The Treasury Inspector General for Tax Administration published a March 30 report that shed light on pertinent changes for cannabis businesses. From the jump, no, IRS Code 280E isn’t going anywhere just yet.
“Industry sources projected that the U.S. legal marijuana industry took in nearly $11 billion in sales in 2018 and are expected to rise to $13 billion in 2019 and $25 billion by 2025,” according to the report, which cites the ongoing wave of state legalization measures. This business boom is leading to more interest on the part of the IRS.
The report does lay out two important points that business owners should note in the midst of tax season. For one, cannabis business owners should expect renewed pressure for records and tax audits in the future. The report cites millions of dollars left on the table and a generally high rate of “noncompliance” with 280E among cannabis businesses on the West Coast. In the 2016 tax year, “the IRS could have issued $48.5 million in tax assessments,” according to the report. Extrapolate that across the next five years, and the report warns the IRS that $242.6 million could be escaping the federal government’s grasp. And that’s just Washington, Oregon and California.
The report stresses that other areas aside from those legacy markets out West deserve further scrutiny, as well, now that cannabis markets are maturing in places like Massachusetts and Illinois. The title of the report, after all, is “The Growth of the Marijuana Industry Warrants Increased Tax Compliance Efforts and Additional Guidance.”
“They found that there were a lot of errors with the way tax returns were being prepared in a number of states,” Rachel Gillette, partner and chair of Greenspoon Marder’s Cannabis Law Practice, says. “The long and short of it is that, it appears, the industry should plan for more audits—not fewer audits—in the future.”
The second point is that the Tax Cuts and Jobs Act of 2017 may have opened the door to some tax relief for small cannabis businesses.
This point involves IRS Section 471(c), which was written as part of that sprawling federal bill to permit some relief for small businesses whose previous three years of gross receipts average out to $25 million or less. The way it’s written, this section could apply to cannabis businesses, too.
“Under this new provision, marijuana businesses could argue they are entitled to use a method of accounting that includes all expenses in cost of goods sold to potentially avoid the impact of I.R.C. 280E,” the report states. “According to IRS Chief Counsel, at least two practitioners have identified this issue and have questioned IRS personnel on how the IRS plans to handle I.R.C. 471(c) as applied to marijuana industry taxpayers.”
In short, this section would bar the IRS from pursuing tax adjustments if a company’s accounting method aligns with 471(c).
The report goes on to classify this new section and its relation to cannabis business as a “potential unintended consequence.”
“What I would say about this and their characterization of it is that I don’t believe that it was unintended,” Gillette says. “It was intended to help small businesses. While I don’t know that I’d go so far as to say every single thing can be put into cost of goods sold, it does and it can give taxpayers wide latitude—but intentionally so.”
Gillette stresses that cannabis businesses can’t simply file their taxes in accordance with 471(c) without first having a record of accounting that properly aligns with the section. The books need to match the tax filings. (N.B.: The federal tax deadline was bumped back to July 15. Many states and localities have since followed suit.)
More broadly, this small business relief is another likely incremental step toward cannabis tax reform. The same goes for the SAFE Banking Act, which has passed the U.S. House and now awaits a vote in the U.S. Senate. Formal banking relationships would further legitimize cannabis businesses and, at a very basic level, make tax season easier on ownership.
“When you take a normal [cannabis] business that has to follow all the other federal laws—like filing a tax return, federal employment laws, federal OSHA safety standards, everything else they have to go through—and then you tax them punitively on top of that, even though what they’re doing is legal and allowable … and the state has determined to regulate it, it shows how the application of 280E could be costing more money than the revenue it’s collecting,” Gillette says.
Often, 280E guidelines tend to become so knotted and confusing that business owners or their accounts may not understand exactly how to apply it, she adds. This could result in overcollection or undercollection of taxes. Further, a unique tax burden like 280E could incentivize the illicit market, which continues to thrive in many U.S. states—even in jurisdictions that have legalized adult-use cannabis.