Recent court rulings complicate the already onerous tax code for cannabis businesses
With the entire cannabis industry running scared of Internal Revenue Code 280E, what else can the IRS possibly do to make it even more burdensome? Well, let me tell you.
As we have seen in the most recent court rulings in the Alterman and Alpenglow cases, the IRS has made its intentions quite clear when it comes to dispensaries. In previous cases, non-cannabis business activities such as selling merchandise and having a non-cannabis business operation was all well and good, but now it has gotten even more complicated and confusing.
In Alterman v. Commissioner of Internal Revenue, the IRS upheld that, due to an extreme lack of records, the costs of non-cannabis items were disallowed. The Alpenglow Botanicals v. the United States case was based on the plaintiff applying for a tax refund and being denied because IRC 280E was once again upheld in court.
According to the IRS, simply having non-cannabis activity is not enough. For example, if you are selling merchandise, the sales activity from those revenues may not be enough in relation to your total gross revenue to allow deductions. If, in the opinion of the IRS, it is not “enough,” then it will not be considered a separate activity and the IRS may deny all deductions.
Yet, the IRS did allow depreciation expense in the Alterman case. How is this possible? We are also not sure if the IRS would allow Section 179 depreciation or regular depreciation; in either case, it was very peculiar to allow this expense when 280E clearly states this would not be allowable.
In addition, to make this more absurd, if the merchandise you are selling has your logo or brand-related information on it, the IRS may consider this “advertising” and disallow the cost of goods sold for those purchases as well, in addition to any payroll or cost allocated expenses related to those sales. It seems as though the IRS is on a power trip to exert its authority by any means possible. The sad part is the courts have ruled in its favor, which is very disturbing.
Another unfortunate realization, according to the attorneys I deal with, is that these recent cases seem to erode the solid foundation of cases such as CHAMP (Californians Helping to Alleviate Medical Problems v. Commissioner). Trying to navigate workarounds appear insurmountable; it seems every case that passes through the court system has a new twist and yet another obstacle for the industry to deal with. But there are things you can do to help mitigate the hostile surroundings.
First, both Alterman and Alpenglow had poor accounting practices. Trying to claim a deduction for weed purchased at Home Depot is not a good sign (believe it or now, a company actually tried to claim a COGS deduction for this).
One of the aspects of trying to win a case against the IRS is to have a complete, accurate set of books. In addition, the activity must be done contemporaneously; if a mass journal entry at the end of the year is stuck in QuickBooks, you’re dead. More than 95% of the businesses in this industry perform incorrect, poor accounting because the work is not begin done by accounting professionals who are trained and experienced in the cannabis industry.
Because of the complexities of accounting and taxes for the cannabis industry, it is a critical to have this work performed by people who know the business. Not having your accounting and taxes properly prepared can cost you tens of thousands of dollars in taxes, penalties and interest. Staying compliant on all state and federal levels is paramount to keeping the doors open; it can be the difference between keeping or losing your business.
Another huge item to consider is how your entity is taxed — C corporation? S corporation? Partnership? Making a mistake here can cost you dearly, in addition to putting you on the hook personally for a load of income taxes. Due to the new tax laws enacted in 2018, you will want to consult with your attorney and tax adviser as to the proper entity tax classification. Again, dealing with professionals that focus on cannabis is imperative; I have seen far too many mistakes made by non-cannabis industry professionals that cost their clients a fortune.
Finally, because of these recent court rulings, multiple entities may be a consideration to combat the IRS’s aggressive tactics. In the past, having cannabis and non-cannabis activities under one roof may have been good enough, but not any more. Having clearly defined, separate entities will put a nice wall of defense in being able to take advantage of your non-cannabis business interests. Again, setting this up the correct way is extremely important to your overall success in dealing with the IRS and allowable deductions.
As of this writing, there is an IRS audit initiative going on in the Denver area. Accountants and attorneys representing cannabis clients are dealing with changes on the fly as to how the IRS is interpreting and carrying out 280E compliance, the IRS is getting more aggressive. The takeaway is that businesses should plan on being audited. The IRS has stated cannabis companies will be audited every three years; it’s not a matter of if, but when. Prepare for the worst-case scenario, depending on the timing, because we don’t know how the IRS will interpret the next case to pass through the courts. Unfortunately, there is an abundance of flat-out bad information about 280E scattered around the internet, and you must have adequate representation on the accounting as well as the legal side to have a chance of surviving an audit without too much damage.
The IRS is not fooling around. It sees low hanging fruit when it comes to cannabis companies, and it is attacking and winning. You can fight back with the right ammunition and by staying compliant on all fronts. Don’t go cheap when it comes to your professionals because as we have seen in the last several court cases, lack of knowledge can literally put you out of business.
Michael Moran is the CEO of Cannabis Tax Solutions. He is a tax and accounting expert in the cannabis industry with 30 years of public accounting experience. His primary goal is helping clients combat the oppressive IRC 280E tax burden by maximizing every deduction allowable under current tax law. He can be contacted at firstname.lastname@example.org or through the website www.cannabistaxsolutions.com.