Harborside Beats Penalties
Harborside Beats Penalties T.C. Memo. 2018-208 – we certainly were not expecting this result, especially after the holding in Alterman T.C. Memo. 2018-83 where the Tax Court seemed to give the IRS the ability to amend penalty assertions based upon Graev – 149 T.C. No. 23.
It’s our turn to eat crow, see my being quoted in thestreet.com where I stated:
“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.”
The Tax Court stated:
Harborside argues, however, that it showed that its return positions were reasonable and taken in good faith. It specifically argues that they were reasonable because from 2007 until 2012 the only relevant case was Californians Helping to Alleviate Med. Problems, Inc. v. Commissioner (CHAMP), 128 T.C. 173, 181 (2007), where we did hold that medical-marijuana dispensaries were “trafficking” under section 280E, but allowed a dispensary to deduct its non-drug trafficking-related expenses. CHAMP was the first of our marijuana-dispensary cases, and the Commissioner conceded any penalty. CHAMP, 128 T.C. at 173, 185-86.
In CHAMP, however, we did not analyze the main argument that Harborside relied on Patients Mutual I–that the phrase “consists of” in section, 280E must mean something like “consists entirely of.” And there the caselaw sat until 2012 when we issued Olive. Olive v. Commissioner, 139 T.C. 19, 36-42 (2012), aff’d, 792 F.3d 1146 (9th Cir. 2015), disallowed deductions only after highlighting major factual differences with CHAMP; allowed estimated COGS adjustments under the Cohan rule, see Cohan v. Commissioner, 39 F.2d 540, 543 44 (2d Cir. 1930); and was on appeal until 2015.
In Olive, we did discuss the meaning of the phrase “consists of” in section 280E but treated it rather summarily, presumably because the taxpayer’s only revenue was from marijuana [*5] sales. Olive, 139 T.C. at 22, 42. In these cases, Harborside elaborated on the argument very considerably–and almost persuasively–in what we find was a reasonable hope for a more elaborate judicial analysis of that position for a business with some, albeit comparatively tiny, revenue from nonmarijuana sales. In any event, Olive did not become final and unappealable until years after Harborside filed the last of the returns at issue in these cases. And Harborside also points out that, apart from CHAMP and Olive, there was very limited guidance available to marijuana dispensaries. Harborside correctly points out that the IRS has never promulgated regulations for section 280E and didn’t issue any guidance on marijuana businesses’ capitalization of inventory costs until 2015. See Chief Counsel Advice 201504011 (Jan. 23, 2015).
This leads us to the conclusion that Harborside’s reporting position was reasonable. Not only had its main argument for the inapplicability of section 280E to its business not yet been the subject of a final unappealable decision, but as discussed at length in Patients Mutual I, the meaning of “consists of” as used in section 280E is subject to more than one reasonable interpretation. See Patients Mutual I, 151 T.C. at ___ (slip op. at 24-37). Even by 2012–the last of the tax years at issue here–, the only addition to this casel aw was our own opinion in Olive, and it too was still years away from a final appellate decision.
The closing commentary from Judge Holmes should be read and reread by cannabis industry business owners and their tax advisors…the message couldn’t be more clear…complete and accurate records and thorough analysis of the applicable law is worth a tremendous premium.
We also believe the testimony of Steve DeAngelo–Harborside’s cofounder and boss–that he actively sought to comply with California law and our caselaw. After trying the case and looking at the records and testimony that Harborside presented, we find no bad faith in its taking the reporting positions that it did.
We’ve previously declined to impose accuracy-related penalties when there was no clear authority to guide taxpayers. See Petersen v. Commissioner, 148 T.C. 463, 481 (2017); Williams v. Commissioner, 123 T.C. 144, 153 (2004); see also Foster v. Commissioner, 756 F.2d 1430, 1439 (9th Cir. 1985), aff’g in part, vacating in part 80 T.C. 34 (1983). We will do so again here. We therefore find that Harborside acted with reasonable cause and in good faith when taking its tax positions for the years at issue. Harborside isn’t liable for penalties.