It is no surprise that Cannabis businesses face frequent Federal tax audits. The IRS has formed special audit groups that are tasked with conducting cannabis tax audits on medical and recreational cannabis businesses. IRC §280E is at the forefront of all IRS cannabis tax audits and enforcement of §280E could result in unbearable tax liabilities. Working with one of our cannabis tax attorneys will allow you to protect yourself, as well as ensure that you receive the proper treatment of COGS versus ordinary and necessary expenses.
In addition to IRS audits, state cannabis audits are also complex and thorough and generally include all taxes specific and nonspecific to the cannabis business. Potentially at risk is the cannabis license that enables the business to operate. State audits will focus on records regarding sales and use tax, excise taxes, and seed-to-sale tracking records.
Substantiation Issues – Proving deductions to the IRS is a two-step process:
• First, you must substantiate that you actually paid the expense you are claiming.
• Second, you must prove that an expense is actually tax deductible.
Step One: Incurred And Paid The Expense.
For example, if you claim a $5,000 purchase expense from a marijuana distributor, offering a copy of a bill or an invoice from the distributor (if one is even provided) is not enough. It only proves that you owe the money, not that you actually made good on paying the bill. The IRS accepts canceled checks, bank statements and credit card statements as proof of payment. But when such bills are paid in cash as it typical in a marijuana business, you would not have any of these supporting documents but the IRS may accept the equivalent in electronic form.
Step Two: Deductibility Of The Expense.
Next you must prove that an expense is actually tax deductible. For marijuana businesses this is challenging because the I.R.C. §280E limitation.
If your cannabis tax audit is not resolved, the results may be challenged and litigated (depending on the type of tax) in the U.S. Tax Court, Federal District Court, or State Court. The U.S. Tax Court has jurisdiction to hear disputes over federal income taxes before final assessment and collections while the federal district courts generally require taxpayers to first pay the liability then seek repayment through a refund request.
If you have received a Notice of Deficiency you have the opportunity to challenge the audit result court. The Notice will give you 90 days to file petitioner in U.S. Tax Court or, for the State, 30 days to file a protest.
Having access to a Board Certified Tax Attorney-CPA with specialized knowledge in the cannabis industry and more than 30 years of experience in advising businesses in tax compliance and planning, accounting systems and cash management can help you meet your challenges to minimize your taxes and conduct business in a manner that avoids prosecution by the Federal authorities and meets State & Local laws and regulations to ensure your cannabis business remains operational. Don’t delay call us today!
