99 Iowa L. Rev. 523 (2014)

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Abstract

In recent years, many states have legalized marijuana while the federal government has not. But marijuana industry insiders consider not federal criminal law but federal tax law to be the biggest impediment to the development of a legitimate marijuana industry. State-sanctioned marijuana sellers are required to pay federal income taxes pursuant to I.R.C. § 280E, a formerly largely symbolic provision that Congress enacted to punish drug dealers, but which now could potentially drive legitimate marijuana sellers underground.

This Article proposes a tax strategy that enables state-sanctioned marijuana sellers to avoid the impact of § 280E by qualifying as a tax-exempt organization. The IRS has already stated that a marijuana seller cannot be exempt under I.R.C. § 501(c)(3) because the so-called “public policy doctrine” does not permit a charity to have purposes that are contrary to law. This Article proposes for the first time that the public policy doctrine does not apply to § 501(c)(4) organizations, which opens the door for marijuana sellers to qualify as tax-exempt. The organization would have to be operated to improve the social and economic conditions of a neighborhood blighted by crime or poverty by providing job training, employment opportunities, and improved business conditions for commercial development in the neighborhood, just like many existing community economic development corporations that run businesses.

This novel argument is more than just a “tax loophole” to avoid the impact of § 280E. Rather, IRS recognition of tax-exempt status for marijuana sellers could actually provide a mechanism to resolve the federalism issues raised by the conflict between state and federal marijuana laws. A federal policy that incentivizes marijuana sellers to be nonprofit, neighborhoodbased organizations in effect ties federal approval to local support.