Purple Heart Patient Ctr., Inc. v. Comm'r
| Decision Date | 29 March 2021 |
| Docket Number | T.C. Memo. 2021-38,Docket No. 24994-15. |
| Parties | PURPLE HEART PATIENT CENTER, INC., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent |
| Court | U.S. Tax Court |
Henry G. Wykowski, Matthew A. Williams, and Rik D. Jeffery, for petitioner.
Lesley A. Hale, Nicholas R. Rosado, and Audra Dineen, for respondent.
PUGH, Judge: In a notice of deficiency dated July 24, 2015, respondent determined the following deficiencies, additions to tax, and penalties:1
| Year |
| Deficiency |
| Addition to tax |
| sec. 6651(a)(1) |
| Penalty |
| sec. 6662(a) |
| 2010 |
| $1,488,964 |
| $372,241 |
| $297,793 |
| 2011 |
| 1,268,373 |
| 317,093 |
| 253,675 |
| 2012 |
| 1,981,728 |
| --- |
| 396,346 |
After concessions, the issues for decision for the years in issue are whether Purple Heart Patient Center, Inc. (Purple Heart): (1) was entitled to offset its gross receipts with any cost of goods sold (COGS), (2) underreported its gross income, and (3) is liable for the accuracy-related penalty pursuant to section 6662(a).2
Some of the facts have been stipulated and are so found. The stipulated facts are incorporated in our findings by this reference. Purple Heart's principal place of business at all relevant times, including when the petition was filed, was in Oakland, California.
Purple Heart is a California nonprofit mutual benefit corporation with members, rather than shareholders, which is treated as a C corporation for Federal tax purposes. Keith Stephenson organized Purple Heart in 2006 and obtained a license from the City of Oakland to operate a medical cannabis retail dispensary under California law.3 During the years in issue he served as Purple Heart's sole director and received wages that he reported on Forms W-2, Wage and Tax Statement.
Mr. Stephenson has suffered from a chronic condition since his youth and found relief by using medical cannabis. His experience with medical cannabis inspired him to found Purple Heart and share with its members how cannabis changed his life and could improve theirs. Aside from operating Purple Heart Mr. Stephenson also has served as a member of several cannabis-related committees and taught as an adjunct professor at Oaksterdam University, the first cannabis-focused school in America. He also has been interviewed by several national publications about his groundbreaking role as an African-American operator of a cannabis dispensary.
Purple Heart did not cultivate its own cannabis plants; rather it acquired cannabis-containing products from its members, processed them, and dispensed them in various forms to other members via a "closed-loop" or "closed-circuit" system. We described this type of closed system in detail in Alt. Health Care Advocates v. Commissioner, 151 T.C. 225, 230 (2018). Purple Heart's system was similar in all material respects.
Medical cannabis accounted for most of Purple Heart's sales during the years in issue, but it also sold noncannabis items. Specifically, it sold items to use with cannabis, such as rolling papers and pipes; branded apparel, such as clothing; and coffee mugs. Noncannabis items accounted for approximately 3% of Purple Heart's gross receipts for each year in issue.
Purple Heart also offered free services as part of its medical cannabis dispensary business. These services, which it called "health counseling" or "alternative health" services, included assisting its members in selecting cannabis products and understanding various aspects of the cannabis "lifestyle". Purple Heart's complimentary services did not include counseling by any licensed medical professionals or therapists.
Purple Heart purchased all of its inventory with cash,4 and its members purchased cannabis with cash; they could not use checks or credit cards. It did not deposit all of its cash from its sales into bank accounts. Purple Heart used cash registers to record cannabis purchases and sales and noncannabis sales and then used the tapes that those cash registers produced (Z-tapes) to log purchases and sales in a general ledger. Mr. Stephenson reviewed the general ledger each week to ensure that all purchases and sales were properly recorded.
Purple Heart did not preserve the general ledger, Z-tapes, or any other source documents for any of the years in issue. Mr. Stephenson shredded the Z-tapes after Purple Heart paid its California State sales and use taxes each quarter and the general ledger and source documents after it submitted its Federal tax return each year. Mr. Stephenson understood that he risked criminal prosecution and asset forfeiture even without those records, but he feared that the records might be used in any prosecution and result in a lengthy mandatory minimum sentence.
