A new report, written by the Treasury Inspector General for Tax Administration (TIGTA), “The Growth of the Marijuana Industry Warrants Increased Tax Compliance Efforts and Additional Guidance”, confirmed that the Internal Revenue Service (“IRS”) is planning to commence an all-out audit effort nationwide. The IRS will attempt to capture uncollected tax revenue, which they believe has been left on the table due to misinterpretation of who is subject to Internal Revenue Code (IRC) Section 280E and compliance with the regulations.
How big is the issue?
In a statistical sampling of California, Oregon and Washington, the Treasury Inspector estimates that 59% of the 237 businesses underpaid their taxes by $48.5 million. Extrapolating that figure over the next five years, the TIGTA estimates that $242.6 million in tax revenues could be lost. In their experience, this represents the tip of the iceberg for 280E non-compliance, considering cannabis commerce is legal in 33 states plus the District of Columbia. 280E eliminates the deduction of operating expenses, resulting in a large federal income tax bill. The cannabis industry also faces high excise, sales and state/local taxes.
We, at SingerLewak, continuously remind our clients that the IRS is monitoring the cannabis industry and intends to target businesses that they find may be underpaying or avoiding taxes.
Significant relief, however, is available under IRC Section 471(c). This provision, amended by The Tax Cut and Jobs Act of 2017, allows certain small-business cannabis taxpayers to allocate some indirect expenses (in addition to direct expenses) to Cost of Goods Sold. It was suggested by the TIGTA that the IRS provide and distribute internal and external guidelines for administration of this provision. Although guidance and final regulations will be forthcoming, the real test will be in tax courts.
What can you do to minimize your audit risk?
- Comply with all local and state guidelines, stay abreast of license requirements and be
- Clearly delineate your deductions and process for arriving at your taxable income utilizing 280E.
- Get familiar with the provisions of IRC Section 471(c).
- Timely file all forms, including Form 8300 for cash payments.
The IRS Small Business Division has been monitoring cannabis companies coast-to-coast, utilizing a “participant guide” for an internal program named the Compliance Initiative Projects (CIPs). The program which began in Colorado in 2016, conducted its marijuana-related training for IRS agents in Nevada, Arizona, Michigan and on the West Coast.
The TIGTA recommended that the participant guide be made public and the CIPs be developed nationally. While the IRS plans to expand the CIP program, it has so far kept the participant guide out of the public eye.
Without a national program to address the inadequacies of federal enforcement (no reference to marijuana business can be found in IRS publications), the TIGTA has provided recommendations that the IRS Small Business/Self Employed Division should:
- Develop a comprehensive compliance approach for the industry and leverage publicly available information, such as state and local marijuana business lists, state licensing rosters and other cannabis data to identify noncompliant taxpayers. Many companies are not clear about their marijuana connection and therefore, fly under the radar and avoid 280E. Any unlicensed cannabis company should expect examinations with a higher level of scrutiny.
- Provide specific guidance to taxpayers and tax professionals on the application of 280E and 471(c). Although the IRS claims its comprehensive cash business audit technique guide along with additional information offered for cash-intensive businesses is adequate, they were informed by the TIGTA that their guidelines did not target appropriate issues pertinent to cannabis.
- Increase educational outreach towards unbanked taxpayers, making cash payments and deposits, regarding penalty relief policies available.
What does all this mean for the cannabis industry and their advisors? Be prepared. Recognizing there is an IRS offensive coming soon:
- Make sure your accounting and documentation is in order.
- Maintain sufficient evidence and backup for your books and records and be consistent in their preparation.
- Finally, utilize IRC Section 471(c) and apply Section 280E as it is intended.
SingerLewak is here for you. We have the resources, expertise and experience necessary to work within the cannabis industry, including preparation of tax filings and representing clients in tax controversies.
The IRS will be knocking on the doors of cannabis companies soon. Don’t let your profits and cash go up in smoke. Give us a call or send us an email.
DEAN FREDGANT VANITA SPAULDING