[Originally Published in the California Journal of Tax Litigation (November 2014]
This is the third article of a three-part series of articles. In the first article I discussed the Federal income tax treatment of medical marijuana dispensaries. In the second article I discussed the California income tax treatment of medical marijuana dispensaries. In this final article I discuss something different than the tax treatment. This article focuses on concerns and issues applicable to the professionals who counsel and provide advice to the organizations, entities and individuals who are engaged in the medical marijuana industry.
In Part One, I discussed that under the Federal tax regime, the Internal Revenue Service and the United States Tax Court, both take the position that any business that sells marijuana, even if for medical reasons, cannot deduct necessary and ordinary business expenses like a normal business. Because medical marijuana is considered a Schedule I controlled substance within the meaning of the Controlled Substance Act, I.R.C. § 280E does not allow the deduction or credit for any amount paid in carrying on a medical marijuana business activity. In Part Two, I discussed that in California it is not a criminal act to distribute medical marijuana under Proposition 215, the Compassionate Use Act of 1996 (“CUA”). Notwithstanding stark contrast to Federal criminal law, California tax law models the Federal tax law and disallows all business expenses if the medical marijuana dispensary is not being taxed as a corporation under the Revenue and Taxation Code. If the medical marijuana dispensary has been structured in a way as to be taxed as a corporation, it is entitled to deduct all of its necessary and ordinary business expenses. However, if there is a criminal court or other proceeding in which the State of California, county, city or other political subdivision was a party and it was determined that the medical marijuana dispensary engaged in illegal activities, the dispensary will not be allowed to deduct the business expenses or the cost of goods sold under California tax law, regardless of whether the dispensary is structured to be taxed as a corporation, flow through entity, or sole proprietor. Now that we know the tax rules related to these businesses, what are the rules related to the professionals who are providing advice to them?
In my opinion tax professionals play an important role in society because we help make sure that businesses and individuals adhere to the tax rules. I believe that tax professionals who are dedicated to doing a good job for their clients might not always realize the dangers that exist to them personally in performing these duties as it relates to a client who has a medical marijuana business.
Our tax system is based on a voluntary compliance method in which all businesses are required to file annual tax returns, on which they are required to list the source of their income.1 It is still a Federal crime to distribute marijuana, even for medical purposes. So taxpayers engaged in the medical marijuana business, when stating the actual nature of the underlying business on a filed tax return, are making an admission on a document that is signed under the penalty of perjury, that it has committed a federal crime.2 This is true in spite of the fact that the possession or distribution of marijuana for medicinal purposes is legal under California law. Taxpayers engaged in the medical marijuana business and their tax professionals who are advising them with respect to their tax return can be caught in a pickle because knowingly failing to file a tax return can also be a criminal act.
Lawyers and accountants providing tax advice to, or preparing the tax return of, a medical marijuana business must take into account the possibility that this may subject him or her to criminal liability. Section 2(a) of Title 18 of the United States Code provides, “Whoever commits an offense against the United States or aids, abets, counsels, commands, induces or procures its commission, is punishable as a principal.”3 Given that the medical marijuana business is illegal under Federal law, an attorney or accountant who assists in incorporating a medical marijuana business or arranges a lease of space for a medical marijuana business may face criminal prosecution for aiding or abetting the illegal business.4 Similar charges could possibly be brought against an accountant who handles the bookkeeping for the medical marijuana business. What about presenting a lecture or publishing an article on the tax treatment of medical marijuana businesses? Does this constitute the aiding and abetting to induce or procure the commission of a Federal offense? I would hope not, given the implications to freedom of speech and that such speech advocates compliance with at least one area of the law, not how to violate it, albeit potentially directed at those who have already violated other laws.5
Practitioners could also be considered to be in violation of state licensing and professional responsibility rules. The Model Rules of Professional Conduct state: “A lawyer shall not counsel a client to engage, or assist a client in conduct that the lawyer knows is criminal or fraudulent.” Model Rules of Prof’l Conduct R. 1.2(d) (2011). The California Rules of Professional Conduct have a similar rule that states: “A member shall not advise the violation of any law, rule, or ruling of a tribunal unless the member believes in good faith that such law, rule, or ruling is invalid. A member may take appropriate steps in good faith to test the validity of any law, rule, or ruling of a tribunal.” Cal. Rules of Prof’l Conduct R. 3-210.
