Does my California Cannabis Business have to be a nonprofit?

Posted by Margolin & Lawrence on October 10, 2017

The short answer is yes, for now. Until the law changes, you need to operate as a nonprofit. You should also prepare yourself for for-profit operation so that your business is not caught off guard when the law does change. There is a great deal of misinformation and misunderstanding about how cannabis businesses are allowed to be organized in California.  California Health & Safety Code § 11362.765 is the law of the land, stating in part: “nor shall anything in this section authorize any individual or group to cultivate or distribute cannabis for profit.”  Note that this section was not repealed or replaced by any provisions in SB 94 (our Guide to SB94 is available here). Appellate decisions have interpreted this language to mean that all cannabis cultivation and distribution in the state is required to be conducted on a non-profit basis, and that anyone cultivating or distributing cannabis “for profit" is subject to criminal sanctions (currently a misdemeanor in most cases, with potential jail time and fines).

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The new MAUCRSA regulatory system is about to take effect, meaning that starting on January 1, cannabis businesses with a local license can apply for state licensure. We also anticipate the state will address the nonprofit issue within the next few months. With these significant legal changes, many individuals and businesses are trying to make plans on how to organize in order to operate going forward.  

The California Franchise Tax Board has published guidance on its web site.  According to this agency:

“Medical cannabis businesses should operate as a nonprofit cooperative or collective under current law. The California Department of Justice published guidelines that state businesses may operate as statutory cooperatives (incorporated) or as a collective (either incorporated or unincorporated).  Cannabis businesses are not eligible for California income tax exemption. Although some medical cannabis businesses formally incorporate as nonprofit mutual benefit corporations or nonprofit mutual benefit cooperatives, they do not meet the requirements for income tax exemption described in Internal Revenue Code Section 501(c) or California Revenue and Taxation Code (R&TC) Section 23701.  Incorporated cooperatives, incorporated collectives, and unincorporated collectives must report income by filing an annual tax return. Incorporated entities generally file a Form 100, California Corporation Franchise or Income Tax Return.”

The Franchise Tax Board goes on to explain that the “Law Beginning in 2018” will be different, as follows:

“Cannabis businesses who have already received any required licenses or permits from their local jurisdiction may apply for state licenses to operate from various agencies:

Cannabis Business Licenses, by Agency

Agency

License Types

Bureau of Cannabis Control

Testing Laboratories

Distribution

Retail

Micro-Businesses

CalCannabis Cultivation Licensing, California Department of Food and Agriculture

Cultivation

California Department of Public Health

Manufacturing


Businesses operating under these state licenses can choose any form of valid business structure for their business.  They are able to operate on a for-profit or not-for-profit basis. They are not eligible for California income tax exemption, as they do not meet the requirements.”

It is unclear why the Franchise Tax Board states that cannabis businesses will be “able to operate on a for-profit ... basis” beginning in 2018, as Health & Safety Code § 11362.765 remains good law unless and until it is revoked.  Many have speculated that the California legislature will remove the non-profit requirement from section 1162.765 after the state licensing system goes into effect, but so far, the non-profit requirement of that statute remains for the indefinite future.

If in fact cannabis-related businesses will be allowed to operate for-profit in 2018 or later, and the non-profit requirement of section 11362.765 is deleted, then many have wondered how the new for-profit entity should be structured.  California law allows for-profit entities to be structured in various ways, including as C-Corporations, S-Corporations, Limited Liability Companies, and Partnerships. Managers and organizers of cannabis-related companies need to think carefully about how to organize in order to build the strongest organizations and comply with the rapidly-changing laws. The unique pros and cons between these types of corporate entities will be discussed in a future post.  

Contact us! for more information. 

MAUCRSA, California Cannabis Law, SB 94, California Cannabis Attorney, Nonprofit

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This blog is not intended as legal advice and should not be taken as such. The possession, use, and/or sale of marijuana is illegal under federal law.