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Lessons for Cannabis Operators from Harborside vs. IRS

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December 06, 2018

Even the most accomplished, groundbreaking leaders in the cannabis industry overlook things – especially where it concerns cannabis taxes and the 280E. A closer look at the case involving Harborside Health Center, the largest non-profit medical cannabis dispensary in California, demonstrates just how far the IRS can reach in prosecuting mistakes.

Avoid succumbing to changing state regulations, running into immutable federal laws, and paying the wrong amount of taxes. Learning from industry leaders doesn’t just mean learning from their accomplishments. It also means being able to look at their failures and adjust your cannabis business practices accordingly. Here’s what we can take away from the industry landmark case of Harborside vs. the IRS.

Who is Harborside?

Harborside Health Center is a medical cannabis dispensary that was originally located in Oakland and now has a second location in San Jose. It was founded in 2006 by Steve DeAngelo, who also founded Steep Hill Labs and ArcView Group: cutting-edge leaders in the US cannabis industry.


Harborside was DeAngelo’s first cannabis business venture, and is recognized as the first dispensary to introduce lab testing. Harborside’s entrepreneurial thinking led them to take  patient cooperatives to a new level by offering a variety of free wellness services, such as acupuncture, yoga, and reiki, to name a few. Harborside began to conduct adult retail sales in January, 2018.

The business has been operating as a non-profit medical cannabis dispensary since 2006. This is important, as they are only now understanding that there are better ways to structure a cannabis company and how to file taxes accordingly.

Harborside vs. Northern California District Attorney

In 2012, the Northern District of California US Attorney, Melinda Haag, attempted to evict the dispensary by going after the landlords of the property where Harborside was operating. Fortunately for Harborside, their lease expressly stated that the business would be dispensing medical cannabis. The judge presiding over the case dismissed Haag’s eviction. At the time, it seemed that no other cases could be brought against them due to the legal concept res judicata, which means that since the forfeiture case was dismissed any other pending cases would be dismissed. However, Harborside was in for a rude awakening.

Harborside vs. IRS

The first case concerning forfeiture was dismissed by the preceding judge, but Harborside was then faced with IRS audits. These audits resulted in an “assessment of deficiencies and penalties” resulting in millions in fines.

The conclusion the United States Tax Court came to was that all four of the presented arguments in defense of Harborside were inadequate. Harborside has to pay a high price in fines.

Arguments

There were four main arguments presented by Harborside’s defense. These were found to be lacking in basis and relevance by the court. The four arguments:

  1. Based on the legal concept of res judicata, since the initial forfeiture action failed, the entity (Harborside) could not be subject to 280E.

  2. Since the 280E was passed prior to the legalization of cannabis, then 280E shouldn’t apply to cannabis businesses.

  3. The third argument tried to establish separate entities within the operational structure of Harborside. This would allow for the entities to be taxed separately. However, this argument was found to be inadequate since “entities that are close and inseparable in an organizational and economic relationship will not be treated as two separate businesses for tax purposes. If they are truly inseparable, one business cannot live without the other, then all lines of business are treated as one, and subject to 280E.”

  4. Harborside’s defense tried to creatively apply the definition to the Cost of Goods Sold (COGS) by saying that the entity was being taxed more than what is allowed by the Constitution since the Uniform Capitalization Rules could not be used.

Unfortunately, none of the defense’s arguments held water with the presiding judge. Harborside could face eight-figure fines to be determined at a later point by the judge.

Lessons from Harborside vs IRS

The first and most obvious lesson we can learn from this setback is that everyone needs to file their taxes the right way and pay them. Irrespective of whether or not the taxes in question come from legal or illegal business operations and dealings, the IRS will not rest until the state is given what it is owed.

The second important lesson is that cannabis businesses should keep it simple. The fewer entities involved, the better. There is no reason to have five business entities dealing in one business process if the main objective is to skirt paying the government. 

The third lesson, which every strictly cannabis retail business should consider is streamlining operations to cover and include all processes and verticals in order to maximize 280E and keep the cost of goods sold down. 

There are a multitude of professional tax and finance providers that are able to maneuver complicated tax laws and code. However, the cannabis industry has proven, time and time again, that it takes more than a seasoned certified public accountant and diligent bookkeeper to tackle to trenches of complexity surrounding 280E.

If you are a cannabis business owner and/or operator, finding an experienced professional tax and accounting firm that deals with cannabis businesses is the best course of action to take. Green Growth CPAs has been serving cannabis businesses since 2010. We are here to help prevent what happened to Harborside from happening to you. Get started at the button below!

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Filed Under: News, Compliance