An Elegant Solution – we are writing this article for the cannabis cultivators of the Emerald Triangle as well as all of the cannabis growers in smaller and less well-recognized enclaves of cannabis cultivation throughout California. This Article Is For You!
As our followers are aware, we have written a number of articles regarding the financial advantages of the use of a Cannabis Cooperative Association (“CCA”) for California’s cannabis industry[1]. This article describes a use of a CCA that appears to have been wholly overlooked by many of the advisors to California’s cannabis industry.
Everyone who follows the cannabis industry is aware the United States Tax Court hammered the industry with its opinion in Northern California Small Business Assistants Inc. v. Commissioner[2], This case affirmed the earlier decision of Judge Mark V. Holmes in the first Harborside case[3] ,, that IRC §280E disallows any deduction to a cannabis dispensary of ordinary and necessary business expenses for federal income tax purposes.
A CCA provides an elegant solution to this problem for well-advised California cannabis cultivators. A CCA is a special form of California corporation created by the California legislature to allow small California cannabis cultivators to organize the equivalent of an agricultural cooperative. The Long Valley Cannabis Cooperative Association is the legal equivalent to the Sacramento Valley Pear Growers Association under California law. Both of these organizations are marketing and processing agricultural cooperatives.
The critical aspect under California law for the Long Valley Cannabis Cooperative Association and the Sacramento Valley Pear Growers Association is that both of these organizations are legally recognized cooperative organizations. Both of these organizations can own and operate an incorporated distributorship. A wholly-owned corporation that operates a distributorship for a cooperative will be deemed to be conducting a portion of the business activities of the cooperative for federal and California income tax purposes.
At this point a reader should ask, What does this have to do with IRC §280E? Cooperatives can have buyer members as well as grower members. Pear connoisseurs can join the Sacramento Valley Pear Growers Association as members in order to be confident they will receive the best pears at the lowest possible price. Cannabis connoisseurs can join the Long Valley Cannabis Cooperative Association as members in order to be certain they will receive the highest quality Emerald Triangle cannabis at the lowest possible price.
The financial relationship between the purchaser members of a cooperative and the cooperative is determined by the membership agreement as a matter of contract law. As long as the contractual relationship does not improperly circumvent tax laws, the contractual relationship will be respected for federal and California income tax purposes. If a consumer member of Long Valley Cannabis Cooperative Association contractually agrees to reimburse the cooperative for the taxes and non-deductible business expenses the organization incurs in connection with the member’s purchase as a contribution to the capital of the cooperative, the agreement will be respected for federal and California income tax purposes. The cooperative will receive the money required for the organization to tax the taxes imposed on the sale of the cannabis as well as the non-deductible business expenses without being required to include this money in revenue.
Of course, great care must be taken in the organization and operation of a cannabis cooperative as a CCA in order to secure these tax benefits. Is it worth the effort? Of course, it is. The income tax deficiency asserted by the IRS in the Northern California Small Business Assistants Inc. case for the one year before the Tax Court exceeds $1.0M.
[1] See Licensing a Cannabis Cooperative Association, CCA’s Create Profits and Towards A Better Mousetrap
[2] 153 T.C. No. 4 (2019).
[3] 151 TC 3 [2018]
