Marijuana, classified as a Schedule I controlled substance under the Controlled Substances Act, faces unique challenges in the business world. One major hurdle is the limited banking access for marijuana businesses. Moreover, these businesses are subject to a specific tax provision, Internal Revenue Code (I.R.C.) Section (§) 280E, which prevents them from deducting expenses related to the trafficking of Schedule I controlled substances. This creates a risky situation for the IRS, as noncompliance arises when marijuana businesses fail to report their full income, as required by I.R.C. § 61, and attempt to deduct expenses that are not allowed under I.R.C. § 280E.
As the marijuana industry continues to expand rapidly, it is crucial to ensure that businesses in this sector comply with tax regulations and receive adequate guidance. Due to the unique challenges faced by marijuana businesses and the legal restrictions they encounter, the Internal Revenue Service (IRS) addressed these issues and provided clear instructions for proper income reporting and deduction eligibility.
A recent audit revealed significant noncompliance among marijuana businesses when it came to tax returns. In three states, 59 percent of the sampled tax returns showed adjustments related to a specific tax code provision (I.R.C. § 280E). When extrapolated to the entire population, this amounted to approximately $48.5 million in unassessed taxes for Tax Year 2016, or a projected total of $242.6 million over five years.
The audit also estimated that the application of I.R.C. § 280E had a substantial impact on federal income taxes for the sampled marijuana businesses. It amounted to $95 million for Tax Year 2016 alone, with a projected total of $475.1 million over five years.
Furthermore, the audit revealed that 26 percent of the sampled tax returns from the State of Washington likely involved underreported income or nonfiling of tax returns under I.R.C. § 61. The IRS missed the opportunity to address potential assessments of $3.9 million for Tax Year 2016 in Washington alone, or a projected total of $19.3 million over five years.
The lack of clear guidance provided by the IRS to taxpayers and tax professionals in the marijuana industry was also highlighted. It is particularly important for small businesses in this industry, who struggle with inventory tracking, to receive proper guidance on tax filing requirements and the correct application of tax code sections I.R.C. §§ 280E and 471(c).
To address these challenges, the audit made the following recommendations:
- Develop a comprehensive compliance approach for the marijuana industry, including effective methods to identify businesses and track examination results.
- Provide industry-specific guidance that clarifies the application of I.R.C. § 471(c) alongside I.R.C. § 280E, ensuring businesses understand the rules and regulations.
- Utilize publicly available information at the state level and strengthen collaborations with state authorities to identify noncompliant businesses and unreported income.
- Enhance educational outreach to unbanked taxpayers who rely on cash deposits, informing them about available relief policies and ensuring their compliance.
The IRS has agreed with five out of the six recommendations. Although immediate development of guidance on I.R.C. § 471(c) is not guaranteed due to competing priorities, the IRS has expressed its willingness to consider it once current priorities are resolved. This commitment aims to ensure better coordination between I.R.C. § 280E and 471(c) in the future, providing greater clarity to businesses in the marijuana industry.
It is of paramount importance for cannabis CEOs to align themselves with specialized cannabis accountants and engage a cannabis accounting firm that has the necessary expertise and knowledge. Here, at The Canna CPAs, our cannabis accountants and cannabis CFOs have years of experience, representing businesses before the IRS for tax audits. Furthermore, our cannabis CPAs and cannabis accountants have tremendous knowledge and accolades in the cannabis space. Combining these two fields of expertise will ensure the minimization of risk for your cannabis business in the event of a cannabis tax audit.
Call or email now to schedule your appointment to learn more about our cannabis accounting and cannabis tax services. Our 280E accountants are standing by to help you!
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Sandy Suchoff, CPA is the Founder and principal of Lefstein-Suchoff, CPA & Associates, LLC D/B/A The Canna CPAs. Suchoff has been featured and interviewed on MSNBC, FOX News, and Tune In Business Talk Radio as a tax advisor, as well as ONR Oklahoma PBS TV, Chasing News on FOX & WOR, KRQE 13, Cannabis Radio, Purple Haze Radio, and Cannabis Tech & Today as an advisor on cannabis tax and accounting.