Is Your Cannabis Accounting a Ticking Time Bomb?
Not only did her Colorado Medical Marijuana business fail, but Mrs. Alterman and her husband owed the IRS over $469,000 when they walked out of U.S. Tax Court earlier this year.
In June 2018, the Alterman vs. IRS Commissioner case held that Altermeds LLC, a dispensary / cultivator, was “not entitled to any business-expense deductions”. The judge also lowered their Cost of Goods Sold (COGS) deduction, and hit them with a bill:
- $391,242 for income tax deficiencies
- $78,248 for accuracy related penalties attributed to negligence (20% penalty)
According to their books, Altermeds LLC only made $64,534 in net profits over the two years in question, but the owners were now down over $400,000 for that period due to the unique nature of the taxation of cannabis businesses. Medical marijuana businesses are still federally illegal, so Internal Revenue Code § 280E applies – this means NO DEDUCTIONS a.k.a. tax write-offs for business expenses that any normal business would be entitled to.
Sidebar: The good news is that the 16th Amendment of the Constitution allows for taxable income to be reduced by the Cost of Goods Sold (COGS) only if these costs are properly recorded and attributed to inventory (cannabis products in this case). Click here for more on the taxation of cannabis businesses.
Poor record keeping, shoddy books, and a host of other accounting issues led the Tax Court to hold that Altermeds LLC was negligent due to their failure to keep adequate books and records or to substantiate items properly. They could have sought relief if they relied on professional advice about the tax treatment of their business. Although they had bookkeepers and tax preparers, they never sought specific advice regarding proper inventory accounting or the effect of IRC section 280E. The Tax Court memo stated, “This lack of inquiry evinces their lack of interest in complying with the federal tax laws”.
Remember, the taxpayer bears the burden of proving the IRS is incorrect in its findings. This means that you need evidence (accurate records) and a knowledgeable accounting and finance team in place now if you are going to make it through an audit unscathed. Be proactive; cannabis businesses are more likely to be audited by the IRS due to a history of noncompliance.
Selected highlights of Altermed’s blunders:
- The IRS recalculated and reduced Altermed’s COGS (deductions)
- The court couldn’t determine employee wages paid for work performed at the grow site versus the dispensary
- Altermeds had instances of general ledger purchases of smokable marijuana with the payee being Home Depot or Lowes – they mixed up receipts
- Altermeds recorded cash taken from the register to purchase marijuana products
- Alterman paid her son with a check which he cashed and used the cash to buy merchandise for the business
- Pages were missing from their Visa statements
- The bookkeeper, when they had one, relied on documents provided by Alterman to do the books, and didn’t have corroborating bank slips, receipts or records of transactions
- Altermeds opening inventory each year for three consecutive years was $0 (as if they had sold everything on hand by December 31st at midnight)
- The end of the second year showed over $12,000 in inventory, but there was no record of how any costs were assigned to units of inventory.
- Their 1040 Schedule C, “profit or loss from business” showed that they selected the Cash Method of Accounting (Accrual is required for proper cost accounting)
- The court held that Altermeds selling non-marijuana merchandise was not separate from the business of selling marijuana merchandise. NOTE: If, however, selling non-marijuana merchandise were considered a separate business, then the expenses of that business would be deductible. See CHAMP, 128 T.C. at 183-185
by Brian S. Whalen, CPA, MST/MSF