Financial Relief Legal Advocates, Inc.

John H. Bauer


California Cannabis (Marijuana) Law

“MAUCRSA” is the new California Statute which describes procedures to license both commercial medical marijuana and recreational (adult use) marijuana related facilities/activities in the State of California.  Medical marijuana was approved for usage in California, subject to specific legal requirements, in 1996.  Recreational marijuana (adult use) was approved for usage in California, subject to specific legal requirements, effective January 1, 2018. At this time, old medical marijuana entities should be modified from non-profit to profit.  As a result, one of the first important decisions to make is:

“What entity should I choose for my prospective cannabis business?”

We can help you to choose the right entity. These choices generally include C-Corps, S-Corps, LLC’s, General Partnerships, and Sole Proprietorship. The choice you make will depend upon what plan you have for the growth and expansion of your business and how you want to structure you taxes. Take a look below at a comparison, for example, between a C-Corp and S-Corp entity as it relates to business expansion and tax structure.

C-Corp Factors:

1.Double Taxation

For example, if you choose a C-Corp., there will be double taxation—taxation of the corporate net income at the new corporate rate of 21% + taxation of the distributed income to individual tax payers at their normal personal income tax rates (let’s assume 23.8%). This can amount to a very substantial tax cost.  *On the other hand, the corporation can retain its earnings and therefore severely reduce the amount of tax cost to the individual taxpayers.

2.Multiple Levels of Stock:

In addition, the corporation can offer multiple types of stocks—some with corporate control and others without corporate control. The corporate officers can retain control of the company while still distributing stock ownership to employees as bonuses or outside parties who are purchasing shares in the company.

3.Types/Breadth of Shareholders:

If you wish to “go public,” and greatly expand the finances and size of the company, this is the entity to use.  For example, institutional investors, other corporations, stock and income funds, and foreign investors can all purchase stock of a C-Corp.

Let’s compare the C-Corp structure briefly to an S-Corp:

S-Corp Factors:

1.No Double Taxation

This entity is known as a “pass through” entity. There is no double taxation. There is no federal taxation to the S-Corp itself.  All the income is simply passed through from the Federal Tax Returns to the Personal Tax Returns of the individual owner(s) of the entity. Of the net income which is passed through to the individual returns, part of this income is attributable to corporate profit which is non-taxable and “fair and reasonable compensation” of the taxpayer for his role in the company which is taxable. This is a very different tax structure and does not involve a structure of double taxation.

2.No Multiple Levels of Stock

Unlike the C, the S does not allow for multiple levels of shareholders. When a person purchases stock, he/she has a right to equal control of the property as the founders of the company. This is a potential disadvantage for an S-Corp. The founders can quickly lose control of their company.

3.Types/Breadth of Shareholders

The breadth of shareholders is extremely limited.  S Corp investors are limited to 100 shareholders—each of whom must be a US citizen or US resident and certain trusts. There is a very limited pool of potential shareholders for an S-Corp. Corporations, stock funds, and foreign investors are not even eligible.  This is not an ideal entity to become a large corporation. As a result, this is not an ideal entity to go public.

*There are other tax liabilities, in addition, which must be paid by the entities discussed above.

Also, there are issues of individual liability involved with respect to each different entity.  We will discuss those during the course of our consultation.

In addition, other entities including the LLC, general partnerships, limited partnerships, and sole proprietorship all have differing tax structures and liability issues. We can help you to determine the best and most beneficial entity for your prospective cannabis business.

Other questions of concern for you may be:

Where can we set up our business?

You must have a local city or county license approved and issued before you can be approved for your California state license.  Many counties don’t allow for any type of cannabis business while some cities within those counties do and vice-versa. Also, some jurisdictions will provide licenses for medical marijuana but not for recreational marijuana.  You need to know your options. Also, will you be dealing with medical marijuana or recreational marijuana or both? We can help you with this question.

I’ve found a business premises.  Will this landlord’s lease work for my business?

