Cannabis Management Companies – What Your Lawyer Isn’t Telling You
Time and again we get questions about what we like to call “musical entities”. “Management company” this, and “holding company” that. “Real estate company” this, and “Non § 280E company” that. There are valid legal reasons to establish multiple entities, for instance, a holding company with separate real estate, management, cultivation, and dispensary companies underneath it. Emphasis on legal reasons that should be discussed with an attorney! The IRS looks at substance over form for tax purposes, meaning that if you think you can set up multiple legal entities to skirt § 280E, you may be creating nothing more than “sham transactions” (IRS terminology).
IN PLAIN ENGLISH: Creating multiple entities is not a good strategy to reduce tax liabilities under § 280E.
“Substance over form” is tax law doctrine that requires transactions to have a substantial purpose aside from reducing Federal taxes and to have a profit motive (aside from the tax effect). In addition, the business purpose doctrine effectively requires a substantial business purpose for a transaction other than avoiding or reducing Federal tax. These concepts arose from a Supreme Court case from 1935 (Gregory v. Helvering). The IRS relies on this case law when analyzing your financial statements to determine whether you have failed to honor either doctrine. Your financial statements should “give a complete, relevant, and accurate picture of transactions and events”. Furthermore, if you are creating transactions among businesses that you have a stake in for the purpose of avoidance or reducing taxes, the IRS has the authority to and has been known to deny any tax benefits that arose. As it may take up to a few years for the IRS to unveil these transactions, you may be subject to penalties and interest as well as back taxes.
IN PLAIN ENGLISH: Historical case law gives the IRS a powerful weapon against those creating a business entity for the sole purpose of lowering taxes.
Setting up business entities or transactions for the sole purpose of avoiding or reducing taxes (§ 280E for our discussion) could result in you owing penalties, interest and back-taxes.
Many vertically integrated cannabis companies or separate companies with at least one shared owner may have what are essentially “inter-company transactions” (i.e. cultivator to dispensary, management company to cultivator, etc.,). This is when the same parties or parties that are not at arm’s length (a.k.a. related parties) buy from/ sell to each other. The IRS can rely upon IRC § 482 to redistribute among groups or individuals the dollar amounts of those transactions in the way that would most clearly reflect how the transaction would have occurred if it were undertaken with an unrelated 3rd party. Part of avoiding scrutiny in these transactions might entail, as an example, keeping documentation of what market prices are for wholesale cannabis products that you are transferring to your retail company.
IN PLAIN ENGLISH: If you are using business entities to create transactions between you and you, they should be priced as if they were between you and a 3rd party, or the IRS can make them so.
In any transaction among related parties or in the establishment of multiple business entities, ask yourself if you set up the legal entity or set up a transaction between companies to obtain deductions that would otherwise be disallowed by § 280E. If your answer is yes, there is a good chance you will not come out of an IRS audit unscathed. We would expect the IRS to take notice of a company that has only income, but no expenses and that pays a company with only expenses, but no income. If you set up a shell company with a building and the necessary equipment to cultivate or manufacture cannabis products, you may be subject to § 280E. If you have made loans to a cannabis touching company with an option to convert to equity, this may be subject to § 280E. On the other hand, if you are a landlord/ property management company with absolutely no involvement in the cultivator’s business, you have a good argument that you should not be subject to § 280E. As always, consult with cannabis attorneys and CPAs on all matters regarding business entity.
IN PLAIN ENGLISH: If your intention is to outsmart the IRS in regards to § 280E, think again.