By Benjamin Leff
I promise that I think about things other than marijuana, but if you’re following my posts on this blog so far, there is little evidence of that. In 2014, I published Tax Planning for Marijuana Dealers, which argued that sellers of marijuana could qualify as tax-exempt organizations under section 501(c)(4), which would enable them to avoid a draconian federal tax created by IRC section 280E. This article inspired a thoughtful response by fellow blogger Philip Hackney, in which Phil argued that such organizations cannot qualify for tax exemption. Among other things, he argued that that the so-called public policy doctrine applies to (c)(4) organizations just as much as it applies to (c)(3)s. We replayed some of our disagreement about the breadth of the public policy doctrine last month on this blog (here, here and here). But now I’ve posted a new draft article that addresses the application of the public policy doctrine to independent government entities that are exempt from federal income tax under IRC section 115 instead of 501(c).
In his original response to my article, Phil made a suggestion, “in the spirit of not just offering criticism, but also offering a solution[.]” His suggestion was that “in the case of medical marijuana, instead of placing the battle between relatively unaccountable private entities and the federal government, the state … should open up medical marijuana clinics [because] the state can provide more accountability to its community, the federal government, and other states.” Then, in March, 2015, the Cannabis Corner was opened by an independent public development authority created by the municipality of North Bonneville, which is itself a political subdivision of the State of Washington. This store sells recreational marijuana, rather than medical marijuana, and it was created to be fairly independent of Washington state legislature (and even the town of North Bonneville), but it otherwise takes up the constructive proposal Phil made in 2014.
On January 16 of this year, UC Davis Law Review held an excellent symposium on marijuana law issues called Disjointed Regulation: State Efforts to Legalize Marijuana, and I presented a paper called Tax Benefits of Government-Owned Marijuana Stores, which I have finally posted (in draft form) on SSRN. The article argues that public development authorities, like the one created to operate the Cannabis Corner, and other independent entities created by state or local governments to sell marijuana could be exempt from federal tax under IRC section 115. So, the article takes up the question of whether section 280E can be avoided by governmentally-created organizations if one is unconvinced that section 501(c) does the trick. The ultimate goal of the article is to clear up some confusion amongst marijuana policy folks over whether a state seeking to create a governmental monopoly over marijuana sales could use an independent agency or authority to do that, instead of having to do it “itself.” (For example, in the discussion on pages 63-64 of “near monopoly” in this excellent Research Report created for the Vermont legislature). Therefore, the article focuses on independent entities created by governments to carry out their purposes (which are exempt from tax under section 115) rather than entities which are part of the government itself, or which have sovereign functions delegated to them by the government, which are exempt from tax for other reasons. If a government wants to sell marijuana or otherwise directly intervene or control the supply chain of marijuana, it can do so either “itself” or through an independent authority or commission. This is important because of the argument made powerfully by Pat Oglesby and others that at least some state should experiment with a government monopoly on marijuana sales as a way to cautiously ease into legalization of marijuana. I have become convinced that the District of Columbia, where I live, would be an excellent place to carry out this experiment.
Along the way, my article continues the debate with Phil over the extent of the “public policy doctrine” in federal tax law. At least some folks over at the IRS, and Phil, appear to be of the view that a free-standing public policy doctrine exists that bars deductions or exemptions for any activity that is illegal or violates a fundamental public policy. In my paper, I argue that there is no such free-standing public policy doctrine, ever since Congress amended section 162 to codify those specific expenditures that are not deductible because they violate public policy. When Congress did so, it removed the option of the IRS (or courts) adding to the list of expenditures that cannot be deducted because of public policy, including even expenses incurred in an illegal activity. Of course, Congress reserves the right to deny deductions for such activities, as it did when it enacted section 280E, denying deductions for ordinary and necessary business expenses for non-exempt entities engaged in trafficking in controlled substances. And, of course, the Supreme Court upheld a public policy exception to exemption under section 501(c)(3) that it derived from the common law of charities. But neither the prohibition under 280E nor the charity-law doctrine apply to governments, their instrumentalities, or independent entities they create to carry out their governmental purposes. There is no general free-standing impediment in the federal income tax to state and local governments making their own determinations about what constitutes good public policy. Of course, the same could not be said of federal criminal law, since an employee of such public development authorities could presumably be arrested for violating federal law by selling marijuana, no matter how legal such activities are at the state level. But that’s a topic for another blog.