You typically have to lease or purchase a business premises in order to get even a local license.  One of the first issues becomes:  how can I sign a lease for a cannabis business if I don’t have a local license and State License for my business?  In addition, there are multiple other issues that must be dealt with in the lease—which include (but are not limited to) disclosure to the landlord regarding the specific use of the premises, handling lease provisions which refer to the “legality of the business,” and insurance, utility, and security provisions.

How do I get insurance for my business?  I’m having trouble finding insurance!

You will find that it may be very difficult to get insurance for your cannabis business because it is an “illegal business” under Federal Law. We can identify insurance companies that cover cannabis businesses in California. The issue of coverages will also be critical to your business.

How will I set up banking for my cannabis business?

You will find that many, in fact most, banks simply will not give your company financing and a regular bank account since your cannabis business is deemed an “illegal business” based upon federal law. We will discuss this issue with you and identify a company which provides certain necessary banking services for your business.

How does President Trump’s new tax and jobs bill impact the taxes I pay for my cannabis business?

The new bill provides an additional important deduction which may reduce your company’s tax liability. We can explain this to you.

How much marijuana can I possess as a recreational marijuana user?

Any person 21 years of age of over can legally possess 28.5 grams of marijuana (1 ounce) which you can take outside of my home. You can also possess up to 8 grams of “hash and concentrates.”

Can I legally grow marijuana plants at home as a recreational marijuana user?

Yes, you can legally grow 6 marijuana plants inside your home regardless of their stage in the growing process. Outside growing may be illegal based upon local law or if you live next to places like a public park.

Can I legally purchase and possess medical marijuana?

At the least, you should have a written recommendation from a California licensed physician to use marijuana for an accepted medical condition.

As a medical marijuana patient, how many marijuana plants can I grow at home, if any?

You can grow 6 mature or 12 immature plants inside your home and may be able to grow more if the amount you grow is “reasonably related to your medical needs.” That’s a touchy subject, however, as you better be able to prove your sincere necessary medical needs if the police visit your home.  You better have a physician’s recommendation or California Medical Marijuana ID card to prove your entitlement to all this marijuana.

In closing this section, there are multiple issues to discuss regarding possession of cannabis (marijuana) as regards to your personal use and establishment of a cannabis business if you wish to proceed with this goal.  We stand ready to discuss these issues and assist you with your goals in this growing industry.

Additional Information

Los Angeles International Airport has seen arrests surge 166 percent since marijuana was legalized across the State of California in 2016.

Authorities at LAX say airline passengers carrying small amounts of marijuana have been emboldened by reduced marijuana penalties, but that drug traffickers stuffing entire checked bags with pot have also been apprehended in much larger numbers.

More smugglers are hopping onto flights out of California to escape the state’s saturated weed market, police and defense lawyers told The Los Angeles Times. California legalized the use, production, and sales of recreational marijuana with the passing of 2016’s Prop. 64, which went into effect January 1, 2018.

But regardless of California’s state laws on marijuana, the Transportation Security Administration (TSA) and the federal government—which still view marijuana as an illegal Schedule 1 narcotic alongside heroin, cocaine, and LSD—prohibits interstate travel with marijuana. The California Bureau of Cannabis Control, a state agency, dodged a fight with the DEA and other federal authorities and prohibited the export of marijuana to other states.

However, the Los Angeles Police Department allows LAX passengers with small amounts of marijuana to pass through security—but not smoke—at the airport. And authorities caution that passengers face arrest or charges at their destination should they be headed toward any state where marijuana is not legal.

LAX, the world’s fourth-busiest airport, is quickly becoming a marijuana hub alongside California’s other major airports for passengers with small amounts of pot for personal use they perhaps “forgot” as well as those carrying several pounds of vacuum-sealed marijuana packages.

“We intercept large quantities of marijuana regularly,” said Sgt. Ray Kelly of the Alameda County Sheriff’s Office, which has jurisdiction over Oakland International Airport, in an interview with The Los Angeles Times. “We find it in about 50-pound quantities…the carry-on rate for luggage. I would imagine we’re only intercepting some of it, not all of it.”

