Management Companies Survive Alternative
Management Companies Survive Alternative – [Please note that this post is an excerpt from another post which we wrote that appears on our main site which you can link to at the end of this one. We thought that while the Tax Court Decision in Alternative is bad news for the cannabis industry, by no means should the use of management companies where there is a valid non-tax business purpose be considered tainted.] It should not have been necessary that we write this article. We have known for a long time that the commercial cannabis industry was not well-served by the tax advice it was receiving. We have from time to time commented on some egregious instances of inane advice. The commentary relating to the three cases recently decided by the United States Tax Court, however, compels us to again take pen to hand.
The root problem seems to be that a substantial portion of the tax advisors involved with the cannabis industry lack the breadth of business knowledge and experience is a fundamental requirement in order to justifiably claim to be sufficiently skilled to advise cannabis business clients. This is particularly true in connection with transactional. Cannabis businesses are businesses even though the federal government insists such businesses are drug traffickers. Cannabis businesses need advice from tax practitioners who skilled in providing such advice to businesses.
The majority of the practitioners who are skilled in providing tax advice to businesses tend to be certified public accountants [“CPA’s”] with graduate degrees in taxation [an “MST”] or attorneys with accounting education and an LLM in Taxation. Experience tells us a significant background in accounting and finance is a necessity. We note that more and more frequently tax issues arising in the cannabis industry will require a skilled attorney as well as a CPA with forensic knowledge who is employed by the attorney under Kovel protections.
Based on published information and solicitations, two groups of practitioners with different skill sets, specifically Enrolled Agents [“EA’s”] and criminal attorneys, appear to be the tax advisors for a majority of cannabis businesses. While most members of both groups are talented in their own right, few have the accounting and finance education and
experience to be skilled tax advisors to cannabis businesses. The problem appears to have been exacerbated because criminal attorneys were “first on the scene” in the cannabis industry as a consequence of the evolution to a legal industry. A similar circumstance brought many EA’s into the cannabis industry. EAs tend to work solo or in small shops that lack complexity and variety of business clients that one finds with a “Big 4” or national CPA firm. [This is not intended as a swipe, but rather an acknowledgment of the way tax practitioners acquire experience and expertise]. We constantly remind ourselves that cannabis is nothing more than an agricultural crop that has “special status” at the present time, which will dissipate over time, particularly once the Federal government removes it from CSA Schedule I.
One of the unfortunate consequences of the Federal government’s approach to cannabis is that legal cannabis businesses are subjected to a draconian regimen of expense disallowance that is otherwise reserved for illegal trafficking in controlled substances. There have been a substantial number of Tax Court cases involving IRC Sec. 280E most of which involved dispensaries where a confluence of factors involving poorly maintained record and sloppy practices led to taxpayer receiving harsh rulings. The Tax Court in Feinberg, refused to recognize a very well know cannabis industry tax practitioner under its Rule 702, its version of the Daubert standard.
The Tax Court issued a very thorough analysis in a case involving Harborside Dispensary that was reviewed by the entire court. We will leave the discussion of the Judge Holmes analysis to the myriad of other posts that have been written, some of which reach outrageously incorrect conclusions. Judge Holmes provided Harborside with a small victory with respect to the application of IRC Sec. 6662 substantial understatement penalties in his TCM opinion based on his perception of the quality of recordkeeping and Harborside’s diligence in seeking to comply with the law.
The foregoing discussion brings us to the even more recent decision of the Tax Court in ALTERNATIVE HEALTH CARE ADVOCATES, ET AL., Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent, 151 T.C. No. 13. This case involves the use of a management company by a cannabis business, which is a practice that appears to have evolved from the decision in Californians Helping to Alleviate Med. Problems, Inc. v. Commissioner (CHAMP). The use of management companies has always been contentious due to the perception that somehow the standards were different due to the existence of IRC Sec. 280E.
The Tax Court’s decision in Alternative, which like Harborside was a reviewed opinion, seems to have caused a number of practitioners to “go off the deep end” and prognosticate that ANY use of a management company would attract fraud penalties.
Alternative was a costly defeat for Los Angeles dispensary owner Donald Duncan. Mr. Duncan had attempted to circumvent 280E through the use of a management company to run his cannabis business. Judge Pugh determined both the dispensary and the management company – Wellness Management Group – were liable for the income tax and penalties.