cannabis business banking law

Federal Cannabis Banking Bill Moving Through Congress – If You Can’t Beat Them, Then Join Them!

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Under Federal law (Controlled Substances Act 21 U.S.C. 801) marijuana is designated as a Schedule I controlled substance due to the historical belief that it has a high potential for abuse, no currently accepted medical use in treatment, and lack of accepted safety for use under medical supervision. This status has prompted banks to prevent and block banking access to legal cannabis businesses.

Secure And Fair Enforcement (SAFE) Banking Act – HR 1595

The Secure And Fair Enforcement Banking Act (the “SAFE Banking Act”) was introduced just less than two weeks ago by Representatives Ed Perlmutter (D-CO), Denny Heck (D-WA), Steve Stivers (R-OH) and Warren Davidson (R-OH). The SAFE Banking Act would prevent federal banking regulators from punishing banks for working with cannabis related businesses that are obeying state laws or halting their services, taking action on loans made to those businesses, or limiting a depository institution’s access to the Deposit Insurance Fund. The SAFE Banking Act would also protect ancillary businesses that work with the cannabis industry from being charged with money laundering and other financial crimes, and requires the Financial Institution Examination Council to develop guidance to help credit unions and banks understand how to lawfully serve cannabis businesses.

On March 28, 2019, the House Financial Services Committee approved an updated version of the SAFE Banking Act, which would provide safe harbor and guidance to financial institutions that wish to work with legal cannabis businesses. The vote was 45-15 in support of cannabis banking which supporters included 11 Republicans. Now, the legislation will go back to the House for further consideration and should be approved for a full floor vote. It will then move on to the Senate for consideration. Stay tuned for further developments.

While this development is favorable for cannabis business, the enactment of the SAFE Banking Act into law will not solve all the problems and challenges of legal cannabis businesses.

Higher Taxes Still Remain

It still remains to be seen when favorable changes will be made to the Internal Revenue Code which treats businesses in the marijuana industry differently resulting in such business paying at least 3-times as much in taxes as ordinary businesses.

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.

Reporting Of Cash Payments Still Remain

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 totaling 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.

How Do You Know Which Cannabis Tax Attorney Is Best For You?

Given that cannabis is still illegal under existing Federal law and the enactment of the SAFE Banking Act will not solve all your problems you need to protect yourself and your marijuana business from all challenges created by the U.S. government.  While cannabis is legal in California, that is not enough to protect you.  It’s coming down that the biggest risk is TAXES.  Be proactive and engage an experienced Cannabis Tax Attorney in your area. Let the tax attorneys of the Law Offices Of Jeffrey B. Kahn, P.C. located in Orange County, Inland Empire (Ontario and Palm Springs) and other California locations protect you and maximize your net profits.

Marijuana Businesses Substantiate To IRS Expenses Paid In Cash Are Your Cash expenses tax deductible?

How Do Marijuana Businesses Substantiate To IRS Expenses Paid In Cash?

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It is outrageous that the $6.7 billion U.S. cannabis industry is forced by disparities in state and federal law to conduct nearly all transactions in cash.  Experts believe that by 2021 the cannabis industry is expected to balloon to $21 billion.  The lack of banking opportunities for marijuana business and being forced to deal in cash creates challenges for these business to not only manage the cash but how to substantiate expenses paid in the event the business is select for audit by the IRS.

Yes – Marijuana Businesses Have to Report Income To IRS And Pay Taxes!

Legal marijuana businesses have to pay taxes under I.R.C. §280E, the same category reserved for illegal drug traffickers. Cannabis is categorized as a Schedule I substance under the Controlled Substances Act. While more than half of the states in the U.S. have legalized some form of medicinal marijuana, and several others have passed laws permitting recreational cannabis use, under federal drug laws the sale of cannabis remains illegal.