California is the top marijuana-producing state in the country, pushing out 13.5 million pounds of marijuana in 2016 which is about fivetime more than state residents consumed. The massive surplus has driven—or in this case, flown—people out of the state for business and consumers in states where stricter marijuana policies are enforced.  Additionally, authorities say hundreds of passengers who forget that federal authorities have dominion over the country’s skies are increasingly being apprehended with small pouches and viles containing marijuana in both their carry-on or checked bags.

LAX arrest records showed the most popular flight destinations for pot smugglers were Chicago, Indianapolis, Atlanta and Dallas. In 2018, which was the first year for legalized recreational pot use in California, LAX police made 101 trafficking arrests. In 2017, there were only 38 arrests and in 2016 there were only twenty.

The move follows California’s Jan. 1 start date for its adult-use market.

When adult-use marijuana became legal in California on Jan. 1, the California Secretary of State’s office followed the news by accepting trademark applications for cannabis products.  As long as those products “are lawfully in commerce under California law,” according to Secretary of State Alex Padilla’s office, they may be eligible for registration.

It was an unexpected move in the largest legal cannabis market in the world.  Marijuana remains illegal under federal law, and so the U.S. Patent and Trademark Office (USPTO) does not register cannabis products.  States that oversee legal and regulated cannabis may allow trademark registration through their own trademark registries.

A key component of state trademark law is the matter of intrastate commerce.  In this case, cannabis products are eligible for California trademark registration only if they are actively sold within the state of California at the time of registration (and only if they comply with state law).  An “intent-to-use” application, which exists at the federal level, will not be applicable for cannabis product trademark registrations in California.

As…explains:  “In order to obtain protection you must 1. Obtain a manufacturing or cultivating temporary license; and 2. Product must fully comply with MAUCRSA.

And even if a company obtains a registered trademark for a cannabis product, that will not impact any future applications with the USPTO.  According to case law: “[T]he fact that the provision of a product or service may be lawful within a state is irrelevant to the question of federal registration when it is unlawful under federal law.”

Ever since California voters passed the Adult Use of Marijuana Act in 2016, the majority of the focus has been on the monumental task of regulating California’s billion dollar black market cannabis industry.  However, Prop. 64 as its popularly known, also included language that provided for the reduction or elimination of hundreds of thousands of cannabis-related convictions going back over 30+ years.  Reducing and eliminating criminal convictions was viewed as an important first step in addressing the harm suffered by people caught up in the war on cannabis.  For many, a cannabis conviction meant they could not obtain desired employment, loans for college education, or be able to vote or own a firearm.  Others were still serving jail sentences or probation, or paying off hefty fines levied upon them for possession of a substance which is now legal for all California adults over the age of 21.

While Prop. 64 created the ability to reduce or eliminate cannabis convictions, it did not create a mandate or apparent pathway to achieve the intended results.  Moreover, no funds were specifically allocated to assist local jurisdictions with the task of identifying and processing the reductions.  Driven individuals could retain the services of an attorney or even petition the courts on their own using the forms created by the California Judicial Counsel, however, many folks were either unaware of the new law or unable to take advantage of its benefits.  Enter San Francisco District Attorney George Gascon and tech-based civil rights advocacy group Code for America.  Together they developed the technology that helped identify over 8,000 people with cannabis convictions in San Francisco that were eligible to take advantage of Prop. 64.  Mr. Gascon’s office is now taking affirmative steps to retroactively dismiss cannabis convictions dating back to 1975.

While San Francisco is leading the charge, many other jurisdictions have also taken steps to assist people to take advantage of Prop. 64.  For instance Alameda County, which includes the City of Oakland, has created a “clean slate” web page where people can obtain information regarding resentencing.  Anyone interested in obtaining relief from cannabis convictions under Prop. 64 should contact the District Attorney’s office in the County where they were convicted.  Anyone who is uncertain as to whether they have a conviction that can be reduced, or in which jurisdiction they were convicted, can obtain their criminal records from the California Department of Justice.

