Attorney General Eric Holder said Thursday that the Obama administration would soon announce regulations that would allow banks to business with legal marijuana businesses. Financial institutions have been scared away from such businesses by the threat of legal action for dealing in the profits of a commodity still illegal under federal law.

Attorney General Eric Holder (usdoj.gov)

"You don't want just huge amounts of cash in these places. They want to be able to use the banking system," Holder said during an appearance at the University of Virginia's Miller Center. "There's a public safety component to this. Huge amounts of cash -- substantial amounts of cash just kind of lying around with no place for it to be appropriately deposited is something that would worry me, just from a law enforcement perspective," he explained.

"We're in the process now of working with our colleagues at the Treasury Department to come up with regulations that will deal with this issue," and the new rules are coming "very soon," Holder said. "It is an attempt to deal with a reality that exists in these states."

Holder did not specify whether his remarks were aimed solely at Colorado and Washington, which have legalized marijuana commerce, or were directed more generally at states that allow for legal medical marijuana.

A Justice Department spokesman later "clarified" Holder's remarks to say that instead of new regulations, Holder was speaking of issuing a "guidance" to prosecutors and federal law enforcement. Whether such a "guidance" without further guarantees from the federal government will be enough to assuage bankers' fears remains to be seen.

But marijuana industry advocates applauded the attorney general's remarks.

For the legal, regulated cannabis industry, this is very welcome news," said National Cannabis Industry Association executive director Aaron Smith. "We have been anxiously awaiting clarity on the banking issue from the Justice and Treasury Departments for many months. To hear that guidance will be issued 'very soon' is encouraging. It's critical that we fix this issue before February 20, when our Colorado members must pay their first round of state taxes, or the Colorado Department of Revenue may be forced to accept more than $1 million in cash payments."

Smith added that the NCIA was "grateful" to Holder and other federal officials who have been working on the issue, and that getting it resolved "cannot come soon enough."

It's not just medical and legal marijuana states that watched the Justice Department's announcement of its response to marijuana law reforms in the states with interest. Nine states have laws regulating the production of industrial hemp, and ten more have asked Congress to remove barriers to industrial hemp production.

Rep. Massie, Comm. Comer & Rep. Polis (Vote Hemp via youtube)

At a Tuesday Capitol Hill briefing organized by the industry group Vote Hemp (video embedded below), state and federal elected officials said they thought the Justice Department's policy directive on marijuana opened the door not just to regulated medical and legal marijuana, but also to industrial hemp production. Some states intend to move forward, they said.

"That Department of Justice ruling pertained to cannabis," said Kentucky Agriculture Commissioner John Comer, "and hemp has always been banned because it's in the cannabis family. The Department of Justice ruling pertained to states with a regulatory framework for cannabis, and we feel that includes hemp as well. Our legislation set up a regulatory framework."

The legislation Comer is referring to is Kentucky Senate Bill 50, the Bluegrass State's industrial hemp bill, which passed the legislature with bipartisan support, gained endorsements by both of the state's Republican US senators, Mitch McConnell and Rand Paul, and became law without the governor's signature in April. It establishes an Industrial Hemp Commission and sets up procedures for licensing farming and processing.

"We have a hemp commission meeting Thursday, and we are going to request that Rand Paul send a letter to the DEA telling them we intend to get going next year unless the Department of Justice tells us otherwise," Comer said. "We are taking a very proactive stance in Kentucky. We've been trying to replace tobacco, and hemp is an option not only for our farmers, but it could also create manufacturing jobs in our rural communities."

The commission did meet Thursday, and it voted unanimously to move forward with industrial hemp production, aiming at producing hemp next year.

"That's our first goal, to get the crop established. Then, once companies and industries see that we have a crop here established and growing, we believe industries will start coming here looking for it instead of importing it from other countries," said Brian Furnish, chairman of the Industrial Hemp Commission, after the Thursday vote.

According to Vote Hemp, Kentucky isn't the only state planning on moving forward with hemp next year. Vermont just released its Hemp Registration Form that allows farmers to apply for hemp permits and the Colorado Department of Agriculture is developing regulations to license hemp farmers in 2014. North Dakota has issued permits for several years now.

Imported hemp is now a $500 million a year industry, Vote Hemp's Eric Steenstra said.

