Paying taxes as a cannabis dispensary owner is an extremely delicate affair.
Pretty soon, anyone involved in the cannabis industry from seed to sale will be under scrutiny. This includes everyone in between, whether they be landlords, transportation companies, or management companies. Everyone who has been in the business since the beginning of legalization is about to get hit with the 280E tax audit.
If you want to keep your head above water during the incoming storm, you’ll need a marijuana lawyer. Keep reading to learn more about the 280E cannabis tax audits and how a marijuana lawyer can help you and your business stay afloat.
Understanding the 280E Audits
In January of 2018, the IRS issued a 280E policy update that directly affected business owners in the cannabis industry in the form of cannabis tax. Section 280E is the federal statute stating that any businesses engaging in the sales of a Schedule l or ll controlled substance—i.e., cannabis—is prohibited from tax deductions or credits. In other words, cannabis business owners cannot use business expenses to reduce taxable income.
The policy update was the result of two key court cases in 2018, as was the onset of the Compliance Initiative Project (CIP). The CIP is an IRS program that began in Colorado with the purpose of carrying out the audits of state-legal cannabis businesses. Of course, as the legalization of cannabis spread across the nation, so did the scope of CIP’s audits.
The first court case was the attempt of Harborside of Oakland, California, to argue that the 280E shouldn’t apply to state-legal cannabis companies. Unfortunately, they lost as the tax court ruled that the 280E applies to any business trafficking Schedule 1 controlled substances—even substances legalized by the state.
The second court case was the attempt of Alternative Health Care of Los Angeles, California, to evade paying federal taxes under the 280E. They did this by hiring a management company to handle their day to day business. Not only did they lose the case, but it prompted the IRS to extend the 280E policy to third parties who directly profit from cannabis businesses.
Ultimately, cannabis business owners are paying three times the taxes than that of conventional business owners.
Cannabis Tax Audits and Litigation
There’s currently a lack of clarity as to where the IRS will draw the line for the peripheral companies profiting off the cannabis industry. This means that any business involved will become a potential target for CIP, and as more tax audits roll out, penalties and fines will easily reach the millions. The IRS has provided guidance to its CIP agents on conducting audits, however, agents have the authority to change a business owner’s method of accounting in favor of 280E marijuana taxation. This is something that particularly affects applicable deductions under 280E involving the Cost of Goods Sold (COGS).
Substantiating your claimed expenses is about proof. Unfortunately, providing a copy of a bill or invoice isn’t enough. It only proves that you owe a certain amount of money, not that you’ve made the payment. As proof, the IRS will accept canceled checks, bank statements, and credit card statements. There’s just one caveat—most of these transactions in the cannabis industry are completed with cash thanks to the current banking system.
Additionally, you have to prove that the expense in question is actually tax-deductible. Under the limitations of the 280E, most expenses aren’t deductible. This creates a marginal tax rate much higher than that of conventional businesses. As mentioned before, there are applicable deductions for the Cost of Goods Sold.
COGS are the direct costs of the production of goods. They include the cost of acquiring and distributing cannabis. Your COGS must be detailed down to the last dime, with all the proper documentation. If you fail to prove your claims, you’ll be facing heavy fines. You also run the risk of losing your business entirely.
How a Marijuana Lawyer Can Help
If it sounds confusing, that’s because it is. This is why moving forward, it’s important to enlist the help of an experienced cannabis tax attorney. For cannabis tax audits and litigation, you’re looking at a more in-depth process. Substantiating your claimed expenses and is much more difficult under federal law.
In truth, you won’t be able to navigate your tax audit or any legal repercussions that stem from it alone. An experienced marijuana lawyer will ensure that you receive the proper treatment during your cannabis tax audit, which will greatly reduce any possible income tax liability. Your cannabis attorney will take care of the following:
- Cash management and support services
- Accounting and bookkeeping services
- Transactions and contracts
- Regulatory compliance
- Cannabis applications and intercompany agreements
- Business law
- Audit and criminal representation
- Tax planning and litigation
- Incorporating your business
Of course, as a cannabis business owner, you are responsible for taking certain precautions aside from hiring a tax lawyer. These responsibilities include keeping documentation on all transactions. They also include keeping records of inter-company contracts and agreements in great detail. You’re also responsible for categorizing your employees properly. By assigning them specific roles, it allows for more accurate reporting on wages.
Another thing you want to consider is registering your business as a corporation. Most small businesses do this to reduce tax burdens. They typically choose between a Corporation or a Limited Liability Corporation (LLC). With the 280E tax policies, registering as a standard Corporation is the smarter choice. This is due to limitations on deductions, which cause LLC owners to pay extra taxes on phantom income.
Get Help with Your Cannabis Tax Audit
The laws of the cannabis industry will continue to evolve. Hopefully, they’ll become more manageable for the small business owner.
Hiring a marijuana lawyer is crucial to the success of your business. Especially with the upcoming audits. Our team of professionals can help you with every aspect of your business. We will fight for you when the time comes.
Reach out to us today to see how we can help with your cannabis tax and business.