Tax and Legal Challenges in the Cannabis Industry with Nick Richards Pt 1

Nick, thank you so much for being here. We've been really looking forward to this conversation, as I'm sure you know some of our listeners will be as well.
Thank you, really, and excited to be here on SALTovation.
Thanks, Meredith. Thank and thank you, Judy, too.
All right, so we will just jump in. So can you give us a little bit of your background and how you ended up kind of. Where you started and how you got to kind of the cannabis industry and now getting into the psilocybin and just kind of the more flat, what's the straight path?
So I left the IRS. I was an IRS trial attorney for, I don't know, 11 years or something like that. And I left the IRS right about when cannabis was becoming an industry here in Colorado in 2012 and 2013 and then, ull legalization occurred in 2014 and I got my sort of first cannabis company audit that I handled right about that timeframe.
I think it was a little bit before 2014. And you kind of saw what was going on out there and the IRS then targeted the cannabis industry here in Colorado. And so pretty much every cannabis company got put under audit and pretty much that was the only audits that were going on here in Colorado at that time.
And, so it just became a huge part of my practice. Because I was there at the time and it grew. Now I've joined Greenspoon Martyr, a big law firm. We're an AmLaw 200 law firm with offices all over the country because the cannabis industry expanded from Colorado.
It was great. For me, because I was there in the early days, and then with every new state, there was a new cannabis company and a new guy from Colorado there in the background somewhere. You didn't have a guy from Colorado in those days. You didn't know what you were doing. And, I knew those guys from Colorado, so it worked out really well for me.
And then, you weren't worried about like the federal limitations, since it's not legal federally that you would. My husband, he worked at a state Colorado and then he does this sort of litigation and he didn't want to do the marijuana industry cause he was worried he couldn't litigate in federal court.
But that you don't find that to be an inhibition on your practice. You're able to silo yourself within the state so you don't get hindered from an ability to take it further. Cause you're not really litigating cases, you're helping them get compliant, that kind of thing.
Yeah. Early on the state bar said, Hey, you can represent cannabis clients. Even criminals get to have lawyers, by the way, and not that they are criminals, but you can't help them sort of do any forward planning. Okay, you can represent 'em with things that happened in the past. So that was the first, and that was the advice. And the other part of the advice was, and you can smoke marijuana.
Then the second advice came along and they said, yeah, you can represent cannabis companies and you can actually help them comply moving forward. And you can smoke marijuana. We just want to remind you of your ability that you will not give this marijuana right. To, you know, support your clients in a right.
But, it was a little bit more dicey, I think for CPAs, because CPAs do that planning work. Then a number of cpa societies came out with guidance and really the IRS wants the cannabis industry to use qualified CPAs, and is happy to see them come into the mix.
I've had a ton of cannabis industry audits and even in the early days when they weren't at all correct, the returns that were being done and people were just blatantly ignoring the rules. I never ever saw a return, penalty or anything like that because there just was so much uncertainty out there it wasn't appropriate.
Judy: That's interesting because a lot of the large firms I've worked for, Deloitte, PricewaterhouseCoopers, a regional firm called Eide Bailey, they all said no cannabis. We're not going in that space. And one benefit we have at TaxOps is own the company. We can make those decisions. So we have not turned a blind eye to them either. If they need our assistance, we're here to s support them.
We don't do as much multi-state cause everything's siloed, if that makes sense. So we have a lot of clients that serve the cannabis industry, meaning they'll. One of 'em is like the Home Depot of cannabis suppliers. We have other clients in like CBD industries, so that was a kind of a game changer a few years ago when like, oh, D H D, it's bad.
It's like, no, it's not. But they still have compliance issues and so forth and so we're able to help them. So we've always been kind of pro cannabis, I suppose you would say, to give good advisory services, but cuz we weren't curtailed. So it's very interesting cuz the even law firms have made those decisions of whether they are in or out.
But obviously Greenberg has made a decision.
