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No Charitable Exemption for Medical Marijuana Nonprofits

Uncle Bill is a child of the Sixties. He is told you the story many a time how the lead singer for the Zombies stole his Beatle boots when they played at Old Orchard Beach the summer when he was 17. When Bill calls you out of the blue to discuss a hypothetical charitable exemption for medical marijuana nonprofits, you assume his interest is more than simply academic.

After all, as Bill describes it, he was a “pharmaceutical rep” in college, which, you have to admit, is the classiest way of admitting that someone was a drug dealer that you’ve ever heard. It’s safe to say that Bill’s “studies” in cannabis goes back decades. Thus, when Maine legalized marijuana in 2016, Bill was as happy as a dog with two tails, and he’s been chasing a charitable exemption for medical marijuana ever since.

Searching for a Charitable Exemption for Medical Marijuana Nonprofit

After Bill’s failed attempt to obtain and IRC § 501(c)(3) exemption for the organization that he created to raise money for Cousin Leroy who had an unfortunate run-in with a bull moose during mating season (read more about that here), Bill is a bit gun shy to go back to the well with the IRS. Nevertheless, one day after coming into possession of some rather strong weed, Bill gets the idea into his head that indigent people need access to marijuana—for medicinal purposes, of course—just as much as the entitled yuppies he sees at the dispensary three to seven times a week.

charitable exemption for medical marijuanaBill calls you one fine morning in February and tells you of his plan to form a charity they give poor people weed. (They have glaucoma, too, man.) However noble his intentions, and however legal pot is in Maine, you explain to Bill that under federal law marijuana remains a controlled substance, and it is, therefore, illegal to possess or sell marijuana under federal law.

Bill asked why you have to “harsh” his “buzz” all the time, and the quality anthimeria[1] aside, you sigh and for some reason apologize. Whether stoned or stubborn, Bill challenges you to prove it. Never one to back down from a challenge, you perform an hour or so of research and confirm that when it comes to picking out good bud from bad bud, Bill will always prevail.  When it comes to questions of law, his expertise goes up in smoke.

Analysis

IRC § 501(c)(3) provides for the exemption from federal income tax of corporations organized and operated exclusively for charitable or educational purposes, provided no part of the net earnings inures to the benefit of any private shareholder or individual. Treas. Reg. § 1.501(c)(3)-1(a)(1) states that, in order to be exempt as an organization described in IRC § 501(c)(3), an organization must be both organized and operated exclusively for one or more exempt purposes. If an organization fails to meet either the organizational test or the operational test, it is not exempt.

Treas. Reg. § 1.501(c)(3)-1(c)(1) provides that an organization operates exclusively for exempt purposes only if it engages primarily in activities that accomplish exempt purposes specified in IRC § 501(c)(3). An organization will not be operated exclusively for exempt purposes if more than an insubstantial part of its activities is not in furtherance of an exempt purpose. Id.

Medical Marijuana Straight DopeMarijuana is defined as “all parts of the plant Cannabis Sativa L. whether growing or not; the seeds thereof; the resin extracted from any part of such plant; and every compound, manufacture, salt, derivative, mixture, or preparation of such plant, its seeds or resin.”[2] Marijuana is listed as a hallucinogenic substance, and it is included on Schedule I of the Schedules of Controlled Substances.[3]

A Schedule I substance, in turn, is a substance that (1) has a high potential for abuse; (2) has no currently accepted medical use in treatment in the United States; and (3) there is a lack of accepted safety for use of the drug under medical supervision.  The Controlled Substances Act[4] states that it is illegal for anyone to knowingly or intentionally manufacture, distribute, or dispense, or possess with intent to manufacture, distribute, or dispense a controlled substance.

The Legal Background to the Potential Charitable Exemption for Medical Marijuana

In Rev. Rul. 75-384, the IRS held that a nonprofit organization, whose purpose was to promote world peace, disarmament, and nonviolent direct action, did not qualify for exemption under IRC § 501(c)(3) or (c)(4). The organization’s primary activity was to sponsor antiwar protest demonstrations in which demonstrators were urged to violate local ordinances and commit acts of civil disobedience. Citing the law of trusts, the ruling stated that all charitable organizations are subject to the requirement that their purposes cannot be illegal or contrary to public policy.

In Better Business Bureau of Washington, D.C., Inc. v. United States, 326 U.S. 279, 283 (1945), the Supreme Court held that the presence of a single nonexempt purpose, if substantial in nature, will destroy the exemption regardless of the number or importance of truly exempt purposes.”  Earlier, in Ould v. Washington Hospital for Foundlings, 95 U.S. 303, 311 (1877), the Supreme Court noted that a charitable use, where neither law nor public policy forbids it, may be applied to almost anything that “tends to promote the well-doing and well-being of social man.”

