Cannabis / Marijuana Tax Representation & Defense
How to Prevent an IRS Audit From Becoming Your Worst Nightmare
Proliferation Of Legalized Marijuana
Medical marijuana is now legal in 29 states plus the District Of Columbia and recreational marijuana is legal in 8 states plus the District Of Columbia. Almost 60% of the U.S. population lives in a State where marijuana is legal.
|Click here if you are under investigation or audit by the IRS.
Key Federal Tax Developments
While the sale of marijuana is legal in California as well as in a growing number of states, marijuana remains a Schedule 1 narcotic under Federal law. As such businesses in the marijuana industry are not treated like ordinary businesses. Despite state laws allowing marijuana, it remains illegal on a federal level but is obligated to pay federal income tax on its taxable income because I.R.C. §61(a) does not differentiate between income derived from legal sources and income derived from illegal sources.
I.R.C. §280E – Deduction of Business Expense
Generally, businesses can deduct ordinary and necessary business expenses under I.R.C. §162. This includes wages, rent, supplies, etc. However, in 1982 Congress added I.R.C. §280E. Under §280E, taxpayers cannot deduct any amount for a trade or business where the trade or business consists of trafficking in controlled substances…which is prohibited by Federal law. Marijuana, including medical marijuana, is a controlled substance. What this means is that dispensaries and other businesses trafficking in marijuana have to report all of their income and cannot deduct rent, wages, and other expenses, making their marginal tax rate substantially higher than most other businesses.
A marijuana business can still deduct its Cost Of Goods Sold (“COGS”). Costs of goods sold are the direct costs attributable to the production of goods. For a marijuana reseller this includes the cost of marijuana itself and transportation used in acquiring marijuana. To the extent greater costs of doing business can be legitimately included in COGS that will that result in lower taxable income.
Bank Secrecy Act – Reporting Of Cash Payments
The Bank Secrecy Act of 1970 (“BSA”) requires financial institutions in the United States to assist U.S. government agencies to detect and prevent money laundering. Specifically, the act requires financial institutions to keep records of cash purchases of negotiable instruments, and file reports of cash purchases of these negotiable instruments of more than $10,000 (daily aggregate amount), and to report suspicious activity that might signify money laundering, tax evasion, or other criminal activities. The BSA requires any business receiving one or more related cash payments totalling more than $10,000 to file IRS Form 8300, Report of Cash Payments Over $10,000 Received in a Trade or Business.
The minimum penalty for failing to file EACH Form 8300 is $25,000 if the failure is due to an intentional or willful disregard of the cash reporting requirements. Penalties may also be imposed for causing, or attempting to cause, a trade or business to fail to file a required report; for causing, or attempting to cause, a trade or business to file a required report containing a material omission or misstatement of fact; or for structuring, or attempting to structure, transactions to avoid the reporting requirements. These violations may also be subject to criminal prosecution which, upon conviction, may result in imprisonment of up to 5 years or fines of up to $250,000 for individuals and $500,000 for corporations or both.
Marijuana-related businesses operate in an environment of cash transactions as many banks remain reluctant to do business with many in the marijuana industry. Like any cash-based business the IRS scrutinizes the amount of gross receipts to report and it is harder to prove to the IRS expenses paid in cash. So it is of most importance that the proper facilities and procedures be set up to maintain an adequate system of books and records.
18 U.S.C. §1956 – Laundering Of Monetary Instruments
18 U.S.C. § 1956(a) defines three types of criminal conduct: domestic money laundering transactions (§ 1956(a)(1)); international money laundering transactions (§ 1956(a)(2)); and undercover “sting” money laundering transactions (§ 1956(a)(3)). Marijuana-related businesses need to be aware of domestic money laundering transactions (§ 1956(a)(1)).
To be criminally culpable under 18 U.S.C. § 1956(a)(1), a defendant must conduct or attempt to conduct a financial transaction, knowing that the property involved in the financial transaction represents the proceeds of some unlawful activity, and the property must in fact be derived from a specified unlawful activity.
Violations of § 1956 have a maximum potential twenty year prison sentence and a $500,000 fine or twice the amount involved in the transaction, whichever is greater. There is also a civil penalty provision in § 1956(b) which may be pursued as a civil cause of action. Under this provision, persons who engage in violations of any of the subsections of 1956(a) are liable to the United States for a civil penalty of not more than the greater of $10,000 or the value of the funds involved in the transaction.
Several cases have held, that EACH separate financial transaction should be charged separately in an individual count. For example, if an individual earns $100,000 from offense. If he then withdraws $50,000, he commits a second offense. If he then purchases a car with the withdrawn $50,000, he commits a third offense. Each transaction should be charged in a separate count.
Because the sale of marijuana at the Federal level is an unlawful activity that could trigger application of this Statute, it is important for marijuana-related businesses to have legal counsel in place to set up proper reporting systems so as not to be afoul of this law.
Avoiding Tax Pitfalls
The Sixteenth Amendment of the U.S. Constitution prohibits the Federal government from taxing “gross receipts”. While I.R.C. §280E disallows marijuana-related businesses to deduct “ordinary and necessary” business expenses, it would be unconstitutional for the IRS to disallow businesses to deduct Cost Of Goods Sold when calculating gross income. This concept was first applied in the Tax Court case of Olive vs. Commissioner Of Internal Revenue, 139 T.C. 19 (2012).
Check out the following example of a marijuana-related business with monthly gross receipts of $100,000 ($1,200,000 annually):
With No Tax Planning
With Tax Planning
|Cost Of Goods Sold
|Taxes at 35% on Gross Profit
|Ordinary And Necessary Business Expenses
|Your Net Profit
You can see how important it is that the business be able to capitalize as much of these expenses into inventory which will show a higher Cost Of Goods Sold and hence lower taxes which equates to higher profits. Of course the IRS will see things differently as they typically do in any audit.
What Should You Do?
California may well be a cannabis-friendly state, but it is still possible to face a criminal prosecution at the Federal level and given the uncertainty regarding federal limitations and complex compliance regulations so it is critical to have the proper legal counsel. Having access to a Board Certified Tax Attorney-CPA with more than 29 years of experience in advising businesses in tax compliance and planning, accounting systems and cash management can help you meet your challenges minimizing your taxes and conduct business in a manner that avoids prosecution by the Federal authorities and meets California laws regulations. Don’t delay call us today!