Pubdate: Tue, 18 Feb 2014
Source: Sacramento Bee (CA)
Copyright: 2014 The Sacramento Bee
Author: Peter Hecht


Sacramento's Canna Care dispensary, an evangelical medical marijuana 
provider renowned for doling out buds with Bibles, is waging a public 
fight with the Internal Revenue Service over an $873,167 tax penalty 
sought under a tax code aimed at illegal drug traffickers.

On Feb. 24, the U.S. Tax Court in San Francisco is due to hear Canna 
Care's challenge over whether the IRS can impose the hefty tax demand 
under a 1982 law intended to close a loophole that allowed a 
Minneapolis cocaine and methamphetamine dealer to claim tax 
deductions for a scale, his apartment rent and telephone expenses.

In the case of Canna Care, the IRS has refused to accept $2.6 million 
in business deductions for employee salaries, rent and other costs 
after auditing 2006, 2007 and 2008 federal tax returns for the north 
Sacramento dispensary. However, the IRS did allow the dispensary, 
which handles about $2 million in medical marijuana transactions a 
year, to deduct the costs of the marijuana itself.

The IRS has used the Reagan-era tax code, known as 280E, to seek tax 
penalties against numerous California dispensaries under the argument 
that their business expenses constitute support of drug-trafficking operations.

Those targeted have included the state's largest medical marijuana 
provider, Harborside Health Center, which is negotiating with the IRS 
over the government's demand for $2.5 million in back taxes for 
Harborside's Oakland and San Jose dispensaries.

The IRS also played a role in sweeping crackdowns on medical 
marijuana businesses that California's four U.S. attorneys initiated 
in late 2011. IRS agents joined in the raids on the Oaksterdam 
University marijuana trade school and dispensary of Richard Lee as he 
was seeking to negotiate down his tax debt under the 280E tax code. 
Lee was the architect of Proposition 19, an unsuccessful 2010 bid to 
legalize recreational marijuana in California.

The agency also raided Sacramento's former El Camino Wellness 
dispensary and seized its bank accounts under federal 
money-laundering statutes used to target narcotics traffickers. No 
charges have resulted in either case.

Canna Care director Lanette Davies said she and her husband, Bryan 
Davies, the dispensary CEO, had no dispute with the IRS over any of 
the figures reported in their tax returns. She said the IRS made an 
offer as low as $100,000 to settle their tax case. But she said they 
decided to challenge the demand in court because they considered it a 
punitive tax against cannabis outlets that other businesses don't pay.

Davies, whose family-run dispensary runs radio ads inviting neighbors 
and medical marijuana patients for nightly prayer sessions, said the 
couple won't accept a settlement that calls for paying "a couple 
extra percent of your gross sales" to the government.

"To me, that's buying protection money," she said.

Davies said the dispensary operates as a not-for-profit business 
under California medical marijuana laws and declared a modest 
business loss on its taxes in 2006. She noted that IRS allows 
deductions for the business costs of acquiring marijuana  the one 
item that is illegal under federal law  but won't let the dispensary 
claim routine business deductions.

"They don't accept that I pay my employees well and that I provide 
them with full dental and medical insurance," Davies said. "They 
don't accept the rent of our place, our liability insurance, our 
workman's comp insurance, our phones or our security, a big expense for us."

While the IRS doesn't comment on tax cases, court papers say the 
agency demanded that Canna Care pay $229,473 in additional income 
taxes for 2006, $304,090 for 2007 and $339,604 for 2008.

In a petition challenging the IRS finding of tax deficiencies for 
Canna Care, attorney Spencer Malysiak argued that the agency's 
refusal to accept the dispensary's routine business expenses violates 
the Equal Protection Clause of the U.S. Constitution. The petition 
argued that the IRS was "tacitly" working to enforce U.S. drug laws 
against the dispensary even as it allowed Canna Care to deduct its 
costs of goods, the marijuana.

The IRS action "amounts to a de facto prohibition against medicinal 
marijuana dispensaries, and is tantamount to a criminal prosecution," 
Malysiak wrote in the petition.

Henry Wykowski, a tax attorney who is representing Harborside, said 
it is common for dispensaries to fight IRS tax claims in court with a 
goal of minimizing their financial burden. But he said Canna Care 
stands out by appearing to reject negotiations to reduce its taxes 
and penalties.

"I would say the big picture is they were offered the settlement and 
for whatever reason they decided not to take it," Wykowski said. "Now 
they're set for trial with regards to the (tax) deficiency. I can't 
give you any idea of what their chances of success are."

Wykowski was one of the attorneys involved in a landmark California 
case in which the IRS tried  and failed  to win a $426,000 judgment 
for back taxes and penalties against a San Francisco medical 
marijuana provider, Californians Helping to Alleviate Medical 
Problems Inc. The 2007 case resulted in a court ruling that CHAMP's 
biggest expense  the marijuana  was deductible because U.S. tax law 
allows businesses to deduct the cost of goods sold.

The tax court also ruled that the dispensary could deduct the 
majority of its employee costs as care-giving expenses. CHAMP ended 
up paying a tax assessment of $4,905.

Davies said Canna Care employs 12 people and that her husband 
receives an average salary of $100,000 as the CEO and she earns 
$75,000 a year as the director and an advocate on medical cannabis 
issues. She said other employees make between $30,000 and $40,000 in 
addition to health benefits. She said the dispensary maintains its 
not-for-profit status in part by supporting charities, including 
cancer research and a community Christmas event in Del Paso Heights.

"We're hoping to bring awareness to this statute and the fact it's 
unconstitutional," she said. "All cannabis businesses in the United 
States should be treated as legitimate businesses."
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