Thirty states and the District of Columbia at present have laws broadly legalizing marijuana in some kind. However, marijuana remains illegal beneath Federal law, and this creates an uncertain landscape for marijuana companies in the preparation of their Federal revenue tax returns and in handling an IRS audit. In addition, marijuana companies should be conscious of money handling difficulties. This report addresses a couple of of the prevalent tax difficulties facing marijuana companies and why these companies should really seek the assistance of a tax lawyer in any communications with the Internal Income Service.
Section 280E, Organization Expenditures, and Charges of Goods Sold
In extremely basic terms, the Internal Income Code (IRC) enables companies to deduct “ordinary and necessary” costs incurred throughout the taxable year in carrying on a trade or small business. See particularly IRC Section 162.
Nevertheless, beneath IRC Section 280E, companies are prohibited from deducting small business costs or taking credits connected to revenue from the sale of federally controlled substances, such as marijuana. Interpreted strictly, IRC Section 280E prohibits a marijuana small business from deducting any small business costs – even salaries, wages, employee advantages, instruction, rent, travel, marketing, and depreciation.
Attempts to fight Section 280E in Tax Court have been unsuccessful. For instance, the IRS audited Canna Care Inc., a California health-related marijuana dispensary, and denied Canna’s deductions for operating costs, such as substantial amounts for employee salaries and automobile costs. The enterprise appealed the IRS’ findings to the United States Tax Court. Relying on section 280E, the Court upheld the IRS’ determination and denied all of Canna’s deductions. See Canna Care, Inc. v. Commissioner, T.C. Memo 2015-206.
Nevertheless, in Californians Assisting to Alleviate Healthcare Difficulties, Inc., v. Commissioner, 128 T.C. 173 (2007)(“CHAMP”), the government acknowledged that Section 280E does not prohibit a taxpayer from claiming fees of goods sold (COGS). Footnote four of the opinion delivers as follows: “respondent [the IRS] concedes that the disallowance of sec. 280E does not apply to fees of goods sold, a concession that is constant with the caselaw on that topic and the legislative history underlying sec. 280E.” The CHAMP Court also permitted small business expense deductions connected to the taxpayer’s separate counseling and caregiving small business. According to the Court, “section 280E does not preclude petitioner from deducting costs attributable to a trade or small business other than that of illegal trafficking in controlled substances merely due to the fact petitioner also is involved in the trafficking in a controlled substance.”
Most not too long ago, on June 13, 2018, the United States Tax Court issued its opinion in Alterman & Gibson v. Commissioner, T.C. Memo. 2018-83.
In the course of the years ahead of the Court, the taxpayers owned a health-related marijuana dispensary in Colorado. The dispensary sold smokable marijuana as effectively as edibles. It also sold marijuana paraphernalia such as pipes, papers, and other products utilized to consume marijuana. The IRS audited taxpayers and permitted their fees of goods sold, but disallowed all small business expense deductions (beneath Section 280E) except depreciation.
The Tax Court upheld the IRS’ disallowance of all small business expense deductions, even these connected to that portion of the taxpayers’ small business that sold non-marijuana solutions such as marijuana paraphernalia. Specifically, the Court stated:
Beneath the situations, we hold that promoting non-marijuana merchandise was not separate from the small business of promoting marijuana merchandise. First, Altermeds, LLC, derived just about all of its income from marijuana merchandise. Second, the forms of non-marijuana solutions that it sold (pipes and other marijuana paraphernalia) complemented its efforts to sell marijuana. Altermeds, LLC, had only one particular unitary small business, promoting marijuana. If, nevertheless, promoting non-marijuana merchandise have been viewed as a separate small business, then the costs of that small business would be deductible. See CHAMP, 128 T.C. at 183-185.
