Medical Cannabis Dispensary Seeking Immunity in IRS Audit

Medical Cannabis Dispensary Seeking Immunity in IRS Audit

A medical cannabis dispensary in Colorado is asking the Internal Revenue Service (IRS) for immunity from federal drug prosecution before providing documents requested in a tax audit. The case highlights that the existing conflict between state and federal law can cause serious legal issues for New Jersey cannabis businesses.

Risks of Federal Drug Prosecution for Cannabis Businesses

Marijuana remains a Schedule I controlled substance under the Controlled Substances Act. Accordingly, the IRS has refused to recognize tax deductions taken by state-legal cannabis businesses because of their illegal operation under federal law. In addition, as long as cannabis remains federally illegal in all forms, there is also a risk of federal drug prosecution.

Under the Obama Administration, the Department of Justice (DOJ) adopted a “hands-off” approach in states where cannabis is legal. The Cole Memo, a guidance document drafted by former US Attorney General James M. Cole in 2013, stated that the DOJ would not challenge state-legal cannabis operations so long as the states at issue maintain robust controls regarding their respective markets and did not allow cannabis operations to undermine federal enforcement priorities pertaining to cannabis. 

However, Attorney General Jeff Session recently reversed course. As discussed in further detail in a prior article, on January 4, 2018, Sessions rescinded the Cole Memo and re-established prior policy that instructs federal prosecutors in cannabis-legal states to use certain criteria and their discretion in deciding how aggressively to enforce federal law prohibiting cannabis operations. “Given the Department’s well-established general principles, previous nationwide guidance specific to marijuana enforcement is unnecessary and is rescinded, effective immediately,” Sessions wrote in a one-page memo.

Cannabis Dispensary Tax Audits

Marijuana dispensaries, particularly in states like Colorado where recreational cannabis is legal, are often targeted by the IRS. Last year, the agency issued summonses to obtain information about a Colorado medical cannabis dispensary, Standing Akimbo, from the Colorado Department of Revenue, Marijuana Enforcement Division (MED). Specifically, the IRS requested employees of the MED to create reports from the state’s seed-to-sale inventory tracking system about the marijuana possessed by the dispensary, and how and when the marijuana was transferred to other third parties – including the identity of these other third parties. 

Sessions’ decision to rescind the Cole Memo puts cannabis businesses subject to an IRS audit in a precarious legal position. In response, Standing Akimbo is seeking immunity from federal drug prosecution prior to turning over documents in its tax case. In a letter to IRS officials, the company wrote: 

We are certain that you are aware that the evidence you are demanding of the

growing/selling of marijuana would be the same evidence that would “convict

overwhelmingly” under federal criminal drug laws should this information be shared

with the Department of Justice and prosecution ensue. Nevertheless, you are

demanding this potentially incriminating information purportedly to determine the

correct tax…

In order to resolve this issue, in accordance with Marchetti v. United States,

390 U.S. 39 (1968) and Counselman v. Hitchcock, 142 U.S. 547 (1892), we request

that the government provide the Taxpayer with absolute immunity from prosecution

under federal criminal drug laws. It is only in this manner can the government

compel the information you are seeking. If absolute immunity is not granted to the

Taxpayer, there will be a full claim of Fifth Amendment privilege. 

Standing Akimbo also raised the threat of prosecution in support of its motion to quash the summons. In its most recent court filing, the dispensary argued that the IRS is likely to share the information it obtains with the Department of Justice and other law enforcement agencies for criminal prosecution purposes. “The Government makes general assertions that the Petitioners do not have sufficient evidence demonstrating this information sharing, but never outright denies that it is doing so,” the brief argues. “Also, the Government’s actions are coming contemporaneously with Attorney General Jeff Sessions’ rescinding of the Cole and Ogden memos – an indication that criminal prosecutions of the marijuana industry may be imminent.”

In seeking to quash the summonses, Standing Akimbo also highlighted that METRC is a plant-tracking system. “[It] does not contain any financial information of substance…The only information the Government will receive through these summonses will be related to the alleged possession and distribution of marijuana,” the dispensary wrote. Accordingly, it maintains that the IRS’s motivation for seeking the records is unrelated to the audit.

What’s Next?

The Colorado court has yet to rule on the motion to quash. Meanwhile, another Colorado dispensary has asked the U.S. Supreme Court to weigh in on the authority of the IRS to determine whether a cannabis business broke federal drug laws. “The IRS claims it is necessary and within its power to make administrative determinations that a person is criminally culpable under federal drug laws. Such a claim of power by the IRS is unprecedented,” The Green Solution Retail Inc. wrote in its petition for certiorari.

While the IRS maintains that it is not auditing state-legal marijuana businesses as a means to bring non-tax-related charges, it remains an area of concern for the cannabis industry, particularly in light of the recent rescission of the Cole memo. We encourage New Jersey cannabis businesses to closely monitor this rapidly developing area of law.

If you have any questions, please contact us

If you have any questions or if you would like to discuss the matter further, please contact me, Dan McKillop, at 201-806-3364.

This article is a part of a series pertaining to cannabis legalization in New Jersey and the United States at large. Prior articles in this series are below:

• Industrial Hemp Farming Poised for Growth Under NJ Bill
• Gov. Murphy Greenlights Expansion of the NJ Medical Marijuana Program
• Can Medical Marijuana Help Solve the Opioid Crisis?