Nick: Yeah, and we were actually early in the space. We were all in publicly with a dedicated cannabis practice early on. Okay. Judy, one thing you just said that's very interesting on, on the, on the state tax side for cannabis companies and C B D companies.
It's interesting. Many people would probably say that the CBD industry is actually kind of less safe in a way than the marijuana industry because there's really no rules in the CBD industry, whereas marijuana has robust regulations around the marijuana industry. Right? And so now, this year actually, what we're seeing in that space is that a lot of those C b D manufacturers went ahead and were doing something called Delta eight and Delta nine, which is THC derived from hemp.
And now, a number of states are going back in and saying, we think you're a marijuana company. Guess what? Tax applies to all of your sales for the past four years, right? The marijuana tax. Oh boy. And that's a big number, right? Now they want to apply that to the sale of hemp THC as well. That's going on both in California and Colorado.
And I've heard it's spreading to Florida and other states as well. Heads up on that. That's brand new. Well, and that's just so unfortunate. It's a legitimate business. It doesn't get business deductions. I mean, there's just so many things I think that are still wrong about in how we're handling this legal industry and now we're like going after it more for classification issues when there's no alternative substance in A T H C.
Right? Yeah. Were you gonna say something, Meredith? Oh no, I was just going back to like a penalties, cuz some of those kind of marijuana taxes are up to like 20, 30%, right? Mm-hmm. They're not hit with excise taxes and whatnot. They're not cheap for a lot better. They're oftentimes 30%.
I mean, I think the average one is around that number and you know, there might be a 10%. Production excise tax and a 15% sales tax. Mm-hmm. Adding up to 25 to 30% depending on what state you're in. But then you look back and you do a three year, four year, calculation of that tax on the sales of hemp.
Nationwide, that's a big number. They did schedule Delta eight as a controlled substance and I believe Delta nine as well. So it was scheduled as a federal controlled substance. Judy, was that a, a month or so ago? A month and a half ago.
Not too long ago it was listed, yeah. That's some scary stuff. Honestly, I just feel such empathy for these people getting into this space and it's such a good curative space, it's so good for the body and all the things have been proven. Charlotte’s Web was a client of ours, and they got the Sanjay Gupta green light.
I mean, it was just all kinds of wonderful things, and I think so many people are benefiting from these products to deal with stress and anxiety. Kind of like the saving life from 1984 or whatever. Saving lives. A hundred percent. A hundred percent. Yeah. And here comes psilocybin, right, Meredith?
There we go. There's that. The transition that I was gonna make is just cuz Colorado decriminalized the possession of mushroom psilocybin. Two or three years ago, Denver did, maybe that's where I was confused cuz that's where I reside and voted on favorably.
This also is a Denver thing or just statewide. The ability to kind of use it at home, not sell or distribute. You can kind of walk us through what some of the changes are? Or what some of the rules are associated with mushrooms that Colorado has done, and where you think maybe some of that interplay to kind of the regulations that have been in place, certainly in Colorado for 10 years or associated with cannabis, how that's going to kind of carry over into the mushroom space.
Well, the rules are still being written in the mushroom space. It looks to us like it's less retail and more medical, which is good for the industry if that allows 'em to be profitable. Because it starts to align with a case out there in the marijuana space called Champ, rather than subsequent cases that found that all the activities of a cannabis related enterprise were subject to a code section called 280e rather than just the specific area where the sale of marijuana was occurring. What Section 280e is is a code section that, I'll try to paraphrase it here. It's pretty short. It basically says that there are no deductions or credits allowed for trafficking in a scheduled one or scheduled two controlled substance psilocybin and M D M A. And, the various drugs that were legalized here in Colorado are still federally controlled substances.
And so, 280e would still apply to that business. And the extent to which it applies, it is still an open question. There's a lot of therapy activity that goes on in or should go on into those new businesses that are coming along. And you know that case I mentioned, Champ, is a case involving an AIDS clinic in San Francisco in the really early days.