Next, in Harding Hospital, Inc. v. United States, 505 F.2d 1068, 1071 (6th Cir. 1974), the Sixth Circuit held that an organization has the burden of proving that it satisfies the requirements of the particular exemption statute. The court noted that whether an organization has satisfied the operational test is a question of fact.

The case of United States v. Oakland Cannabis Buyers’ Cooperative, 532 U.S. 483, 490 (2001), further emphasizes that there is only one exception for cannabis: Government-approved research projects. “It is clear from the text of the Act that Congress has made a determination that marijuana has no medical benefits worthy of an exception.” Id. at 493. In Mysteryboy, Inc. v. Commissioner, T.C. Memo 2010-13 (2010), the Tax Court held that the organization failed the operational test partly because the organization proposed to promote illegal activities.

Application

Under IRC § 501(c)(3), an organization can be recognized as exempt only if it shows that it is both organized and operated exclusively for charitable, educational, or other exempt purposes. If an organization fails to meet either the organizational test or the operational test, it is not exempt. Treas. Reg. § 1.501(c)(3)-1(a)(1). Bill’s weed charity will not satisfy the operational test of Treas. Reg. § 1.501(c)(3)-1(c); therefore, no charitable exemption for medical marijuana for Bill…

An organization seeking tax-exempt status under IRC § 501(c)(3) carries the burden of proving that it satisfies the requirements of the statute. See Harding Hospital, 505 F.2d at 1071. Only an insubstantial portion of the activity of an exempt organization may further a nonexempt purpose. As the Supreme Court held in Better Business Bureau, 326 U.S. at 283, the presence of a single nonexempt purpose, if substantial in nature, will destroy the exemption regardless of the number or importance of truly exempt purposes.

Bill would be providing financial assistance to indigent persons to obtain marijuana for medical and/or recreational use. Federal law does not recognize any health benefits of marijuana and classifies it as a controlled substance.[5] Furthermore, federal law prohibits the manufacture, distribution, possession, or dispensing of a controlled substance.[6] As such, Bill’s attempt to obtain a charitable exemption for medical marijuana nonprofits is not going to happen as the law exists today.

The Supreme Court has held that Congress has “made a determination that marijuana has no medical benefits worthy of an exception” to the general rule that the manufacture and distribution of cannabis is illegal. Oakland Cannabis Buyers’ Coop., 532 U.S. at 493.

charitable exemption for medical marijuana nonprofitsCurrent federal law prohibits the use of marijuana and cannabis except in limited circumstances; those limited circumstances do not include its use for medicinal or recreational purposes. The fact that Maine legalized distribution of marijuana and cannabis is not determinative because under federal law the distribution of marijuana is illegal.

Because Bill would be advocating and engaging in activities that contravene federal law, his charity would be serving a substantial nonexempt purpose.  Therefore, it’s a hard no on the charitable exemption for medical marijuana nonprofits.

Although the organization described in Rev. Rul. 75-384 had the goal of educating the public on the benefits of topics such as world peace and disarmament, its primary means of meeting their goals precluded them from receiving exemption under IRC § 501(c)(3). Their activities were deemed to induce or encourage the commission of criminal acts by means of civil disobedience by planning or sponsoring these events intentionally.

As the Revenue Ruling states, highlighting the law of trusts, all charitable trusts (and by implication all charitable organizations) are subject to the requirement that their purposes may not be illegal or contrary to public policy. Thus, despite any educational or charitable purpose Bill may plan to achieve through his organization’s activities, he is promoting an illegal activity under federal law. Therefore, Bill’s organization would not be operating for an exclusive exempt purpose within the meaning of IRC § 501(c)(3).

Additionally, in Mysteryboy, the Tax Court held that an organization encouraging an activity that violated public policy (as reflected in federal and state laws) would not be exempt from federal income tax. Because Bill’s organization would provide financial assistance to individuals, who did not have the financial wherewithal to buy a dime bag violates public policy, the organization would not qualify for an exemption under IRC § 501(c)(3).[7]

Takeaways

Medical Marijuana HarshThe exemption from taxes afforded to an IRC § 501(c)(3) organization is, itself, Federal in nature.  Thus, if the organization seeks to violate Federal law, then the IRS has every right to deny the charity IRC § 501(c)(3) status.  It is likely that marijuana possession and use is decriminalized; however, until that time, Bill’s efforts to obtain a charitable exemption for medical marijuana nonprofits are eight miles high and falling fast (futile).


Footnotes:

[1] The use of a noun as a verb, such as “to pen a tale.”

[2] 21 U.S.C. Section 802(16).

[3] 21 U.S.C. Section 821(c), Sch. I(c)(10).

[4] 21 U.S.C. Section 841(a).

[5] 21 U.S.C. Section 812.

[6] 21 U.S.C. Section 841(a).

[7] See also Oakland Cannabis Buyers’ Coop., 532 U.S. at 493.

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Tax analysis that you (actually) want to read:

served up weekly, with a heaping helping of snark.

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