When it comes to marijuana and taxes, there is no bigger buzzword than “280E.” However, there is still a lot of confusion about what exactly 280E is and does.  In reality, section 280E is a single sentence of the Internal Revenue Code.  It states: “No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances (within the meaning of schedule 1 and 2 of the Controlled Substances Act) which is prohibited by Federal law or the law of any State in which such trade or business is conducted.”

Section 280E was passed by Congress in 1982 in response to a case where the Tax Court ruled that a taxpayer could deduct expenses relating to his sales of cocaine, amphetamine, and marijuana.  Deductible expenses included the costs of packaging, travel, and even scales used to weigh the illegal substances.  However, this is no longer possible in the world of 280E.

Since cannabis is a Schedule 1 controlled substance, the IRS has used section 280E to disallow marijuana businesses from deducting their ordinary and necessary business expenses.  The result is that marijuana companies face much higher federal tax rates than similar companies in other industries.  There are differing opinions on the level of tax rates imposed on marijuana companies – from 40% to 70% to as high as 90% – all of which are higher than the 35% corporate tax rate paid by most other businesses in the United States [Please note that, under President Trump’s new tax law, that corporate taxes have now been reduced to 21%].

So what does this mean for those currently operating or looking to form a marijuana company? Normal business expenses such as rent, advertising, and employee salaries won’t reduce your taxable income unless they can be allocated to Cost of Goods Sold (COGS).  For marijuana growers, COGS includes expenses directly related to production of the plants, such as the seeds, electricity,, and labor that went into growing and preparing the flowers for sale.  For marijuana dispensaries, COGS is much more restrictive, and generally includes only the amount they paid for the cannabis products they sell plus a few additional allocations.

Much like the rest of the industry marijuana tax laws and policies are constantly changing.  For a while, many tax accountants and attorneys advised their clients to include a generous amount of expenses in COGS to reduce taxable income.  However, in January of 2015, the IRS released Memo. 201504011 that clarified what types of costs could be allocated to COGS, further limiting the ability of marijuana businesses to reduce their federal tax rates.

For now, this single sentence is still largely up to interpretation and is even causing headaches for the IRS themselves.  As more and more states legalize cannabis for medical and recreational use, more and more companies are being subject to the 280E bite. Some free advice for all you ganjapreneurs – get your books in order, keep good records, and remember that the IRS is years behind in audits, so just because you haven’t been audited for your last year’s return does not mean you won’t be hit with a large tax bill a few years from now.

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The cannabis industry has garnered a lot of hype.  But the plant’s federal illegality hinders it from functioning as a legitimate line of business.  The most common example of this is the lack of financial assistance available to the industry.

Another crucial service withheld from cannabis businesses is insurance.  Dave Jones, California’s Insurance Commissioner, has aimed to change that since the beginning of 2017.  After a year and a half of encouraging insurers to write insurance for the legal cannabis industry, various forms of protection are now available to cannabis businesses.

On June 4, Commissioner Jones announced the approval of the first Cannabis Business Owners Policy (CannaBOP) in California.  Crafted by the American Association of Insurance Services, the CannaBOP program is a package consisting of property and liability coverage for dispensaries, processors, manufacturers, distributors, cannabis storage facilities and other relative businesses operating in the state.  As of now – even with the new program in place – the majority of cannabis businesses have no choice but to absorb the cost when something goes awry, which can mean losing millions of dollars.  No other legalized businesses or industries favor that kind of financial risk.

“My objective is anytime a consumer walks into a cannabis retail facility or a vendor enters into a contract or delivers goods to a cannabis business, or anytime someone invests in or operates a cannabis business, insurance is in place to cover risks,” Commissioner Jones said in a phone interview, “just as there is in any other form of business in California.”

But the CannaBOP isn’t the only major announcement this month regarding insurance coverage for the cannabis industry.  In May, Commissioner Jones approved California Mutual Insurance Company as the first provider in the state to add lessor’s risk coverage for property owners who are exposed to risks from renting to tenants who use the space for commercial cannabis-activities.  The lessor’s risk coverage policy provides liability and property insurance for commercial property owners who lease building space for cannabis labs, product manufacturing, cultivation, and dispensary operations.

