Interest and excitement in the cannabis industry are at an all-time high. As the cannabis market continues to grow following record-breaking sales in 2020, complying with local, state, and federal law should be the top priority for all owners and operators.
This can be challenging for an operation and requires an investment of time and resources, but it is absolutely necessary for all cannabis businesses hoping to continue operations without legal repercussions. Failure to sufficiently comply with all regulations can result in severe penalties for all involved in a cannabis operation, including hefty fines, a loss of business licensure, and the possibility of criminal charges.
Moving forward, owners and operators must pay close attention to the requirements applicable to their operation and stay informed of regulatory changes that can happen quickly. While cannabis has not yet reached full legalization across the U.S., all businesses are still required to follow applicable laws and federal tax codes, including the dreaded IRC 280E (which prohibits any deductions or credits for ‘trafficking’ controlled substances). Some cannabis business operators may be tempted to search for loopholes or ways to skirt these requirements, but this can be a disastrous mistake that lands a business in hot water.
Below are examples from two major legal cases involving cannabis businesses, demonstrating the cause and consequences of failing to comply with Federal and State regulations. Let these serve as cautionary tales and lessons in cannabis compliance for your business.
Lesson #1 – Limiting Sales: Denver vs. Sweet Leaf
In 2018, the city of Denver, Colorado conducted a series of undercover operations and raided several facilities belonging to the Sweet Leaf dispensary chain. This operation followed a tip which claimed that Sweet Leaf regularly disregarded regulations restricting the amount of cannabis product an individual could purchase in one day. This resulted in more than a dozen arrests and at least eight Sweet Leaf stores forced to shut down.
After a year of legal battles, Sweet Leaf’s three primary owners would ultimately accept a plea deal that banned them from any future involvement in cannabis operations for 15 years, over $10 million in fines, and one year in prison.
At the heart of this case was the practice of “looping.” Looping refers to purchasing the maximum daily amount of marijuana (one ounce) in a single transaction and then returning, sometimes several times a day, to repeat the purchase.
Surveillance showed a man who was able to purchase three pounds in a single day, and according to court documents, an undercover officer at another location was able to buy five ounces in the span of an hour.
Prosecutors in the case described a company culture in which owners actually encouraged employees to promote looping. Officials estimate that Sweet Leaf’s illegal sales may have resulted in 2.5 tons of marijuana hitting the black market. While Sweet Leaf has since tried to continue operations, the brand has so far been unable to fully recover.
Lesson #2 – Tax Code Compliance: IRS vs. Harborside
Another common compliance issue, perhaps the most prominent, involves the IRS and cannabis businesses maintaining federal tax compliance, particularly under section 280E. Harborside, one of California’s largest dispensaries, learned this the hard way.
In 2020, Harborside was ordered to pay $11 million in back taxes for attempting to circumvent the restriction on deductions for cannabis businesses. Harborside unsuccessfully appealed this decision, arguing that 280E is unconstitutional.
Harborside’s issues arose when they attempted to claim deductions for their cannabis operation under a non-cannabis business entity they also owned. While Harborside maintained they kept sufficient separation between the cannabis sales operation and their non-cannabis operation, the IRS and U.S. Tax Courts ultimately disagreed.
The courts determined that a single legal entity could operate more than one business; however, for cannabis business owners, the separation between entities must be distinct, with the non-cannabis entity able to function wholly on its own. Non-cannabis businesses linked to cannabis businesses must demonstrate regular business operations consistently, generate its own profit, and function independently. In other words, it must be able to stand alone.
Cannabis businesses can succeed in today’s market while maintaining 100% compliance with local, state, and federal law. For your business, carefully consider the processes and legal requirements within your cannabis operation, and consult with experts.
While the two examples above demonstrate what can happen when a business is found to be non-compliant, these cases are not equivalent. In the case of Harborside, they were not proven to knowingly break the law and the business is recovering. In the case of Sweet Leaf, the intent or negligence was clear. Either way, the companies suffered. The bottom line moving forward is that compliance should consistently remain the number one priority of all cannabis owners and operators.