Last week, the IRS issued a final adverse determination in Private Letter Ruling 201917008 for an organization that has the primary goal of providing financial assistance to disadvantaged patients who use medications containing the chemical compounds THC (tetrahydrocannabinol) and CBD (cannabidiol), which are derived from plants in the Cannabaceae family (commonly known as Marijuana). Apart from providing financial support to patients and their families, the organization has two secondary purposes, as well. The first is to educate health care providers and the general public about cannabis-derived medications, and the second is to support and engage in research in the use of these medications as medical treatments.
The Law. By way of background, it is important to note that although a number of states have legalized the medicinal (and in some cases recreational) use of cannabis and its derivatives, under federal law it is still considered a controlled substance. In fact, The Controlled Substances Act classifies cannabis as a Schedule I hallucinogenic substance along with heroin and LSD, making the manufacture, distribution, or dispensing of such substance a felony. Schedule I substances are considered to have a high potential for abuse, have “no currently accepted medical use in treatment in the United States,” and are considered to be unsafe for use even under medical supervision.
In order to qualify as tax exempt under Section 501(c)(3), an organization must satisfy both the organizational and operational tests, which require the organization to be organized and operated exclusively for charitable, educational, or other exempt 501(c)(3) purposes. Failure to meet either of the tests results in the organization not being eligible for exemption. Furthermore, an organization cannot be operated for the private benefit of individuals rather than in the interest of the general public, meaning that the beneficiaries of the organization’s programs and activities cannot be a small number of interested individuals, but must instead be members of a broad charitable class. This is known as the private benefit doctrine.
The Ruling. Relying on the common law of trusts and Revenue Ruling 75-384, 1975-2 CB 204, which hold that a Section 501(c)(3) organization cannot be created for a purpose that is illegal or against public policy, the IRS concluded that the organization in PLR 201917008 did not satisfy the organizational nor operational tests to qualify as tax exempt. Specifically, because cannabis use is illegal under federal law, a tax-exempt organization cannot validly be organized to enable patients to access an illegal substance by providing financial support –doing so violates public policy. The IRS stated specifically that the fact that the state in which the organization is located had legalized the distribution and use of cannabis was not determinative.
Further, the IRS held that the operational test is also not satisfied because the illegal nonexempt activity is more than insubstantial, being that it is the organization’s primary activity. Finally, the IRS noted that the directors of the organization also have an ownership interest in an LLC that prescribes CBD- and THC-based medications to patients. Thus, the organization’s directors stand to directly benefit from the organization’s financial support of patients, which enables patients to pay for their medications. As such, the IRS concluded the organization is conferring a private benefit rather than being operated in the public interest—meaning that even if cannabis was legal for federal purposes, the exemption for this particular organization would still likely have gone up in smoke.