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Partners are not employees

Gavel to Gavel appears in The Journal Record. This column was originally published in The Journal Record on August 29, 2019.


Jessica Cory web

Jessica N. Cory represents businesses and individuals in a wide range of transactional matters, with an emphasis on tax planning.

By Phillips Murrah Attorney Jessica N. Cory

On June 28, the Internal Revenue Service finalized Treasury regulations relating to the tax treatment of partners (T.D. 9869).

These regulations confirm that owners of an entity treated as a partnership for federal income tax purposes, including limited liability companies, cannot be treated as employees for purposes of employment taxes and income tax withholding. Instead, an owner is treated as “self-employed” to the extent he or she receives compensation for services rendered to the partnership. This has important tax consequences for both the owner and the partnership.

For example, because an owner is not an employee, the partnership will not withhold taxes from his or her check or share the responsibility of paying any employment tax. Instead, an owner will be responsible for making estimated income tax payments and paying 15.3% self-employment tax on his or her compensation. Owners must also treat any partnership-paid health insurance premiums as income and are barred from participating in the partnership’s cafeteria plan, unlike the partnership’s employees. In addition, the partnership must report any owner compensation on Schedule K-1 versus the more traditional Form W-2.

Because many owners prefer to be treated as employees, especially current employees awarded an ownership interest in the company as compensation, partnerships have attempted to develop a work-around to these rules. One popular structure involved the formation of a wholly owned subsidiary to employ the partnership’s owners. In this scenario, the subsidiary would be disregarded for federal income tax purposes, allowing the partnership to continue filing a single Form 1065, U.S. Return of Partnership Income, but respected for employment taxes, enabling the partnership to treat its owners as W-2 employees rather than self-employed. The recently finalized Treasury regulations shut down this structure by clarifying that a disregarded entity cannot be used to convert an owner of a partnership into an employee.

Now that the IRS has finalized rules prohibiting this structure, it is important for tax partnerships, including many limited liability companies, to reevaluate how they are treating their owners for federal income tax purposes. To the extent a partnership has owners that would prefer to be treated as employees, or plans to offer an equity interest in the partnership to key employees as an incentive, the business should reach out to an experienced tax attorney to discuss potential structuring alternatives.

Jessica N. Cory is an attorney at Phillips Murrah who represents businesses and individuals in a wide range of transactional matters with an emphasis on tax planning.

Federal income tax challenges for medical marijuana businesses in Oklahoma

Jessica Cory web

Jessica N. Cory represents businesses and individuals in a wide range of transactional matters, with an emphasis on tax planning.

In this article, Oklahoma City Attorney Jessica N. Cory explores the conflict between federal and state law as it pertains to Oklahoma medical marijuana businesses.

What is the primary federal tax issue for Oklahoma medical marijuana businesses?

Jessica Cory, attorney with Phillips Murrah law firm answers: The primary tax issue for Oklahoma medical marijuana businesses stems from the conflicting treatment of the marijuana industry under federal and state law. Although the approval of State Question 788 last summer legalized the use, growth and sale of medical marijuana for state purposes, marijuana remains an illegal drug under the federal Controlled Substances Act. Special tax provisions apply to penalize anything deemed illegal drug trafficking under federal law, including licensed medical marijuana businesses.

What are the specific federal tax burdens a medical marijuana business will face?

Internal Revenue Code Section 280E represents the biggest tax challenge for medical marijuana businesses. Generally, the Internal Revenue Code allows a taxpayer to take a deduction for all “ordinary and necessary” business expenses paid or incurred during the taxable year. Congress has created an exception to this rule in certain instances, however.

One such exception is Code Section 280E, which prohibits a taxpayer engaged in the business of “trafficking in controlled substances” from taking a deduction for ordinary business expenses. Because the federal Controlled Substances Act defines marijuana as a Schedule I drug, Code Section 280E severely limits the types of deductions available to a medical marijuana business.

Although Code Section 280E prevents a marijuana business from taking normal business deductions, it does not bar a business from offsetting its gross receipts with its cost of goods sold (“COGS”). This means a business can at least reduce its potential taxable income by its direct costs of production. However, the Internal Revenue Code has issued guidance strictly limiting the types of costs a taxpayer engaging in a marijuana business can allocate to COGS, to prevent an end-run around Code Section 280E.

Case law supports this narrower interpretation of COGS for the marijuana industry, including prohibiting resellers of marijuana from including any indirect costs — costs other than the price paid for inventory plus any transportation or other necessary acquisition costs — in COGS.

Is there anything marijuana business owners can do to minimize their federal tax burden?

Yes, a tax professional can help marijuana businesses develop strategies for minimizing the impact of Code Section 280E. For example, a tax adviser can help a business differentiate between COGS and business deductions to take full advantage of the COGS offset allowed under federal law. In addition, a tax professional may be able to help a company structure its business to separate out its different activities to avoid having Code Section 280E apply too broadly. It is also essential for marijuana businesses to keep careful records, particularly if the business also engages in additional activities unrelated to growing, processing or selling marijuana.

Has there been any effort in Congress to fix the disparity in treatment under federal and state law?

