Imagine operating a business that is strapped with an effective tax rate that can be between 75% - 85%. This is a major problem that cannabis operators deal with on a regular basis. IRS Code Section 280E is only one sentence, but it severely handcuffs the industry, causing public companies to stress the issue in their financial statements.
We have yet to see a tax court win for any cannabis business since Californians Helping to Alleviate Medical Problems (CHAMP) v. Commissioner in 2007. More recent tax court cases have been losses for taxpayers. Though we have not seen any recent guidance from the IRS, they are still hard at work. With the lack of stable banking and no access to merchant services, the cannabis industry is very cash-intensive. In addition to this, the IRS sees the industry as an easy target and a high risk for underreporting income due to its high tax rate. As such, they have created audit programs and a dedicated team to target the industry, which has led to an uptick in audits in the industry.
Here are some key takeaways from these audits:
- With any industry, it is important to involve a professional when dealing with the IRS on an audit, but with the cannabis industry it is even more critical.
- The IRS always has chief counsel involved, either in the actual meetings or in the background providing guidance to the agents.
- The written conclusions for any 280E position are generally coming from counsel.
- The IRS is taking a broad application of 280E and expects the taxpayer to provide an argument to reduce scope.
- The IRS will do a deep dive via any public databases to prove their positions beyond information that they are provided.
- The IRS does receive information from states and municipalities; they are the great data aggregator, so be truthful and forthcoming.
- The IRS will collapse any structuring that is done for purely tax reasons, so it is important to provide legitimate business reasons for any structuring done and provide contemporaneous documentation for valuations used for any intercompany transactions.
- Good books and records and contemporaneous documentation are the keys to success.
- Maintain all supporting documentation and be responsive.
It is important to note that the IRS does not make the tax law, they merely enforce it. It is the position of the IRS and the United States Tax Court that it is Congress’ job to change the law to alleviate the tax burden on the industry, and any argument placed before them in that regard will fall on deaf ears.
It is not if you will be audited in the cannabis industry, but when. It is important that you maintain all your records and have contemporaneous written documentation for all tax positions taken, as there is no getting around 280E.
For more information on the tax implications and audits for the cannabis industry, please contact Matthew Martin at firstname.lastname@example.org. Citrin Cooperman’s Cannabis Advisory Services Practice is here to help your business focus on what counts.
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