I have not discovered a ruling in California on whether an attorney can ethically provide advice to medical marijuana businesses. However, I did discover a few state rulings on whether an attorney can ethically provide advice to medical marijuana businesses under the Model Rules. Two of these state rulings are divided on the subject.
The State Bar of Arizona held a lawyer can ethically perform legal acts necessary to assist a client engage in conduct that is expressly permissible under the Arizona Medical Marijuana Act. State Bar of Ariz. Comm. on the Rules of Prof ‘l Conduct, Op. 11-01 (2011). However, the State Bar of Arizona held that is only the case if the lawyer advises the client with respect to the potential Federal law implications and consequences thereof. Id. I think this is a very important point and believe that California should follow the same rule.
On the flipside, the State Bar of Maine ruled that a lawyer cannot assist a client to engage in the medical marijuana business. Maine Prof ‘l Ethics Comm’n, Op. 199 (2010). I find this very interesting because in 1999 Maine became the fifth state in the US to provide for dispensaries of medical grade marijuana for persons with debilitating and chronic medical conditions. These not-for-profit dispensaries are even licensed and regulated by the Maine Department of Health and Human Services. Regardless, the State Bar of Maine ruled that it is unethical for a lawyer to assist a client with these activities.
If a state agency disbars or suspends a practitioner as a result of counseling a client in these activities, Circular 230 can sanction that person’s ability to practice before the IRS under section 10.51(a)(10). I think the point is simply to proceed with caution when it comes to the ethical status of providing this type of legal advice in the State of California and be aware that it could lead to other problems.
Another word of caution for tax professionals assisting clients with these activities is that they should check the terms of their malpractice insurance very closely. There is probably a risk of non-coverage due to criminal activity or another intentional act that is not legal.6 In fact, Ann Toney, a Denver lawyer, recently lost her liability insurance coverage over medical-marijuana clients.7 Because part of her practice involves representing medical marijuana businesses, her liability insurance provider, Hanover Insurance Group, did not renew her malpractice insurance coverage. It made no difference that it is legal in Colorado, where she practices law, and it made no difference that she was a former prosecutor who apparently taught classes on medical marijuana law for the Colorado Bar Association.
The bottom line is that the marijuana tax laws are all screwed up and California is the perfect example of how screwed up they can be. In California medical marijuana is legal for criminal distribution purposes but illegal for tax purposes unless of course your are taxed as a corporation, in which case medical marijuana is legal for both purposes unless a criminal court or other proceeding determined that the medical marijuana dispensary engaged in illegal activities. This is the status of the tax law in California.
So if you want to practice law in this area just be mindful of these unsuspecting traps. The last thing you want to happen is to be caught off guard.
1 See I.R.C. §§ 6011(a), 6012(a)(2), 6071, 6072, 6091.
2 See I.R.C. § 6065.
3 18 U.S.C. § 2(a) (2006).
4 See 21 U.S.C. § 812 sched. 1(c)(10).
5 Furthermore, the crime of aiding and abetting also requires criminal mens rea, which would be lacking in someone merely discussing the state of the law. See U.S. v. Barnett, 667 F.2d 835 (9th Cir. 1982).
6 Annette Nellen, Marijuana and the Tax Law: Issues Faced by Tax Practitioners in Representation of Clients (May 6, 2014)
7 See http://www.denverpost.com/ci_20563322/denver-lawyer-loses-liability-insurance-over-medical-marijuana