In sum, the Alterman Tax Court opinion reemphasizes the Court’s previous rulings connected to marijuana companies: (1) small business costs are not deductible beneath Section 280E (two) fees of goods sold are allowable, as lengthy as they are calculated appropriately and (three) small business costs could be deductible if a marijuana small business also conducts a second, ancillary small business that is totally separate from the sale of marijuana.
The challenges inherent in fighting back against an IRS audit have been also exposed in the Tax Court case of Feinberg v. Commissioner, T.C. Memo. 2017-2011. In that case, the IRS audited a Colorado small business licensed for the cultivation and sale of health-related marijuana. The IRS disallowed small business expense deductions beneath 280E and also created adjustments to the business’ claimed fees of goods sold. The COGS adjustment was the primary situation ahead of the Tax Court. Interestingly, the IRS in fact reclassified some of the business’ deductions as COGS, providing the taxpayers higher COGS than initially claimed on its returns. At trial, the small business created no small business records pertaining to its operations. Alternatively, it chose to rely exclusively on an professional report supplied by an accountant who specializes in marijuana market expense accounting. The small business contended that its professional report established that the COGS permitted by the IRS have been incorrect.
The Tax Court concluded that beneath Federal Rule of Proof 702, the professional report was not admissible. Specifically, the Court stated: “The conclusions in the [expert] report are an try to present reconstructed revenue tax returns as proof of petitioners’ appropriate tax liabilities. The report is not primarily based on individual understanding of THC’s small business. To figure out the appropriate COGS for THC, substantiation of THC’s costs is essential. A reconstructed revenue tax return primarily based on market averages does not take the location of substantiation and does not enable figure out a truth in situation.”
The marijuana small business also argued that it should really be permitted higher COGS than what the IRS permitted beneath the Cohan rule. Under Cohan, the Tax Court could estimate the quantity of a deductible expense if a taxpayer establishes that an expense is deductible but is unable to substantiate the precise quantity. The Cohan rule also applies to COGS. However, in Feinberg, the Tax Court located that even beneath Cohan, there should be enough proof in the record to give a basis upon which an estimate can be created due to the fact the small business supplied no proof to assistance COGS greater than what the IRS permitted, the Court upheld the IRS’ final COGS adjustment. The Feinberg case highlights the value of retaining a competent tax lawyer when dealing with any IRS audit, particularly if the audit outcomes in litigation in U.S. Tax Court.
IRS Audits of Gross Receipts
Marijuana companies should also be concerned with IRS audits of their gross receipts, particularly, the IRS’ use of indirect solutions of proof. Although neither the Tax Code nor Treasury regulations define or particularly authorize the use of indirect solutions of proof, case law has held that indirect solutions of proof are acceptable and they have to have not be precise, but should be affordable in light of surrounding details and situations. Holland v. United States, 348 U.S. 121, 134 (1954).
The IRS will use indirect solutions of proof beneath a variety of situations, such as: books and records do not accurately reflect total taxable revenue received and the income agent has established the likelihood of unreported revenue costs seem to exceed revenue irregularities in the taxpayer’s books and records gross profit percentage alterations substantially from one particular year to a different taxpayers’ bank accounts have unexplained deposit products taxpayer does not make common deposits and utilizes money tax returns show substantial improve in taxpayer’s net worth which is not supported by recorded revenue and no approach of accounting has been routinely utilized or the approach does not clearly reflect revenue.
The IRS utilizes a selection of indirect solutions of proof such as: the bank deposits evaluation (most prevalent), net worth evaluation, money-t evaluation, and the mark-up approach.
Anytime the IRS intends to carry out an indirect approach of proof audit of gross receipts, the taxpayer should really seek the advice of with a tax lawyer, as there are exposure dangers such as a prospective IRS criminal investigation or civil fraud referral. A competent tax lawyer can advise of these dangers and can enable limit the taxpayer’s exposure. A tax lawyer can also defend against the conclusions drawn by the IRS agent following he or she completes an indirect approach of proof audit.