“Things are moving in a positive direction [in California],” said Commissioner Jones. “But there’s a lot of room for more carriers to come into the market.  I’m doing everything I can as the regulator of the largest insurance market in the U.S. to encourage insurers to provide coverage for the cannabis industry.”

The motivation behind this most recent push for coverage following reports stating that the Trump Administration would refrain from using federal law enforcement against legally operating cannabis businesses in states with medical and adult-use cannabis laws.

“I sent a letter to the 1,300 licensed insurance companies in California informing them that President Trump had told a senator from Colorado that his administration would not take steps to enforce federal law against cannabis industries in the states that have a legalized cannabis industry,” Jones said.  “So I wanted to make sure insurance company executives were aware and encourage them to come into the market, and being writing coverage plans.”

The commissioner says he believes there’s a misplaced concern, particularly among insurers about federal law enforcement intervention.  In the states with state-level cannabis laws – where insurance is being written for those industries – the Federal Government has yet to seize premiums from insurance companies coming from cannabis businesses, he explains.  “President Trump’s most recent announcement should provide additional assurance to businesses.  So, we’re continuing to encourage the progression of the market, and we want to see a broadening of the insurance provided.”

An interesting aspect of the bubbling cannabis insurance trend is how it plays into California’s new law.  As of Jan 1 – the official implementation of the Medicinal and Adult Use Cannabis Regulatory and Safety Act (MAUCRSA) – all cannabis businesses are required to show proof of a $5,000. surety bond in order to get a state license.  Surety bonds are required by the licensing agencies as a way to guarantee the behavior and compliance of licensees.  It’s also a way to guarantee payments related to the cost incurred for the destruction of cannabis goods and materials in the event of a violation of the regulations.  If a company’s product was contaminated, for instance, a surety bond would cover the costs of destroying or properly disposing of the product, as canna-goods – by law – can’t be thrown in the trash.

But at the onset of the MAUCRSA, the only way cannabis businesses could get a surety bond was through a surplus line insurer.  Often called the “safety valve” of the insurance industry, these providers fill coverage gaps in the marketplace by insuring the high-risk companies that are usually declined by the standard underwriting and pricing processes of insurance carriers.

On Feb. 21, however, Commissioner Jones announced the approval of the first surety bond program for the cannabis industry.  Continental Heritage Insurance Company became California’s first approved insurer to offer surety bonds to legal marijuana businesses.  The commissioner explains he hopes other providers will follow the lead of the insurers who now provide coverage to the legal cannabis industry.

The California Department of Insurance is modeling this effort to get insurance for the cannabis industry on the success they experienced with getting insurers to write coverage for ride-sharing companies and drivers.  “We’re doing many of the same things now we did a couple years ago when ride-sharing began to expand in California,” the commissioner said.  “There used to be no ride-share coverage.  There are now 14 commercial carriers writing ride-share insurance for the market, and we’re confident we’ll have the same success in the cannabis insurance space, too.”

Commissioner Jones has had an undeniable impact on the creation of cannabis insurance in California.  But, as he readily admits, there are still major gaps in coverage.  Crop insurance for the cannabis industry, he points out, is an area that needs to be filled.  Although, after the Northern California wildfires last October that scorched homes, vineyards and pot farms, some headway’s been made regarding coverage for cultivators.  “We saw the first major payout of a claim to a cannabis grower by an insurer,” Jones said.  “The insurer paid out over a million dollars, which is very encouraging.  It shows there’s some crop insurance available in some cases, and insurers are paying claims.”

Some coverage is better than no coverage.  But until the cannabis industry has the same insurance options that every other business and industry has, much work still remains to be done. California is on the path to making that happen, however.  “There is still a continuing challenge.”

Commissioner Jones said. “But I’m doing everything I can to demonstrate that I stand firmly behind providers writing insurance for the cannabis industry, and want them to do this.”

Attorneys general from 33 states on Wednesday urged Congress to approve a proposal intended to fully open the doors of the U.S. banking system to the legal marijuana industry.

