Ninth Circuit’s brutal dismissal shows how small mistakes can have huge consequences

Cannabis taxes are a tricky and complicated affair. In a brutal loss for two cannabis companies, the Ninth Circuit rejected their appeal of the IRS’ determination that they owed hundreds of thousands of dollars in taxes. This case, entitled Organic Cannabis Foundation v. CIR, Case No. 17-72874, arose in response to the way cannabis companies are taxed under the Internal Revenue Code. Internal Revenue Code §280E is a well-known tax statute in the cannabis industry, because it prohibits cannabis companies from deducting ordinary business expenses from gross income. This treatment has been criticized by many, but remains the law of the land. Cannabis companies often plan and structure their businesses in ways that are designed to minimize the effects of §280E on their tax liability, and in many cases doing so at the beginning of the year is far more advisable than trying to work it backwards at year’s end.

Case Summary

In Organic Cannabis Foundation, two companies–Organic Cannabis Foundation, LLC and North California Small Business Assistants Inc.–were both hit with substantial tax bills from the IRS. Organic Cannabis Foundation LLC was hit with a bill of about $1.25 million, while NCSBA’s bill was about $638,000. The companies hired a lawyer to appeal these exorbitant bills, but were in for a cruel twist of fate.

Unfortunately, the petitions for appeal did not arrive at the Tax Court until the day after they were due. A combination of factors led to this tardiness, including the law firm using a courier that did not qualify for IRS’s mailbox rule. The mailbox rule considers a package to be “delivered” at the time when it is given to the courier, but only if that courier has been designated as official by the IRS. Because the IRS didn’t designate “Fedex First Overnight” (the courier that was used in the case), the mailbox rule did not apply.

Although the package still was scheduled to be delivered on the due date, unfortunately for the petitioners, that didn’t happen. The courier driver’s notes indicate that he tried to get to the door but couldn’t, and though the exact nature and cause of the obstruction is not known, the package was delivered the following morning, a day late.

Accordingly, the Tax Court decided to dismiss the petitions as untimely. The court concluded that the packages were due the day before, and one day late is inexcusable. The companies then appealed to the Ninth Circuit, which finally handed down their decision on Thursday, June 18, 2020. The court’s decision tossed company’s appeal, stating that the petition was late, the mailbox rule didn’t apply, and there was no basis to find an exception to the rule.

This Ninth Circuit’s decision means that the companies will have to pay its tax bill to the IRS, something which it most likely cannot do. Indeed, this might even mean the end of the companies’ operations. Further, the law firm may in fact be liable to the companies for mishandling the petition. However, the question of firm liability will also depend on whether they would have had any success if the petition was timely filed. We have seen the Tax Court consistently reject these cases, holding that there is no way for these companies to escape §280E even if they are fully legal under state law. However, there is another case currently pending before the 9th circuit, entitled Harborside v. Commissioner, Case No. 19-73078, in which the petitioner is asking the court to throw out the playbook in this regard. At this stage, the parties in Harborside are in the process of filing briefs, and all eyes are on what the court will do with that case.

If the lawyers in Organic Cannabis Foundation had filed the petition timely, and then appealed the case to the 9th circuit, the case would likely have been consolidated with Harborside.  So if Harborside wins a landmark victory, these dispensaries will have been terribly affected by the fact that the mailbox rule didn’t apply.

Takeaways

This case can also teach all of us an important lesson. Both lawyers and nonlawyers need to be hyper aware of the rules that govern their operations, as even seemingly minor mistakes can have colossal consequences.  Cannabis companies have ongoing due diligence requirements that must be maintained carefully, and small slip-ups can mean that a company falls out of compliance, which will cause unforeseen, material consequences. In a recent post, we described how small compliance oversights could spell disaster and lead to massive lawsuits. The mistake in Organic Cannabis Foundation, made by a lawyer’s secretary, highlights the importance of monitoring those who are conducting business on behalf of the company. Especially during the pandemic, where many companies have shifted their usual business practices, extra care must be taken.

As Professor Moody always says, “CONSTANT VIGILANCE!”

The cases are:

ORGANIC CANNABIS FOUNDATION, LLC v. COMMISSIONER 

and

NORTHERN CALIFORNIA SMALL BUSINESS ASSISTANTS, INC., v. COMMISSIONER

No. 17-72874 and No. 17-72877, respectively. Opinion issued June 18, 2020.

Disclaimer: This article has been prepared and published for informational and educational purposes only and is not offered or intended, nor should it be construed, to be legal advice.

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