Dear Pot Lawyer,
How can I get into the cannabis industry? I don’t have any money.
It’s certainly easy to sympathize with this reader. With inflated rent prices for cannabis-friendly properties, expensive security requirements, and the long wait for a license, the barriers to entry into the cannabis industry in Oregon are high at the moment. One way or another, you’ll need significant start-up capital to get your operation up and running. Some lucky few are able to find angel investors, but even this dream scenario is fraught with peril.
You might not be able to bring any money to the table yourself, but if you’re serious about getting into the biz, you more than likely have the skills and connections to make the company a success. We call this sweat equity—but even setting aside the challenge of a sweat equity partner maintaining ownership control of the company, you might end up losing it all to the IRS if you’re not careful.
The core problem is sometimes referred to as “phantom income.” It’s a silly name for a very serious issue. Here’s how it works. Let’s say that you and your buddy John have decided to open a cannabis farm. You’ve been growing all your life and John lucked into a large inheritance. You will work the farm, and John will contribute $1,000,000 and sit back and collect checks. You have been friends for a while, so you agree to a 50/50 ownership split (this is a terrible idea for numerous reasons, but this is just an example). John puts in the money, you sign an operating agreement, and then the IRS comes knocking. The IRS decides the company is worth the $1,000,000 that John contributed, and you just received a 50 percent cut. From the IRS’ perspective, you just earned $500,000 in income, and even though you haven’t earned a dime, the IRS is going to tax you like you just deposited $500,000 into your bank account.
There are ways around this “phantom income” problem, but they are pretty technical—probably too technical to delve into here. So to get back to the reader’s question, if you are considering starting or joining a company as a sweat equity partner, you really need to talk to a CPA or a tax attorney before you get up and running.
UPDATE: We want to report some happy news that came out of one of our previous columns, “Can Users of Medicinal CBD be Denied Organ Transplants?” [Ask a Pot Lawyer, Nov 1]. Shortly after we published, OHSU reached out to the Mercury to clarify that OHSU no longer denies liver transplants based on cannabis consumption, whether medical or recreational. The hospital instead focuses on substance abuse issues of any kind. Any transplant patients with “substance abuse issues are asked to abstain from all potentially addictive substances, including marijuana, due to the increased risk of returning to a pattern of active abuse.” This is great news for anyone treating with CBD.
Got a question? Email us at email@example.com. And remember that if you have a legal problem, contact a lawyer! Our educational musings cannot be relied upon as specific legal advice.