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IRS Officially Targets Cannabis (and offers § 280E exemption?)

by Brian S. Whalen, CPA April 04, 2020
Estimated Reading Time: 2 minutes

 

IRS Officially Targets Cannabis (and offers § 280E exemption?)

On March 30th, 2020, the Inspector General (IG) for Tax Administration released a report to the IRS pointing them toward targeting the legal cannabis industry for lost tax revenue.

 

The three major implications are:

 

1.) The IRS will seek to adjust cannabis tax returns where § 280E is not properly applied.
2) The IRS is going to start getting creative in identifying industry non-filers.
3) There may be RELIEF from § 280E in the form of businesses w/ less than $25 Million in revenue being EXEMPT (we are actively pursuing this possibility).

 

Some BAD NEWS from the report for those who are non-compliant:

 

  • The IG’s review noted that 59% of the 2016 tax filings which they looked at in Oregon, Washington, and California likely required § 280E adjustments, which over a 5 year period would lead to hundreds of millions of revenue for the IRS in those states alone!
  • The IRS should target underreported income across the board, which they found to be rampant in WA state in particular.
  • The IRS will train up their revenue agents in the methods used to properly audit marijuana businesses and identify non-filers.
  • The IRS will use publicly available information to identify who is in the cannabis business, as tax returns don’t always make it clear.
  • IRS Audits of the cannabis industry have brought in upwards of $3,600 per Revenue Agent hour in lost tax revenue.
  • The IRS agreed with all of the guidelines that we might consider bad news, but…

 

Some potentially GOOD NEWS:

 

  • The new tax laws (a.k.a. TCJA a.k.a Trump tax cuts) include a provision (§ 471(c)) where businesses with under $25 Million may be able to adjust their accounting method to include many more expenses in COGS, effectively exempting them from § 280E, and we all know that Cost of Goods Sold is the only current reduction in taxable income for a cannabis business.
  • Of course, the IRS “did not agree with the recommendation to develop and provide guidance on I.R.C. § 471(c) citing other priorities” per the IG’s report.  We will have to do the heavy lifting.

 

There is a lot more to unpack in this report.  We will be conferring with our cannabis attorney colleagues to work on the best approach to pursuing the exemption to § 280E for our clients should it prove more likely than not to be accepted by the IRS.  As we assess the risk of taking such a tax position, the best thing you can do in the meantime is to continue to meet the standards of tax compliance as they exist today in order to avoid back-taxes, penalties, and interest.  Stay tuned and stay vigilant – always be ready for an audit.

 

The summary of the IG report with a link to the full report may be found here https://www.treasury.gov/tigta/auditreports/2020reports/202030017_oa_highlights.html
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