For each year in issue Purple Heart filed Form 1120, U.S. Corporation Income Tax Return, on a fiscal year basis (ending June 30). Mr. Stephenson was responsible for Purple Heart's tax reporting and signed its returns.
Hank Levy, a certified public accountant, prepared Purple Heart's Forms 1120. Purple Heart provided Mr. Levy a QuickBooks file for its 2010 return and a PDF file of its financial statements for its 2011 and 2012 returns. It did not provide Mr. Levy with any source documents for its sales or purchases.5 Mr. Levychecked the records Purple Heart did provide to determine whether any of the sales or purchases appeared to be inaccurate. He returned the records to Purple Heart after he completed each tax return, and those were among the records that Mr. Stephenson shredded after the returns were submitted.
Purple Heart did not request an extension of time to file its 2010 Form 1120 and filed the return late, on August 30, 2012. It reported $4,370,480 of gross receipts and $2,628,027 of COGS for a gross profit of $1,742,453. It offset this gross profit with deductions totaling $1,574,911 for total taxable income of $167,542.
Purple Heart computed its 2010 COGS by adding together its beginning inventory ($48,259), purchases ($2,432,244), and other costs ($242,157), and subtracting its ending inventory ($94,633).6 Its purchases made up 56% of itsgross receipts before accounting for its beginning and ending inventory and 55% after accounting for its beginning and ending inventory.
In column (f) of Form 8275 Purple Heart attributed $1,574,911 to expenses for "health counseling services".
Purple Heart received an extension of time to March 15, 2012, to file its 2011 Form 1120 but filed the return late, on April 29, 2013. It reported $3,470,993 of gross receipts and $1,857,603 of COGS for a gross profit of $1,613,390. It offset this profit with deductions totaling $1,545,058 for total taxable income of $68,350.
Purple Heart computed its 2011 COGS by adding together its beginning inventory ($292,413), purchases ($1,787,471), and other costs ($164,771), and subtracting its ending inventory ($387,052). Its purchases made up 51% of its gross receipts before accounting for its beginning and ending inventory and 49% after accounting for its beginning and ending inventory. Its 2011 Form 1120 included a footnote stating that "BEGININNING [sic] BALANCE SHEET INCLUDES AMOUNTS CORRECTED SINCE FILING OF 2009 FORM 1120."
Purple Heart's 2011 Form 1120 listed "Alternative Health Services" as its business activity. An attached Form 8275 cited Olive and included the same disclosure statement in the "Detailed Explanation" section as for 2010. It attributed $1,545,058 in column (f) to expenses for "health counseling services".
Purple Heart received an extension of time to file its 2012 Form 1120 and timely filed it on February 15, 2013. It reported $5,457,193 of gross receipts and $3,969,956 of COGS for a gross profit of $1,487,237. It offset this profit with deductions totaling $1,377,386 for total taxable income of $109,853.
Purple Heart computed its 2012 COGS by adding together its beginning inventory ($387,052), purchases ($3,807,679), additional section 263A costs ($2,730), and other costs ($159,609), and subtracting its ending inventory ($387,114). Its purchases made up 70% of its gross receipts before and after accounting for its beginning and ending inventory.
Like its 2011 Form 1120, Purple Heart's 2012 Form 1120 listed "Alternative Health Services" as its business activity and attached a Form 8275 that cited Olive and included the same disclosure statement in the "Detailed Explanation" section. It attributed $1,377,368 in column (f) to expenses for "health counseling services".
During respondent's audit of Purple Heart's tax returns for the years in issue,7 Purple Heart was unable to provide the examining agent any books or records. He therefore performed a bank deposits and cash expenditures analysis.
To perform the bank deposits part of the analysis, the examining agent reviewed Purple Heart's bank records and determined its gross deposits by using the beginning balance for the first month of the tax year, the monthly deposited amounts, the monthly withdrawal amounts, and the ending balance for the last month of the tax year. He identified and subtracted nontaxable items, such asrefunds, transfers, and...
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