With the recent news that the IRS is going after Colorado cannabis companies, taxes should be at the forefront of every business owner’s agenda in order to help mitigate the risks of state or IRS tax audits. For marijuana businesses, the risk of an IRS audit comes with more than a potential tax bill. It can also mean criminal charges for money laundering, illegal business practices and more.
Going forward, the winners in the cannabis industry will likely be businesses that choose to follow the rules. Here is why it is important for cannabis businesses to pay all applicable taxes.
State revenue departments may determine that a business has substantial nexus, making the business liable for taxes in that state. This may occur when businesses have entered into licensing agreements with vendors located in other states. Certain states, such as Oregon and Illinois, cast a wide net when it comes to determining whether an out-of-state business is subject to the law of the state.
Back Tax Assessments
In the event that a business is audited by a state tax agency or the IRS, having records of taxes being paid could ease the burden of an audit. Not filing or underreporting income greatly increases the risk of an audit.
The IRS can find out if companies have been underreporting their income by comparing their tax returns to the Form 1099s filed by the companies they do business with. In addition, the IRS can use T-account analysis — which is an accounting method used to determine how the funds from a business are being spent — and financial ratios to compare an individual business to other businesses in an industry.
Since not filing and filing false returns are considered tax crimes if they done intentionally, the tax agency or IRS may also opt to extend the scope of an audit to include additional tax years. Section 6531(2) of the Internal Revenue Code says the status is six years, rather than the standard three years for an audit, beginning once a false return has been filed, or from the time that a company willfully failed to file a tax return.
Since some marijuana-related businesses have already reported that they opted to skip paying taxes because of the battle over Section 280E and business deductions, these businesses are at a substantial risk of being targeted by tax authorities in the near future. (Some marijuana businesses have also avoided paying taxes due to the fear of self-incrimination for manufacturing or selling a controlled substance.) Section 61(a) of the Internal Revenue Code, which defines the meaning of “gross sales” for tax reporting purposes, does not differentiate between income derived from legal sources and income derived from illegal sources.
Excise taxes must be paid by cannabis businesses in several states, including Washington and Oregon. Paying these taxes is a requirement to stay in compliance and maintain the proper licenses. Marijuana-related businesses have been given permission by the federal government to remain in business only as long as they are in compliance with state law. To find out more about the laws in each jurisdiction, contact the appropriate tax agency in your state.
Failing to pay the proper excise taxes and other local taxes could put the company and its stakeholders at risk of losing the liability protection that is afforded to businesses. Even if marijuana is legalized at the federal level in the future, the timing of previous violations may impact a company’s ability to operate.
Paying taxes is the best way to avoid running into problems with state tax agencies or the IRS that could result in losing a business. By keeping on top of tax obligations, business owners can dramatically improve the odds of success and lower their risk of being audited. With proper recordkeeping, they’ll also be equipped with the information needed to prove their case in the event of an audit.
Derek Davis is a certified public accountant who is licensed in California. He spent more than five years at PricewaterhouseCoopers LLP and Deloitte Tax LLP, and has nearly two years of professional taxation experience as a sole proprietor. He is the founder of California Cannabis CPA (www.californiacannabiscpa.com).