Congressman Thomas Massie (R-KY), who also played an important role in passing the Kentucky bill and who is a cosponsor of the House hemp bill, said he was encouraged by the Justice Department policy directive, but that it was not enough.

"We need more than a Justice Department ruling," he told the press conference. "As a farmer and entrepreneur, I want some certainty. I want a legislative remedy for this, and that's why I continue to push hard for our bill, which would exclude hemp from definition as a controlled substance."

Vote Hemp's Eric Steenstra

"If you can attach an amendment to a spending bill, then you can get action," said Massie. "I have to give credit to Rep. Polis for doing this. This is a farm issue, not a drug issue. And while there was debate over whether it was wise to even have a vote, it passed. People decided spontaneously to vote for it as an amendment."

While the Senate has not passed a similar provision, Massie said he was hopeful that it would make it through conference committee.

"There is no equivalent in the Senate, there is no companion amendment, but we do have [Senate Minority Leader] Mitch McConnell, who is all for it," he said. "I'm hopeful it will survive, and we'll continue to work on the standalone hemp bill."

"It was important to get the House language in the Farm Bill," said Polis. "Not only does it allow universities to do research that is needed, but it also symbolically moves forward with embracing the potential for industrial hemp production."

Polis said he was cheered by the Justice Department's policy directive when it came to hemp.

"They listed eight enforcement priorities, and industrial hemp isn't even on the enforcement radar," the Boulder congressman said. "We see no federal interest in going after states or hemp producers. The risk is minimal. But minimal isn't good enough for some folks, and that's why we want to continue to gather support for the Industrial Hemp Farming Act. You don't want to have to depend on a federal prosecutor or the attorney general not getting up on the wrong side of the bed in the morning."

Industrial hemp may be an afterthought for Justice Department policy setters, but the recent guidance has emboldened hemp advocates to push forward faster than ever. Getting hemp research approved in the Farm Bill would be a good first step; passing the Industrial Hemp Act would be even better. But it doesn't look like some states are going to wait for Congress to act.

special to Drug War Chronicle by investigative reporter Clarence Walker, [email protected]

Dispensaries providing marijuana to doctor-approved patients operate in a number of states, but they are under assault by the federal government. SWAT-style raids by the DEA and finger-wagging press conferences by grim-faced federal prosecutors may garner greater attention, but the assault on medical marijuana providers extends to other branches of the government as well, and moves by the Internal Revenue Service (IRS) to eliminate dispensaries' ability to take standard business deduction are another very painful arrow in the federal quiver.

"The 280E provision which requires certain businesses to pay taxes on their gross income, as opposed to their net income, is aimed at shutting down illicit drug operations, not state-legal medical marijuana dispensaries," said Kris Hermes, spokesman for the medical marijuana defense group Americans for Safe Access." Nonetheless, the Obama Administration is using Section 280E to push these local and state licensed facilities out of business."

The provision can be used to great effect. Oakland's Harborside Health Center was hit with a $2 million IRS assessment in 2011 after the tax agency employed Section 280E against. Harborside is fighting that assessment, even as it continues to try to fend off federal prosecutors' attempts to shut it down by seizing the properties it leases. Similarly, when the feds raided Richard Lee's Oaksterdam University that same year, it wasn't just DEA, but also IRS agents who stormed the premises. Lee said it was because of a 280E-related audit.

The attacks on Harborside and Oaksterdam were part of an IRS campaign of aggressive audits using 280E to deny legitimate business expenses, such as rent, payroll, and all other necessary business expenses. These denials result in astronomical back tax bills for the affected dispensaries, threatening their viability -- and patients' access to their medicine.

"Should the IRS campaign be successful; it will throw millions of patients back in to the hands of street dealers; eliminate tens of thousands of well paying jobs, destroy hundreds of millions of dollars of tax revenue; enrich the criminal underground; and endanger the safety of communities in the 17 medical cannabis states," said Harborside's Steve DeAngelo as he announced the 280E Reform Project to begin to fight back.

It's going to be an uphill battle. In the last Congress, Rep. Pete Stark (D-CA) introduced House Bill 1985, the Small Business Tax Equity Act, designed to end the 280E problem for medical marijuana businesses, but it went to the Republican-controlled House Ways and Means Committee, where it was never heard from again.

