AUTHORED BY: JORDAN ZOOT

Background and Further Thoughts on the Tax Court

Decision in Harborside 151 TC 11

We published our original thoughts on the Judge Mark Holmes opinion in case in Tax Court in Harborside. We read several other comment pieces on the decision including:

• Tax Court Issues Long-Awaited Harborside Opinion

• Civilized’s Editorial on Harborside Ruling : “US Tax Court Rules That Legal Cannabis Dispensaries Are Just Drug Traffickers”

We published a follow on piece Harborside – Further Reflections that highlighted several of our thoughts about what we expected to happen in the aftermath of the decision. We were surprised to find our thoughts quoted in a piece by Debra Borchardt that appeared in Cannabis Company Faces Big Tax Bill After Losing Court Battle.

“The judge still has to address the penalties phase in a second opinion. Jordan Zoot, the CEO of cannabis accounting firm ABIZinaBOX estimated that Harborside’s tax deficiency with penalties and interest could approach $20 million. He wrote, “The years before the Tax Court in the case decided November 29 were 2007-2012. Harborside appears to have at least doubled its revenue in the six succeeding years. Harborside may have a substantially larger federal income tax liability for the six succeeding years — 2013-2018.”

FLRish is the company that manages Harborside, and it had announced in August that it was entering into a binding letter agreement with Lineage Grow Company Ltd. (CSE:BUDD) for a reverse takeover in a deal valued at C$200 million. Lineage will acquire all of the outstanding shares of Harborside in exchange for newly issued shares of Lineage. The move will help Harborside expand within the state and across the U.S.

Zoot also noted that the judge pointed out that Harborside used an inefficient tax income operating structure and methodology for its dispensary operations — an opinion that could affect other California cannabis companies that have used this same approach. The opinion by the judge surely had many companies racing to their accountants to make sure their organizations are set up in the most tax-efficient structure.”

We posted a comment in a thread on LinkedIn that Steve DeAngelo, the Founder of Harborside wrote entitled “Harborside Responds to U.S. Tax Court 280E Ruling” with the following:

“We all knew that this was coming based upon the ruling in Alterman¹. I didn’t think Holmes would deviate. The next part if very likely going to cite Graev in asserting an accuracy penalty under IRC Sec. 6662…seems that a fraud penalty is a loser. CA-9 will likely affirm the 15-0 reviewed decision per curium. So now it is back to Washington DC to see if they can get IRC Sec. 280E repealed or cannabis off of Schedules 1 and 2.” 

We have been distressed and disappointed by the sheer number cannabis industry business executives and even thought leaders that have posted comments which clearly demonstrate that they have NOT personally read the Tax Court’s opinion.

The first rule that any law school student, or tax practitioner learns is “you ALWAYS read the original source, be it statute, regulation, administrative pronouncement or court decision and form you own conclusions…never merely repeat what someone else wrote”.

The following is a collection of background documents that will be helpful to anyone seeking a deeper understanding of the Tax Court’s decision.

• Fighting the Feds, Round Two: Harborside vs. the IRS

• The Sexiest Story of Taxes and Marijuana: The History of Tax Code 280E

• How the IRS Screws Legal Weed Businesses

We think this is a good stopping point, rather than repeating what we have said, we hope everyone with skin in the game will read the background materials, form their own conclusions and join the discussion.

 

We came across a short article from Greenspoon Marder LLP, “Another 280e defeat for the cannabis business taxpayer “which we believe does an excellent job of summarizing the sixty-two-page holding with concise language that highlights the bright lines that tax return preparers for cannabis industry businesses that don’t take the time to actually read judicial opinions need to “take away” to be able to prepare tax returns which are consistent with the courts holdings. Specifically,

 

The opinion eviscerates every single argument made by the taxpayer’s counsel, leaving open for a subsequent opinion only the question of whether the taxpayer owes accuracy-related penalties. In the decision, Judge Holmes endorses the reasoning in IRS Chief Counsel Advice Memorandum 201504011 (2015) regarding the interaction of Section 263A and Section 471 with respect to the cannabis-related cost of goods sold (COGS) calculations.

 

Simply put, Harborside reads Section 263A out of the Internal Revenue Code with respect to cannabis-touching businesses, holding that the Section 280E disallowance of deductions prevents any additions to the cost of goods sold under the uniform capitalization rules of more-recently enacted Section 263A.

 

Further, the opinion is entirely dismissive of taxpayer’s Sixteenth Amendment claims, pointing out that “Section 471 wasn’t found unconstitutional during the many decades when it was the only means of calculating COGS, and it wouldn’t be unconstitutional now if Congress repealed Section 263A.”

 

It is also worth noting that the Tax Court held that Harborside was a reseller, not a producer, and that producers are subject to a different set of regulations under Section 471 that allow additional expenses to be included in COGS.