And that AIDS clinic was a legitimate medical facility and they started selling marijuana because it worked. The court held that it was only the portion of that it was a single company too. Only the portion of the company that was for the sale of marijuana was subject to Section 280e. And the rest of it was not.
But in the cannabis space, there's hasn't been a case that's happened since where the court has ruled along those same lines despite things other than the sale of marijuana that goes on in dispensaries and that's mainly because dispensaries are so limited in what they can and can't do in a lot of ways.
Psilocybin is different. It has this heavy duty important therapy mode to it that I think starts to align it closer to the champ facts. That said, they need good lawyers to make sure that they are setting up the right structure and relationship and all of those things to qualify for that, right?
Cuz don't you bifurcate operations a little bit. Like you would want to have separate legal entities so you could not lose the benefit of 280e. So you would want to do certain things operationally to separate the cost so that you could get valid deductions except for on the one component.
Yeah. Is that what you see a lot of advice around, like that kind of stuff? Yeah, I think that's probably right. It could depend though on right now it's Oregon and Colorado and the models. We're not sure how similar or dissimilar they're gonna be, and can you separate 'em? Does this therapy have to be provided by the company that's selling the psilocybin as well?
And so there's some questions around that. I think still Judy, but you're spot on with that. Certainly it's better to have that in a separate company than in the same company, although that wasn't what Champ was. So I don't think it's required but I think it's better too. Well, especially in theory, right? The possibility of less kind of co-mingling of, you know, kind of duality behind, you know, if you think of like a cost, like how much of your electric, you know, your electric bill is used for growth versus, you know, the accounting department over cubicles. So you allocate costs like that and it really goes.
So there's that part of it, and then there's the hobby loss rules, the Section 183 rules as to whether that other business is a separate business. So it, and that requires profit motive, right? Uh, realistic profit motive. And the problem with a lot of the cannabis cases was that they put so many expenses on the other non 280e company that it could never make a profit.
So it was found to be not a legitimate company and merely just part of the cannabis company. And again, that's because they're so limited. The only other thing they can sell are bongs and t-shirts. We call it glass. Glass and t-shirts. And that's not a viable business. And it's such a small piece of what people are coming to dispensaries for that it's the courts have pretty much held that part is, is as, is merely ancillary to the sale of marijuana. But this, the psilocybin space is way different. It seems like the psilocybin itself is a really small part. It's really the therapy that's the big part of it.
Meredith, I got kind of an old guy view. Um, and I like to know kind of what the cool kids are saying, you know, what are they calling major? Are they calling it smoke? Are they calling it weed? So I'm doing that, I'm doing that in the psilocybin space as well. And I tell you, they're still calling weed the flame or the fire.
That's still good. That's still good speak. I don't know if anybody's calling it the kind or anything like that anymore. Certainly nobody's calling it grass. But the newest I hear is lit. They're saying it's lit, so you're like, oh man, that was lit. I understand that's the new phrase.
And in the psilocybin space. I got two terms for you. If we're gonna do this, we gotta know what they're talking about, right? Fair. And the first term is the stack. And so a lot of psilocybin that's being produced these days, and yes, it's happening. We will have a list of the different kinds of mushrooms that are in it.
And it's not just the psilocybin. They want to put what are known as functional mushrooms in as well. And they call that then the stack. Right. Uh, and then the other thing I'm, I'm hearing from folks in Oregon actually is that when you, and probably this is more than just Oregon, but is when you take it, there's just two different kinds of ways to do it, right?
You can microdose psilocybin, and then you can take a huge dose. And the huge dose is more of the therapy model. I understand, although I don't know if that's true or not, but that huge dose now is called the hero dose. I understand.
Ooh, I like it. Stack and hero. Okay. I was just thinking, I have this book on mushrooms at the side of my bed that I was just reading, and then I just read this book from my book club and it's about these people like that ingest mushrooms and it makes them live forever and then they transfer their body to the next person.
