Treasury Inspector General Targets The Cannabis Industry Recommending Increased Tax Compliance Action
On March 30, 2020, the Treasury Inspector General For Tax Administration (TIGTA) released a report to the IRS pointing them toward targeting the state-licensed cannabis industry for lost tax revenue.
Highlights Of The Treasury Inspector General Report
Cannabis is classified as a Schedule I controlled substance under the Controlled Substances Act. Businesses in this industry have limited banking access and are subject to IRC §280E, which prohibits the deduction of expenses incurred in trafficking Schedule I controlled substances. The IRS risks diminished taxpayer compliance when cannabis businesses fail to report all income as required under IRC §61, regardless of source, and deduct expenses not allowed under IRC §280E.
TIGTA reviewed statistical random samples of cannabis businesses in three States and determined that 59% (140 out of 237) of the tax return filings for Tax Year 2016 had likely IRC §280E adjustments, which when projected over the population totaled $48.5 million in unassessed taxes for Tax Year 2016 or $242.6 million when the results are forecasted over five years.
TIGTA also estimated the tax impact to comply with IRC §280E for the same sampled cannabis business taxpayers. When projected to the population, TIGTA estimated a $95 million Federal income tax impact to these taxpayers from the application of IRC §280E on their Tax Year 2016, or $475.1 million when forecasted over five years.
In addition, TIGTA selected a statistically random sample of 90 cannabis businesses that filed State returns for Tax Year 2016 in the State of Washington to determine whether these taxpayers were reporting all of their income in compliance with IRC §61. TIGTA found that 26% (23 of 90) returns likely have I.R.C. § 61 adjustments involving either underreported income or nonfiling of tax returns. When projected over the population for Washington, the IRS missed the opportunity to address $3.9 million of potential assessments for Tax Year 2016, or $19.3 million when forecasted over five years.
Also, the TIGTA stated that the IRS lacks guidance to taxpayers and tax professionals in the cannabis industry. Such guidance would improve awareness of tax filing requirements for taxpayers in this industry, such as the correct application of IRC §§280E and 471(c), which would reduce the burden of tracking inventory for certain small businesses.
Recommendations Of The Treasury Inspector General Report
TIGTA recommended the following to the IRS:
- The IRS develop a comprehensive compliance approach for the cannabis industry, including a method to identify businesses in this industry and track examination results;
- The IRS develop and publicize guidance specific to the cannabis industry, such as guidance on the application of IRC § 471(c) in conjunction with IRC § 280E;
- Leverage publically available information at the State level and expand the use of existing Fed/State agreements to identify nonfilers and unreported income in the cannabis industry;
- Increase educational outreach towards unbanked taxpayers making cash deposits regarding the unbanked relief policies available.
The IRS did not agree with recommendation #2 above to develop and provide guidance on IRC § 471(c) citing other priorities.
But until Federal law changes, the cannabis industry will still have to bear the followings risks and challenges:
Higher Taxes Still Remain
It still remains to be seen when favorable changes will be made to the Internal Revenue Code which treats businesses in the marijuana industry differently resulting in such business paying at least 3-times as much in taxes as ordinary businesses.
Generally, businesses can deduct ordinary and necessary business expenses under I.R.C. §162. This includes wages, rent, supplies, etc. However, in 1982 Congress added I.R.C. §280E. Under §280E, taxpayers cannot deduct any amount for a trade or business where the trade or business consists of trafficking in controlled substances…which is prohibited by Federal law. Marijuana, including medical marijuana, is a controlled substance. What this means is that dispensaries and other businesses trafficking in marijuana have to report all of their income and cannot deduct rent, wages, and other expenses, making their marginal tax rate substantially higher than most other businesses.
Reporting Of Cash Payments Still Remain
The Bank Secrecy Act of 1970 (“BSA”) requires financial institutions in the United States to assist U.S. government agencies to detect and prevent money laundering. Specifically, the act requires financial institutions to keep records of cash purchases of negotiable instruments, and file reports of cash purchases of these negotiable instruments of more than $10,000 (daily aggregate amount), and to report suspicious activity that might signify money laundering, tax evasion, or other criminal activities. The BSA requires any business receiving one or more related cash payments totaling more than $10,000 to file
IRS Form 8300, Report of Cash Payments Over $10,000 Received in a Trade or Business.
The minimum penalty for failing to file EACH Form 8300 is $25,000 if the failure is due to an intentional or willful disregard of the cash reporting requirements. Penalties may also be imposed for causing, or attempting to cause, a trade or business to fail to file a required report; for causing, or attempting to cause, a trade or business to file a required report containing a material omission or misstatement of fact; or for structuring, or attempting to structure, transactions to avoid the reporting requirements. These violations may also be subject to criminal prosecution which, upon conviction, may result in imprisonment of up to 5 years or fines of up to $250,000 for individuals and $500,000 for corporations or both.
Marijuana-related businesses operate in an environment of cash transactions as many banks remain reluctant to do business with many in the marijuana industry. Like any cash-based business the IRS scrutinizes the amount of gross receipts to report and it is harder to prove to the IRS expenses paid in cash. So it is of most importance that the proper facilities and procedures be set up to maintain an adequate system of books and records.
IRS Is Ready And Motivated To Examine Cannabis Businesses
The TIGTA report shows there is a substantial revenue generating opportunity for the IRS to conduct audits of cannabis businesses. You can expect that the IRS will train their revenue agents in the methods used to properly audit cannabis businesses and identify non-filers. Using publicly available information such as State license registrations, social media and listing services (such as Weedmaps), the IRS should be able to identify non-filers or those taxpayers who filed tax returns concealing that there are in the cannabis business.
How Do You Know Which Cannabis Tax Attorney Is Best For You?
Given that cannabis is still illegal under existing Federal law you need to protect yourself and your marijuana business from all challenges created by the U.S. government. While cannabis is legal in California, that is not enough to protect you. It’s coming down that the biggest risk is TAXES. Be proactive and engage an experienced Cannabis Tax Attorney in your area. Let the tax attorneys of the Law Offices Of Jeffrey B. Kahn, P.C. located in Orange County, Northern California (including Sacramento and the San Francisco Bay Area) and other California locations protect you and maximize your net profits. And if you are involved in crypto currency, check out what a Bitcoin Tax Attorney can do for you.