Congress has enacted an expansive set of laws to prevent money laundering. Still, many tax practitioners are unfamiliar with the rules that punish people who transact in funds that are connected with illicit activity. However, as marijuana becomes legal in more states, and companies that produce and distribute marijuana increasingly seek tax representation, sophisticated tax practitioners must become familiar with laws that prohibit transacting in property connected to activity that is illegal under federal law so that they can provide sophisticated representation without inadvertently committing a federal crime.
Internal Revenue Code Section 280E’s deduction and credit disallowance is one of the biggest federal tax issues facing businesses that produce or distribute marijuana. Sec. 280E prohibits taxpayers from claiming federal tax deductions or tax credits for expenditures made “in carrying on any trade or business” that “consists of trafficking in controlled substances . . . which is prohibited by Federal law or the law of any State in which such trade or business is conducted.” Businesses that produce or distribute marijuana in the United States are effectively prevented from claiming any deductions or credits that non-marijuana businesses could otherwise enjoy. As a result, marijuana businesses can be taxed on their gross income—a punitive regime that can push otherwise profitable enterprises into a loss or even bankruptcy.
Despite the apparent blanket prohibition that Sec. 280E imposes, recent cases show that, with effective representation, marijuana companies may be able to proactively plan to mitigate Sec. 280E or challenge its constitutionality if the government comes calling. Unfortunately, many marijuana businesses never receive the sophisticated representation that is required to plan or mount a well-counseled and vigorous defense because, under the Money Laundering Control Act of 1986 (the “Act”), it could be a crime for a tax practitioner to receive payment from a marijuana business for the practitioner’s services.
However, a marijuana business that operates under state law should be able to be represented like any other taxpayer, and that business should be able to pay its chosen counsel for their services. Although aligning federal law with the laws of the majority of the states and legalizing marijuana at the federal level is the most practical solution to this problem, we believe that there is at least one path forward for tax practitioners to represent marijuana businesses and receive payment for their services without running afoul of the Act. Unfortunately, that path requires a specific set of facts, and therefore is not a generally applicable solution. For that reason, receiving fees from a marijuana business for advice or representation on issues as mundane as the computation of cost of goods sold may well put a bona fide tax practitioner squarely within the crosshairs of the Act—a chilling result.
The Act appears in two sections of the U.S. Code—18 USC sec. 1957 (“Section 1957”) and 18 USC sec. 1956 (“Section 1956”). Both carry prison sentences, criminal penalties, and civil fines. Because both sections punish people who conduct a transaction that uses the proceeds of criminal activity, tax practitioners will never come within the ambit of the money laundering laws if they do not transact in (e.g., receive) “criminally derived property,” for purposes of Section 1957, or the “proceeds of specified unlawful activity,” for purposes of Section 1956. Section 1956 requires some sort of intent to conceal the source of funds or promote illegal activity, whereas Section 1957 does not. Section 1957 is also distinguishable from Section 1956 because the former specifically exempts “any transaction necessary to preserve a person’s right to representation as guaranteed by the sixth amendment to the Constitution,” and in order to be a crime under Section 1957, the transaction has to be through a financial institution for an amount greater than $10,000.
On their face, Sections 1957 and 1956 of the Act appear to preclude a tax practitioner from representing a marijuana business that manufactures, distributes, dispenses, etc. marijuana in the United States if the practitioner knows that the funds the business uses to pay the practitioner’s fees stem from manufacturing, distributing, etc. marijuana in violation of federal law.
One possible position is that most tax practitioners who wish to represent a business that grows or distributes marijuana do not have the intent required for Section 1956 to apply. Tax practitioners do not promote a client’s continued business so much as they advise the client about how the client’s current or anticipated future operations interact with tax and other laws or represent the client in connection with a dispute that typically centers around the client’s historic operations. Though tax and other legal representation may certainly help a marijuana business flourish, that result is merely a byproduct of the representation. That said, the word “promote” can be construed broadly, and we could see a court concluding that providing professional services that further the operation of a marijuana business is tantamount to promoting that business. We think that some legal services would fail to rise to the level of promotion, and a bona fide attorney who provides such services would not meet Section 1956’s intent requirement. The challenge, of course, is figuring out where the line is.
Under Section 1957 on its face, a tax practitioner who merely accepts funds from a marijuana business that manufactures, etc. marijuana in the United States for the practitioner’s tax/legal services likely commits a crime. Practically speaking, the practitioner likely receives fees of greater than $10,000. And given most firms’ practices with respect to client due diligence and “know your customer” rules, the practitioner likely knows or should know that the fees come from activity that is illegal under federal law.