Members of Congress have repeatedly introduced legislation to exempt marijuana businesses lawfully operating under state law from the parameters of Section 280E. For example, the Strengthening the Tenth Amendment through Entrusting States (“STATES”) Act, which would amend the Controlled Substances Act to protect people operating within the bounds of state cannabis laws, was recently reintroduced. Unfortunately, despite bipartisan support and the backing of several 2020 presidential candidates, the odds are not in favor of passage at this time.

Jessica Cory is an attorney with Phillips Murrah law firm.

Federal income tax challenges for medical marijuana businesses in Oklahoma

On June 26, Oklahoma voters approved State Question 788, which legalizes the use, growth, and sale of marijuana in the state for medicinal purposes.  In addition to providing rules for individual use of medical marijuana, the approval of SQ 788 also created a number of opportunities for new related businesses, such as retailers or dispensaries, commercial growers and processors. However, although licensed medical marijuana businesses are now legal under Oklahoma state law, conflicting federal law creates a number of challenges for business owners, particularly with respect to federal income tax law.

Attorney Jessica N. Cory

Jessica N. Cory advises clients regarding corporate and general business matters, including choice of entity, formation, tax-free reorganizations, acquisitions and dispositions and tax planning.

Generally, the Internal Revenue Code allows a taxpayer to take a deduction for all “ordinary and necessary” business expenses paid or incurred during the taxable year.  Congress has created an exception to this rule in certain instances, however.  One such exception is Internal Revenue Code Section 280E, which prohibits a taxpayer engaged in the business of “trafficking in controlled substances” from taking a deduction for ordinary business expenses.  For purposes of this provision, a controlled substance is any Schedule I or Schedule II drug under the federal Controlled Substances Act, which includes marijuana.  Although taxpayers have argued that Code Section 280E should not apply to businesses operating legally under state law, courts have repeatedly rejected this argument, concluding that any business buying or selling marijuana regularly is subject to the restrictions of Code Section 280E until Congress chooses to amend the Internal Revenue Code.

Although Code Section 280E’s bar on deductions represents a significant obstacle for medical marijuana business owners, several exceptions help reduce the burden on these taxpayers.  For example, although a medical marijuana business cannot deduct expenses in the same way as other taxpayers, it is entitled to offset its gross receipts with its cost of goods sold (“COGS”), although the Internal Revenue Service has issued guidance strictly limiting what types of costs a taxpayer engaging in a marijuana business can allocate to COGS.  Caselaw supports this narrower interpretation of COGS, including prohibiting resellers of marijuana from including any indirect costs – costs other than the price paid for inventory plus any transportation or other necessary acquisition costs – in COGS.

Another important exception to Code Section 280E is the separate business rule recognized by the Tax Court in an early medical marijuana case.  Under this rule, although Section 280E may preclude a taxpayer from taking any deductions relating to its medical marijuana sales, it can still deduct its expenses for any separate, non-trafficking trade or business.  Accordingly, it is extremely important for a marijuana business to keep careful records of any other businesses it may also operate, unrelated to growing, processing, or selling marijuana.

Members of Congress have repeatedly introduced legislation to exempt marijuana businesses lawfully operating under state law from the parameters of Section 280E.  Until this type of legislation is enacted, however, federal tax law will remain a potential minefield for any unwary medical marijuana businesses.  It is therefore important for businesses opening under SQ 788 to seek out an experienced accountant or tax lawyer to discuss the best way to structure their business to comply with federal tax law while minimizing their tax burden.


If you would like to know more about how this affects your business, contact Jessica N. Cory at 405.552.2472 or jncory@phillipsmurrah.com.

Phillips Murrah’s legal team welcomes tax attorney

Jessica Cory

Jessica N. Cory

Phillips Murrah law firm is proud to welcome Jessica N. Cory to our downtown Oklahoma City office.

Phillips Murrah welcomed Jessica to the Firm’s Tax Law Practice Group as an associate attorney.

In her practice, Jessica represents businesses and individuals in a wide range of matters, including general tax planning, business succession planning, and the structuring of complex transactions.

Jessica has advised clients regarding corporate and general business matters, including choice of entity, formation, tax-free reorganizations, acquisitions and dispositions, and tax planning.  She has particular experience working with flow-through entities, including disregarded entities, limited liability companies, partnerships, and S corporations.  Jessica has also successfully represented clients in disputes with the Internal Revenue Service.

Prior to entering private practice, Jessica gained valuable experience service as a judicial clerk for United States District Court Judge Robin Cauthron in the Western District of Oklahoma.  She then received her Masters of Law in Taxation at New York University School of Law and worked for a law firm in Houston, Texas before joining Phillips Murrah.  Jessica is licensed in both Oklahoma and Texas.

Jessica has written and presented on a variety of tax topics, including choice-of-entity in light of the 2017 tax reform, the tax implications of foreign ownership of real property, changes to the partnership audit procedures enacted in 2015, and defending against the trust fund recovery penalty.

Jessica grew up in Killeen, Texas but now lives in Oklahoma City, Oklahoma.  In her free time, she enjoys spending time with friends and family, traveling, and training for her next race.