The cannabis industry is walking a fine line between state legality and federal illegality; constantly having to navigate the uncertainty of changing governmental policies, rules and regulations. Given that recreational cannabis is newly legal in only a handful of states, there is not a lot of history on which business owners can base decisions, which has resulted in unexpected expenses and in some unfortunate cases, failed business ventures.
What happens if you can’t pay the bills? It turns out that bankruptcy is not an option, but negotiation with the IRS may be possible.
Typically, if a federal tax lien is levied against a business, it can have the debt discharged in bankruptcy. However, the United States Trustees office’s is taking the position that they do not have the ability to lawfully administer Chapter 7 or Chapter 13 bankruptcies if the debtor is part of a cannabis growing or selling operation. In the case of In re Arenas, the taxpayers owned a marijuana production business in Colorado and filed Chapter 7 bankruptcy. The Tenth Circuit granted the Trustee’s motion to dismiss the grower’s bankruptcy for cause and disallowed the grower from converting the bankruptcy from a Chapter 7 to a Chapter 13 due to the illegality of the crop. The Court found that the Trustee could not administer the assets without violating the Controlled Substances Act, a federal law. Similar cases have been dismissed in California on the same grounds. This ruling would likely apply to all businesses that are directly involved in the growing, processing or selling of cannabis.
If you are in the cannabis industry, you are unable to discharge a federal tax debt through bankruptcy, leaving the options of paying the debt in full or negotiating with the IRS as the only viable paths to discharging the debt. One such method of negotiation is called an Offer in Compromise (often called an OIC). In a recent Federal Taxes Weekly Alert, issued May 19, 2016, the IRS has stated that it will not reject marijuana businesses’ offers in compromise on public policy grounds.
If an individual or business has received notice that the IRS has assessed a tax deficiency, the taxpayer may (if it qualifies) issue to the IRS an OIC. The IRS will only consider an OIC where: (i) the taxpayer can viably dispute all or a portion of the tax debt; (ii) the taxpayer cannot to pay the tax; or (iii) a compromise would promote effective tax administration because collection of the full amount of tax would cause economic hardship for the taxpayer, or compelling public policy or equity considerations provide a sufficient basis for compromising the liability.
The Internal Revenue Manual (IRM) Section 184.108.40.206.2 provides that if there are indicators showing that the taxpayer financially benefits from criminal activity, the case manager may reject an OIC on public policy grounds. The recently issued IRS Alert clarifies that if the taxpayer otherwise meets the requirements for an OIC, the case manager cannot reject the OIC just because the taxpayer is involved in a cannabis business so long as the business is legal under state law.
This Alert may seem small, but it is a step toward legitimizing cannabis businesses at the federal level and may be a sign for things to come.