Still, something needs to happen, said Betty Aldworth, deputy director of the National Cannabis Industry Association, which this year is working with members of Congress to try to find a fix for the 280E problem.

"When Section 280E was created in the 1980s, no one imagined state-legal marijuana providers," Aldworth told the Chronicle. "Whether or not it is part of a larger effort to curtail the development of regulated models for providing marijuana, which is a model that is clearly preferable to leaving this popular and relatively safe medicine (or adult product) in the underground market, these onerous tax rates have severely hampered the development of the regulated market."

It's a brake on the overall economy, Aldworth said.

"Not only has it resulted in stymieing job development, but it also curtails other economic activity such as reinvestment in business and the rippling positive effects of that spending," she argued. "And in many cases, it has created a tax burden that is simply unbearable: many providers have had to close their doors and lay off their staffs because the tax burden was simply too great."

Because of this unintended application of 280E, medical marijuana providers are paying overall taxes at a rate two to three times those of other small businesses, Aldworth said.

"It's important to note that just as they want to apply for licenses, follow regulations, and otherwise participate in the legal business community, state-legal marijuana providers also want to pay their fair share of taxes," she pointed out. "Most small businesses pay an effective tax rate of between 13% and 27% on net income, according to the Small Business Administration. State-legal marijuana providers pay an average effective tax rate of 65-80%. An industry that can provide thousands of jobs is being held back by these crazy tax rates."

While the lobbyists look to Congress for a fix, one academic tax law expert thinks he has hit upon a novel solution, but not everyone agrees.

Benjamin Leff, a professor at American University's Washington College of Law, raised eyebrows at a Harvard University seminar this spring when he presented his report,Tax Planning For Marijuana Dealers, where he suggested that dispensaries get around 280E by registering with the IRS as tax-exempt social welfare organizations, known as 501(c)(3)s or 501(c)(4)s.

The IRS has already ruled that medical marijuana providers can be exempt under 501(c)(3) because its "public policy doctrine" does not allow charitable organizations to have purposes contrary to law, but in the paper, Leff argued that "a state-sanctioned marijuana seller could qualify as tax-exempt under 501(c)(4), since the public policy doctrine only applies to charities, and 501(c)(4) organizations are not charities."

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.

"When taxes get too high, you can drive compliant dispensaries out of business," Leff told the Chronicle.

Americans for Safe Access' Hermes would agree with that, but he's not so sure about Leff's idea.

"The concept of medical marijuana dispensaries registering with the federal government as a 501(c)(4) in order to sidestep section 280E is novel and may be hypothetically valid," he said. "However, the IRS will refuse to grant tax-exempt status to a business that the agency believes is violating federal law. Perhaps, it would be possible for a dispensary to obtain 501(c)(4) status under false pretenses, but such status would not very likely withstand an IRS audit."

There are better ways, he said.

"A much more realistic and sensible approach -- pending a change to the federal classification of marijuana for medical use -- is to amend the tax code to exclude state-lawful medical marijuana businesses from Section 280E," Hermes recommended. "This is the kind of legislation that Congress should pass in order to allow states to implement their own medical marijuana laws, without undue interference by the federal government."

"I agree with everything he said," Leff replied. "But it's not just the Obama administration that is using 280E this way. The Supreme Court has held that there is no exception to the Controlled Substances Act for state-level legal marijuana sales, and since 280E makes references to Schedule I controlled substances, it applies to legal marijuana unless Congress changes the law. I totally agree that Congress should amend 280E to exempt marijuana selling that is legal under state law. Congress could also amend the Controlled Substances Act to remove marijuana from it, which would probably also make sense," he added.

Whether it is by act of Congress, internal policy shifts, or creative thinking by law school professors, some way has to be found to exempt state-permitted medical marijuana providers from the clutches of 280E and its punitive tax burden aimed at dope dealers, or there may not be any medical marijuana providers.

In a statement last Thursday, Senator Mitch McConnell (R-KY), the minority leader in the US Senate, endorsed pending legislation in his home state that seeks to reintroduce industrial hemp cultivation there. The bill already has the support of the state's other US senator, Rand Paul, and Agricultural Commissioner James Comer, who were instrumental in bringing McConnell on board.

Is it sunrise for industrial hemp in Kentucky? (votehemp.org)