It's a very interesting. The book is very gloomy because it's about mushrooms that I like it dark anyway, so, I’m like I should go get those and then put them on here and show them. Um, you can learn about this stuff cuz there are like millions of mushrooms out there too. Like billions. They're everywhere. And during Covid I watched this thing called Fabulous Fungi. It's a documentary about the how bad we thought mushrooms were. And there are so many good palliative reasons for them. And I'm like, oh my God. And then they connect the earth like cuz they grow on the ground and then they come out and they kind of clean up the world and you're like, they just do so many wonderful things for our bodies and nature.
So, I even heard that with the way that we do our gardens at home, we shouldn't till the whole bed cause we, cause we disturb that, what's it called? It's called the mycelium. We disturb the mycelium layer, which is the sort of mushroom layer. Beneath the surface that is used by plants than to communicate that they need resources at this is the story goes, and so the plants actually send signals through the mycelium and then the mycelium will deliver nutrients and things back to the plants or, so one of the books I read said, and then I saw another thing the other day where they said you should, when you're tilling your soil, don't till the whole thing because you disrupt the mycelium layer.
Just go ahead and till where you're gonna put the plan itself and just do that so you, so the mycelium then stays intact around those small areas. Who knew so much useful information here, Judy. I'm telling you. Who knew? Now we gotta learn even more about it. That's what's the cool thing is, like that's legalized.
You're gonna see more. It's good. Maybe in route to being legalized. Well I was gonna just add Freaky, which is right by my house is a smoke shop and tattoo parlor, I guess. So they sell bongs, pipes, vaporizers, there's oil rigs and whatever you got in that whole space. So obviously that's been a viable business somehow, some way.
I don't know how many bongs one human needs, but right. I guess, you know, there is businesses that have been supporting this industry, even though before it was legal because that shop was there were tobacco 20, 30 years. Yeah, it must have been. It's kind of funny. Well, I've always felt that that would be a good model to start a cannabis company in -- you just create a little window in the back and a safe space back there. And now your whole facility is already a profit venture. And now just this little piece is subject to 280e. So far I haven't seen anybody do that, but I've always thought that'd be a good, a good method. Yeah, that's a good point.
I haven't thought about that either. The other thing, Judy, that's important for, psilocybin startups and cannabis industry people to understand is that let me say this first, the psilocybin industry doesn't want to be compared to the marijuana industry, and you could probably understand why on that.
The problem though is that the federal government is gonna see 'em the same. Um, and, and so the, the, the roadmap that we have, the experience that we have is from the cannabis industry. Right. Interesting. In order to think about how the laws might apply to the psilocybin industry, there's no way getting around the cannabis example.
One thing that happened in the cannabis example is that when mar marijuana was fully legalized for adult use, um, taxes came into place as well. Psilocybin, I don't think that's, that's really happening yet, but along with the, those new taxes came. Regular audits. And so I've been saying for a long time, every cannabis company gets audited, period.
End of story. Uh, and they get audited by the federal government and in, in each state, many states have pledged to audit cannabis companies every three years, clockwork. And, and the, and the new audit three years later starts with the day after the end of the prior audit. And they just happen every three years, just like clockwork.
And, you know, that means that the things that many small businesses get away with, the, the innocent little mistakes and the, all of those just little things. Those are all gonna get caught and they're gonna add up. Um, yeah. Which is funny cuz you would see that like, oh, we deal with so many small startup businesses and large startup businesses, but around 10 years that are wildly successful.
Didn't have anything around this and haven't had any punitive ramifications of missed compliance because they just kind of a culture of like, you know, high tech is a perfect example of like, we're breaking it, we're disrupting, and then oh, tax, you know, they don't think about it until they get caught 10 years later.
Yeah. It's a very interesting world we live in, and yet the culture around cannabis and soon to be silo, I can assume, will be more regulatory compliance mindset out of the gate cuz they have so many things to serve to get their acts together to be in the business. So you kind of go in with the mindset of over paper working yourself.