Cannabis Tax Court Cases #1: CHAMP
As a cannabis business, you will be audited. This is a fact. The IRS has already said that cannabis businesses will be audited. It is not a matter of if, but a matter of when. They are hiring more employees for this very reason. The IRS knows that cannabis companies are going to be looking at ways to cut down on the taxes that they are going to have to pay on their revenue. Because cannabis companies have such a high tax rate, the IRS is going to make sure they get every dollar they are due. 280E not only puts cannabis companies in a hard position tax-wise, but it also gives the IRS more power when determining taxes owed. The IRS is not letting any cannabis companies get by. We’ve already seen the tax court hand down several rulings that back the IRS’s findings of cannabis companies owing more taxes than they actually paid. There has been one tax court case so far where a cannabis company has been able to overcome the IRS on section 280E. This was the CHAMP Case. Here what happened and why the company was so successful.
Californians Helping to Alleviate Medical Problems (CHAMP) v Commissioner
CHAMP is the case cited most frequently by cannabis business owners in tax court for claiming that their deductions are exempt from §280E and, therefore, are allowable. Mostly because it’s been the only successful business to overcome an attack by the IRS over 280E. CHAMP operated a facility where individuals with debilitating diseases could receive counseling and other caregiving services. Access to these services was based on membership, where members paid a monthly fee based on the costs for services. CHAMP also offered medical marijuana to its members.
The first business offered several weekly group sessions focusing on different subjects. They also offered food and hygiene products to low-income clients and allowed its members to consult with a counselor about different items, including housing, health, safety, and legal issues. CHAMP also coordinated weekend social events for its members, such as Friday movie nights. They also coordinated monthly field trips. CHAMP provided members with online computer access. The other business offered medical marijuana.
After examination, the IRS determined that CHAMP was trafficking in a controlled substance and disallowed all business expenses except for Cost of Goods Sold, as directed by Section 280E. The IRS then assessed the tax assessment along with penalties and interest. CHAMP fought the assessment claiming that it engaged in two separate businesses, one being the caregiving and counseling service and the other being the supplying of medical marijuana. The Tax Court agreed and CHAMP was able to successfully deduct ordinary and necessary business expenses (aside from its cost of goods sold) as they fell under its primary business of counseling and caregiving services. For purposes of determining the applicability of §280E, the court looked to the degree of economic interrelationship between the two business undertakings. CHAMP’s non-cannabis activities were substantial enough that it was enough to be a standalone business and didn’t need the cannabis activities to survive. The court found that the caregiving services were actually more dominant than medical marijuana sales. The court also noted CHAMP was “regularly and extensively involved in the provision of caregiving services, and those services are substantially different from petitioner’s provision of medical marijuana.”
The CHAMP case is important because it has been the most successful tax court case we’ve seen from a business dealing with cannabis. The takeaways from this case are important because others have tried to use this case to allow regular business expenses and they have failed. If you are going to try this route, it’s important to take the necessary steps. First, set up two different businesses. Make different business entities and structures, have different accounting books for each business and keep expenses separate. This is a basic, but also a very important step as this shows the IRS that you started it as two distinct businesses. Next, make sure both businesses can stand alone. In CHAMP, the caregiving side of the business was more dominant than the marijuana side. If the court thinks the non-cannabis business cannot stand without the cannabis business, you will likely lose your deductions. Cases that have tried to replicate the CHAMP case have failed because they tried to use a second business to avoid 280E. It never works. It is important to have two different and profitable businesses for this to work.
If you need help with your cannabis business, Polston Tax can help. We can not only make sure your business is set up correctly, but also that your books are straight and compliant with the IRS. We will show you how to make the most of the deductions you are allowed. Give us a call at 844-841-9857 or click below to schedule a free consultation.