“This is simple: not incorporating an $8.3 billion industry into our banking system is hurting our public safety and economy,” said California Atty. Gen. Xavier Becerra whose state is the nation’s largest legal pot shop.”

The bill “would reward taxpayers and small and local licensed businesses who play by the rules,” he said in a statement.

The conflict between state and federal law has left many growers and sellers in the burgeoning pot industry in a legal dilemma, shutting them out of everyday financial services such as opening a bank account or obtaining a credit card.  It also has forced many businesses to operate only in cash-sometimes vast amounts-making them ripe targets for crime.

Plans for a state-baked pot bank aren’t feasible, a study says—

The pending bill would allow pot businesses to access loans, lines of credit and other banking services and would shelter financial institutions from prosecution for handling money that is linked to pot.

In a letter to congressional leaders, the attorneys general also argue that under existing law, authorities are less able to track potential financial crimes and that it is more difficult for businesses to pay tax deposits-and for states to collect those tax deposits.

One of the bill’s sponsors, Rep. Ed Perlmutter (D-Colo.) said the endorsement from the state officials “underscores the need to respect states’ rights on this issue and make our communities safer by allowing the marijuana industry and related businesses access to the banking system.”

Along with California, states signing the letter included attorneys general from Alaska, Arizona, Arkansas, Connecticut, Colorado, Delawares, Hawaii, Illinois, Iowa, Kentucky, Maine, Maryland, Massachusetts, Michigan, Minnesota, Mississippi, Nevada, New Jersey, New Mexico, New York, North Dakota, Ohio, Oklahoma, Oregon, Pennsylvania, Rhose Island, Utah, Vermont, Virginia, Washington, West Virginia, and Wisconsin.

It was also signed by attorneys general from the District of Columbia, Guam, the Northern Mariana Islands, Puerto Rico and the U.S. Virgin Islands.

Having two systems for regulating medical and recreational marijuana in California has complicated licensing. To recap the Medical Cannabis Regulation and Safety Act MCRSA was put in place to manage medicine. While the Control, Regulate, and Tax Adult Use of Marijuana Act AUMA that followed later focuses on recreational use.

This had been holding up the rules for licensing the recreational supply chain. Those problems thankfully belong to the past, now the California Senate has adopted the new hybrid Medicinal and Adult-Use Cannabis Regulation and Safety Act MAUCRSA. This repeals the MCRSA, while incorporating some of its provisions in this updated version of the AUMA.

We have more than a new acronym however to learn, since the changes are significant for California medical providers. In summary form:

*The Bureau of Cannabis Control is now the senior regulating authority.

*Cannabis tax will be by average market price, as opposed to gross receipts.

*License applicants may submit proof of historic compliance with local laws. The obligation now falls on their county or city to indicate otherwise within 60 business days of license approval.

*The definition of owner is broadened to 20% or more ownership, ceo, board member, or anyone directing, managing, or controlling an applicant.

*The AUMA residency requirements have fallen away. Even overseas entities can operate freely. However, individual cities may determine otherwise.

*The various AUMA license types remain, except these divide into adult use (A), and medicinal use (M) subclasses. In addition, there are several new niche licenses available.

*However, the old MCRRSA transporter and producing dispensary licenses have fallen away.

*Multiple licenses are available to both A and M applicants, subject to safeguards for over-saturation, and protecting the interests of small licensees.

*The new MAUCRSA defines a solvent as producing a flammable gas or vapor that ignites or explodes “when present in the air in sufficient quantities.”

*Cultivators using water “from any diversion” have until July 1 this year to lodge paperwork with the Water Sources Control Board.

*Retailers may now deliver marijuana from a physical shop that is otherwise closed to public access.

*Quality assurance procedures are tighter. For example, distributors must have procedures for validating packaging and labeling.

*The MAUCRSA provides for future Department of Food and Agriculture standards, governing county origin appellations

*There is also provision for a universal logo for edible marijuana, and for regulating advertising on the internet.

While the MAUCRSA puts regulatory agencies and some others back to square one, this is a defining moment for marijuana in California.  Finally, the product begins to leave the political arena, and enter the mainstream business world, where it belongs.

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