Marijuana companies should also be concerned with the Economic Crimes Enforcement Network (FinCEN), a bureau of the U.S. Division of Treasury that collects and analyzes info about economic transactions in order to combat income laundering and other economic crimes. FinCEN’s self described mission is to safeguard the nation’s economic method from illicit use and income laundering and to market national safety by collecting, analyzing, and disseminating economic intelligence. To that finish, the Bank Secrecy Act (BSA) calls for economic institutions to file currency transaction reports (CTRs) for money transactions exceeding $10,000 (everyday aggregate quantity) with FinCEN. It also calls for institutions such as banks, income solutions companies, securities firms, insurance coverage providers, casinos, and loan and finance providers, to file suspicious activity reports (SARs) anytime a transaction does not make sense, is uncommon for that distinct client, seems to be carried out for the objective of hiding or obfuscating a transaction, or show deposits structured to prevent CTR specifications (i.e., several deposits totaling more than $10,000 but divided up to prevent the $10,000 threshold). CTRs and SARs are vital tools that FinCEN utilizes and shares with other regulatory agencies – such as the IRS – in its try to combat income laundering and the use of Federally backed economic institutions to hide illicit monetary transactions.
A 2014 FinCEN memo stated as follows: “Because federal law prohibits the distribution and sale of marijuana, economic transactions involving a marijuana-connected small business would usually involve funds derived from illegal activity. Therefore, a economic institution is needed to file a SAR on activity involving a marijuana-connected small business (such as these duly licensed beneath state law) in accordance with this guidance and FinCEN’s suspicious activity reporting specifications and connected thresholds.” Therefore, in no uncertain terms, beneath Federal law, a bank should file a SAR anytime it conducts a transaction with a marijuana-connected small business, even when the transaction is under the CTR $10,000 threshold.
In addition, due to the fact marijuana companies deal largely in money, they should be conscious of Kind 8300 specifications. Any small business that receives far more than $10,000 in money in a single transaction or connected transactions should full a Kind 8300, Report of Money Payments More than $10,000 Received in a Trade or Organization. Form 8300 is a joint kind issued by the IRS and FinCEN. Marijuana companies, particularly wholesalers, should be cognizant of Kind 8300 filing specifications.
The IRS started auditing Colorado marijuana companies connected to their Kind 8300 filing specifications in 2016. 1 small business owner, who wished to stay anonymous, reported that some of the marijuana small business directed audits came from the IRS’ fraud division. In all of the Colorado Kind 8300 audits, the IRS utilized a questionnaire and posed concerns unrelated to Kind 8300 specifications. For instance, the questionnaire asked the following concerns: How did you get began in the small business? Who are your competitors in the wholesale marijuana market? If a bank account exists is all of the money deposited into the bank account? Asking beyond the audit scope, open-ended concerns is a tactic frequently utilized by IRS income agents and why it is vital to retain an knowledgeable tax lawyer anytime the IRS conducts an audit or investigation, no matter how effectively the small business has maintained its books and records, and stayed in compliance with federal tax obligations and Kind 8300 filing specifications.
If you personal a small business promoting, increasing, or creating marijuana, you have to have to operate with an knowledgeable tax lawyer to realize your tax rights and responsibilities. The landscape is altering so rapidly that you have to have a legal advocate on your side to enable you navigate it all. If your small business is audited and you do not have detailed info about every single single transaction, you threat forfeiting your COGS claim and you could be topic to penalties for filing an inaccurate tax return.
Silver Law PLC operates in Arizona and Nevada and all of its lawyers are former trial attorneys for the IRS. A tax lawyer from our group can enable you realize how the complicated Tax Code applies to your marijuana small business operations. We’ll enable you assure that you are meeting your obligations. If you have been audited or are facing collections, we are also in a position to enable you navigate that procedure. We can either locate techniques to bring down your tax debt or can negotiate a settlement for you. Contact us nowadays and speak with a tax lawyer in Las Vegas or Phoenix to study far more.
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