Supporting Business Documents

In any typical business, purchases, sales, payroll, and other transactions will generate supporting documents. Supporting documents include sales slips, paid bills, invoices, receipts, deposit slips, and canceled checks. These documents contain the information you need to record in your books. It is important to keep these documents because they support the entries in your books and on your tax return. Keeping them in an orderly fashion and in a safe place will assure that if the time should come that you are selected for an IRS audit, you will be able to produce them and preserve the deductions claims.

Proof of Payments

Proving deductions to the IRS is a two-step process:

First, you must substantiate that you actually paid the expense you are claiming.

Second, you must prove that an expense is actually tax deductible.

So what do you do when your marijuana business operates in a cash environment without using any bank accounts?

Step One: Incurred And Paid The Expense

For example, if you claim a $5,000.00purchase expense from a marijuana distributor, offering a copy of a bill or an invoice from the distributor (if one is even provided) is not enough. It only proves that you owe the money, not that you actually made good on paying the bill. The IRS accepts canceled checks, bank statements and credit card statements as proof of payment. But when such bills are paid in cash as it typical in a marijuana business, you would not have any of these supporting documents but the IRS may accept the equivalent in electronic form.

That is where it becomes essential that an accounting system be developedearly on to track these transactions.

Step Two: Deductibility Of The Expense

Next you must prove that an expense is actually tax deductible. For marijuana businesses this is challenging because I.R.C. §280E states: “No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances (within the meaning of Schedules I and II of the Controlled Substances Act, 21 U.S.C §812) which is prohibited by federal law or the law of any state in which such trade or business is conducted.”

In reading I.R.C. §280E one would think that no deductions are allowed in a marijuana-related business but if that were the case, the U.S. Tax Court has stated that this statute would have been stricken as unconstitutional as the Sixteenth Amendment to the U.S. Constitution prohibits the Federal government from taxing “gross receipts”. Reading vs. Commissioner Of Internal Revenue, 70 T.C. 730 (1978). So the way I.R.C. §280E operates is to allow marijuana-related businesses to deduct Costs Of Good Sold but not “ordinary and necessary” business expenses. This tax treatment prevails regardless that you are conducting a marijuana business that is duly licensed in a State that has legalized marijuana because such business is still illegal under federal law.

It should be apparent that the cost of acquiring the marijuana itself is part of Costs Of Good Sold but what if you produce the marijuana? We advocate that producers can also capitalize the direct material costs (marijuana seeds or plants), direct labor costs (planting, cultivating, harvesting and sorting), and certain indirect costs that include repairs, maintenance, utilities, rent, taxes, depreciation, employee benefits and officer’s salaries). Resellers too should consider a more expansive view of Cost Of Goods Sold that includes capitalizing the costs of transportation and other necessary charges incurred in acquiring possession of the marijuana and maintaining the inventory for resale.

That is why it becomes essential that a proper accounting system be developed to capitalize as much of your expenses into inventory in a manner acceptable by the IRS.

Getting The Money To IRS And State Tax Agencies

This same lack of access to a traditional banking infrastructure making it difficult for cannabis companies to establish exactly the kind of fiscal paper trail that the IRS and state tax agencies could use to help enforce tax compliance also creates a problem as to how to pay the taxes due to IRS and state tax agencies.  Keep in mind that this problem is just not a once a year event, it goes on all year – you have to remit your payroll taxes quarterly, your excise taxes are collected monthly. With all the cash to keep track of, the record keeping involved and the security of string and transporting funds, it is crucial that a proper cash management and accounting system be established and maintained.

What Should You Do?

Don’t wait to be selected for an IRS audit.  Be proactive and implement the proper cash management and accounting systems now.  Marijuana businesses who hire an experienced attorney-CPA should benefit in paying the least amount of tax under the tax code and if audited, the least audit adjustments and avoiding costly litigation. Let the tax attorneys of the Law Offices Of Jeffrey B. Kahn, P.C. located in Orange County, San Jose and other California locations maximize your net profits and get you the best possible result.