Two recent government audits, one from the IRS, the other from the Denver auditor, highlight the continuing tax troubles facing cannabis businesses.
The IRS’s report, titled “The Growth of the marijuana Industry Warrants Increased Tax Compliance Efforts and Additional Guidance,” (“TIGTA”) issued on March 30, 2020, and the Denver auditor’s report, issued in April 2020, both assert that their respective tax collectors are inefficient at collecting taxes and in auditing cannabis tax returns. The TIGTA report reviewed a statistical random sample of cannabis businesses in three states and estimated that 59% of the 237 businesses underpaid income taxes due to IRC Section 280E by $48.5 million, or $242.6 million when forecasted over five years. TIGTA found a particularly high level of noncompliance in California, Oregon, and Washington. The Denver auditor found $19 million of inaccuracies (for both under- and over-assessments) for all types of taxes assessed against cannabis businesses. The auditor also found, amazingly, three unlicensed retail marijuana delivery businesses operating in Denver, even though local jurisdictions may not license such businesses until 2021.
Cannabis businesses are all too familiar with taxing authorities and have had bullseyes on their backs due to Section 280E and often unreasonably high excise and sales taxes. Businesses should continue to monitor their structures, operations, and finances as the IRS Office of Audit and the Denver auditor made a number of important recommendations to their respective agencies. While many of these recommendations concern the internal operations of the agencies, cannabis businesses should be aware of the following:
- The IRS should develop a method to identify cannabis businesses. Not surprisingly, a number of businesses do not identify themselves as cannabis businesses in order to avoid Section 280E.
- The IRS should provide specific guidance to the cannabis industry on the application of Section 280E. The IRS responded that that the its comprehensive audit technique guide for cash businesses along with providing additional information for cash intensive businesses would be sufficient. The Office of Audit replied that the audit technique guide did not address issues specific to cannabis businesses and that the IRS should develop new guidance.
- The IRS should distribute internal and external guidance on the application of IRC Section 471(c) in conjunction with Section 280(E). The Tax Cut and Jobs Act of 2017 amended Section 471(c) and the interplay with Section 280E, which was confusing enough to the cannabis industry and its accountants to begin with, is even more so now. The IRS agreed that such guidance would be useful, but that other general guidance concerning changes to the IRC in 2017 were a higher priority. The industry should expect such guidance anytime soon.
- The IRS should use public available information of cannabis businesses, such as state license information, to identify cannabis businesses subject to 280E. Nonfilers and cannabis businesses who don’t self-identify should expect a higher likelihood of exposure.
- The Denver Treasury Division should communicate and coordinate with the Colorado Department of Revenue. To the extent businesses are providing different data to the city and the state, such businesses might be at higher risk of audit.
- Identify unlicensed delivery businesses by using public resources such as Weedmaps, Leafly, and WeedAdvisor. Cannabis businesses hoping to start delivery in 2021 will need to account for competing with illicit delivery businesses, and licensees using such illicit services should assume that regulators will be on the lookout for such shenanigans.
With governments around the country desperate for tax revenue due to the COVID-19 pandemic, cannabis businesses should be prepared for ever greater scrutiny of their tax returns, whether they be for income tax, excise tax, or otherwise.
While McAllister Garfield does not provide accounting services, we have assisted cannabis businesses with efficient entity tax structuring and in representing businesses in front of taxing authorities. Please contact us about these services.