One way to sidestep both Sections 1956 and 1957 is for the tax practitioner to avoid receiving or otherwise transacting in “dirty” money. Assume the following:
(1) There is a company that has two business units, each of which operates in a separate LLC. We can refer to them as LLC A and LLC B. LLC A grows and distributes marijuana entirely in one state where marijuana is legal, and LLC B sells non-marijuana items, such as cannabidiol (commonly known as CBD, which is not a Schedule I or II drug), wellness products (e.g., vitamins), and rolling papers.
(2) The two LLCs have different employees and different bank accounts.
(3) LLC A engages a tax practitioner for tax representation.
(4) LLC B pays LLC A’s practitioner directly from its own bank account.
The practitioner should not fall under Section 1957 or 1956 to the extent the practitioner avoids receiving funds or property—i.e., the proceeds of criminal activity—from LLC A.
Alternatively, a company may operate a marijuana distribution and/or production business wholly outside the United States, in a jurisdiction where it is legal to do so (e.g., Canada). If that company also establishes a marijuana distribution and/or production business in one or more of the United States, the company ought to be able to use the proceeds of the non-U.S. business to pay for tax services for the U.S. business without running afoul of Section 1957 or 1956 because the proceeds of the non-U.S. business’s activity should not represent criminally derived property.
Of course, the practical question arises of whether an enterprise that makes money by producing and/or selling marijuana will want to operate a successful standalone business that sells federally legal products and services. Even if the enterprise wants to operate two different businesses, it may also be difficult for the enterprise to keep the two businesses truly separate for purposes of maintaining the distinction between the two businesses’ funds to avoid co-mingling issues. In addition, if the tax practitioner is an attorney, the arrangement above raises some not insurmountable legal ethical questions about representing a client whose fees are paid by someone else. Still, a tax practitioner ought to be able to represent the enterprise in respect of its U.S. marijuana business and receive fees from the enterprise that are sourced to its non-marijuana business, or to a legal non-U.S. marijuana business, without risking civil or criminal liability.
We believe that there is a path for a court to construe Section 1957(f), as well as the term “promote” in Section 1956, in a manner that allows for marijuana businesses to receive legal representation. To the extent that the practitioner can show that any money the marijuana business pays the practitioner for the business’s civil representation was “necessary” to ultimately “preserve” its Sixth Amendment right to criminal representation, that money ought not to be subject to Section 1957’s sanctions. We believe that the Section 1957 exemption ought to apply where the civil and criminal matters are closely connected and the marijuana enterprise expresses its understanding that it could be subject to criminal liability. Unfortunately, in light of the unsettled legal landscape, the more conservative position is that Sections 1957 and 1956 potentially apply to criminalize legal services outside the context of active criminal defense representation.
Absurd as it may sound, this position may mean that an attorney who represents a marijuana business that is legal in the state in which it operates in open court on a non-criminal tax issue potentially commits a federal crime. The obvious takeaway is that federal law needs to change—it should not be a federal crime to operate a marijuana enterprise legally under state law, and tax practitioners who wish to represent those businesses should not be subject to draconian money laundering laws. Nonetheless, until these laws change, tax practitioners need to be aware of the risks that federal money laundering laws present. We believe that in certain limited circumstances, tax practitioners can represent state legal marijuana enterprises and receive payment for their work without committing a felony. One approach is to make sure the fees stem from a federally legal business, and from an account that does not contain illicit proceeds. There may be other approaches as well—and given the potential viable arguments against and around Sec. 280E, sophisticated tax practitioners need to start being creative about minimizing the risks associated with representing marijuana enterprises. Clients need it, and so does the law.
This article is based on a November 2022 TAXES—The Tax Magazine (Vol. 100, No. 11) column, INTERNATIONAL TAX WATCH—Getting into the Weed(s): Representing Marijuana Businesses in Tax Matters, by Ethan Kroll, Sonya C. Bishop, Stewart Lipeles, and Julia Skubis Weber. © 2022 CCH Incorporated and its affiliates. All rights reserved.
The full article in its original form can be found at: mag_10011_krollbishoplipelesweber.pdf (bakermckenzie.com)
Sonya C. Bishop (LAW ’18) is an Associate in the New York office of Baker & McKenzie LLP.
Ethan Kroll is a Partner in the Los Angeles office of Baker & McKenzie LLP.
Stewart Lipeles is a Partner in the Palo Alto office of Baker & McKenzie LLP.
Julia Skubis Weber is a Partner in the Chicago office of Baker & McKenzie LLP.