cheaper.
It is cheaper. It’s probably covered with pesticides.
It is if it’s just pesticides, you’re doing good.
Yeah, I hear you.
What advice would you have for anyone that is running into these problems with theirs?
Don’t talk to the IRS. First off, hire a lawyer; the IRS is not your friend. They’re not there to help you. They are there to assess the most amount of tax that they can. So if they call you, you tell them you have a lawyer and get your lawyer on the phone.
In those training materials that we covered earlier, one of the main things they said is to call the taxpayer right away before hiring a lawyer may be the only chance you get information. That is very telling. That’s the IRS’s point of view because they want to ask questions that will hurt you financially.
Having somebody there to handle those questions. You will not lie to the IRS, but having somebody there that can navigate those waters for you and keep you out of the fray is hugely important.
I’ll tell you a funny story I like to tell. one of the questions the IRS wants to ask you when you get audited is, “Hey, taxpayer – do you have a cash hoard?”
There’s nobody out there in the world that would say yes to that question. I mean, if the IRS asks you if you have a cash hoard. You say, “Hell no, no cash hoards here.” Well, guess what? A cash hoard is good for you. A cash hoard means that you take a little bit of your salary – your after-tax dollars – and you put it in the cookie jar, and then after a few months, you deposit it in the bank account.
If you’re a cash taxpayer, they’re asking you that question because then if you say no – well, now all of your deposits are taxable because you don’t have any undeposited money that you’re depositing. So you don’t have a cash hoard.
It’s just a simple example of how not understanding what’s going on can get you into trouble with the IRS.
This also runs counter to the messaging that the IRS is saying. They claim we want to treat you fairly. They’re saying that we’re not after you, we just want to be fair, and we’ll work with you. This suggests otherwise.
It’s still very political, and there are people in the IRS that hate marijuana. Always hated it. I hated the people who liked it and wanted to take a hard line with those folks. There are people in the IRS that don’t feel that way. They think that that that 280E is unfair and don’t want to take a hard line. They’re still going to do their job, but they’re not going to look for additional ways to hurt you, which some agents will do.
Do you think we’ll see an equivalent to what we saw on the legalization side with the Cole Memo – where it’s there, but they don’t necessarily use any resources to enforce it?
I don’t, and here’s why – those 280E audits are amazingly profitable?
A report came out last year that showed the statistics of the revenue generated by cannabis audits compared to other targeted audits. The IRS has a computer program that mines all tax returns for good audit returns using a DIF score. So if you have a high diff score, the computer thinks you will be a good audit.
They compared those DIF score audits to cannabis company audits, and the cannabis audits were three to four times more profitable for the IRS per hour. They had less no changes, and we’re low-hanging fruit for theirs. So I imagine they’re going to continue to pursue them. If anything, they will increase. The treasury inspector general’s office, they’re the ones that audit the IRS – they said, “Hey IRS, you need to do more of these.”
We very much appreciate your time today. We appreciate your insights. Let’s hope that cannabis gets legalized soon and this problem goes away.
Thanks, Patrick. Happy 420 to you in Barcelona.