In Denial 201615018 (released April 8, 2016 and for which I can only find a Tax Notes link) the IRS denied the charitable organization application of a nonprofit organization organized “to provide a way for your members to collectively and cooperatively cultivate and distribute medical marijuana for medical purposes to qualified patients and primary caregivers who come together to collectively and cooperatively cultivate physician-recommended marijuana.” The IRS denied the organization’s applications on two bases: (1) a charitable organization cannot engage in illegal activities and the distribution of marijuana is illegal under federal law; and (2) it provided too much private benefit. I will focus only on the first basis.
Ben Leff and I have previously debated the issue of marijuana distribution and tax exemption. Ben contended that under certain circumstances a social welfare organization under 501(c)(4) could form to distribute marijuana and operate in a tax-exempt vehicle. The reason to try to do this instead of operating in a taxable vehicle is that under section 280E federal tax law prohibits marijuana distributors from deducting trade or business expenses. While I disagreed with Ben, neither of us argued that a charitable organization could engage in the distribution of marijuana. Both of us, and Ben should absolutely chime in, believed that the public policy/illegality limitation on charitable organizations is absolutely clear on this front: engaging in an illegal activity as a substantial purpose just does not cut it under charitable tax rules.
After this recent IRS denial though I have had reporters contacting me to find out if this recent ruling was consistent with the law. There is a sentiment among some that because a majority of states have made a legislative decision to legalize marijuana, particularly for medical purposes, it seems as though the states find such activity charitable. Such organizations seem tailor-made the claim would be to relieve pain and suffering, which surely must be a charitable purpose.
While this does seem to me to be a compelling argument in part, I think that maintaining a hard and fast rule that an organization fails to be operated for charitable purposes if it violates the law as more than an insubstantial part of its activities is probably the right place for administering charitable tax law. Given the challenges I have written about before of administering the charitable tax law in the form of a standard rather than a rule, such a simple rule seems common sensical and likely to save a lot of time on the part of both organizations and the IRS. It also probably more likely than not gets things right.
And I say this with some trepidation regarding the primary IRS guidance document that seems to establish this illegality principle. Revenue Ruling 75-384, 1975-2 CB. 204, held that an organization, whose purpose was to promote world peace, disarmament, and nonviolent direct action, qualified as neither charitable nor as a social welfare organization because its methods involved violating local ordinances and engaging in civil disobedience. In that particular context, I have always felt a sense that this ruling had to somehow be wrong. How can working for world peace and disarmament using nonviolent direct action not be charitable. My answer to that frustration is that the rule prohibiting charitable organizations from breaking the law as a not insubstantial part of their activities is simply the right place to strike the balance on an administrable rule. And yet, were the Civil Rights groups engaged in direct nonviolent action not charitable? Argh. UPDATE: I was thinking this morning that my civil rights example may have problems as a charitable organization if it is an organization substantially focused on lobbying, which presumably many were, rather than just focused on education.
Of course, along these lines, it should be noted that the IRS was certainly right when it found the Church of Cannabis charitable. The Religious Freedom Restoration Act made this a foregone conclusion. As long as the organization is operated for religious purposes and uses marijuana solely within that religious context, the IRS simply cannot deny the organization its charitable status. If the organization were to be operated for the real purpose of distributing marijuana for secular purposes, then we have a different case entirely.
In spite of my trepidations mentioned above, I still feel comfortable that the IRS is on firm ground on this denial and that it is the right rule at this moment in time. There is some talk of the Drug Enforcement Agency reconsidering the Schedule 1 status of marijuana. The change proposed does not appear like it would change the fact that it is illegal for federal purposes to distribute marijuana though. It looks like its primary effect would be to make it easier to research the topic of marijuana in universities. This illegality restriction on charities in todays environment can present some real problems for genuinely charitable organizations, such as hospices, that want to allow patients to use marijuana within the context of their charitable operation. Unfortunately, they are likely stuck in a bad spot if they want to maintain their charitable status as until Congress changes the law; it seems that the IRS’s hands are tied on this issue.
UPDATE: A former IRS colleague of mine pointed out that the IRS almost does too much in this denial, and I think he is right. Cultivating and selling drugs simply is not recognized as a charitable purpose. Pharmacies attached to a hospital are charitable, but most other pharmacies simply do not get that status. I think it is still possible to have the illegality discussion here, but to bring a strong case, someone such as a hospice would have to make the claim that they allow their patients to use marijuana to relieve some ailments, i.e. we need a charitable activity in order to put a real case to the test.