When Facing An IRS Tax Audit, How Do Marijuana Businesses Explain To IRS A Cash Stash Accumulated From The Past?

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With the proliferation of licensed cannabis businesses sprouting in the State Of California and a growing number of States, a lot of cannabis business will be filing tax returns with the IRS for the first time. But beware, the IRS is well aware that successful cannabis businesses don’t just sprout overnight and now that your business is on the radar screen you can bet that the IRS will be inquiring how you accumulated all that cash before 2020. We refer to this accumulation of cash as “legacy cash”.

The Internal Revenue Service released updated guidance on tax policy for the cannabis industry.  The new guidance briefly covers the rules for income reporting, cash payment options, estimating tax payments and keeping financial records.

The IRS guidance states “A key component in promoting the highest degree of voluntary compliance on the part of taxpayers is helping them understand and meet their tax responsibilities while also enforcing the law with integrity and fairness to all.”

This update appears to be in response to a Treasury Department report that was released in April 2020 where the Treasury Department’s Inspector General For Tax Administration had criticized IRS for failing to adequately advise taxpayers in the marijuana industry about compliance with federal tax laws. And it directed the agency to “develop and publicize guidance specific to the marijuana industry.”

Legacy Cash Is A Big Problem For Successful Cannabis Businesses

In the early days of cannabis operations, the biggest issue was what to do with all the cash? Cash is bulky and risky, but you have to do something with it and cannabis entrepreneurs can’t just take it to their local bank and make a deposit like every other kind of business can. So what have cannabis entrepreneurs been doing for all these years? For the most part they are keep the cash and where that income was never reported on prior tax returns, they now run the risk of being caught by IRS and prosecuted for tax evasion.

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

While the sale of cannabis is legal in California as well as in a growing number of states, cannabis remains a Schedule 1 narcotic under Federal law, the Controlled Substances Act. As such businesses in the cannabis industry are not treated like ordinary businesses. Despite state laws allowing cannabis, it remains illegal on a federal level but cannabis businesses are obligated to pay federal income tax on income because I.R.C. §61(a) does not differentiate between income derived from legal sources and income derived from illegal sources.

The Sixteenth Amendment of the U.S. Constitution prohibits the Federal government from taxing “gross receipts”. In Edmondson vs. Commissioner, 42 T.C.M. (CCH) 1533 (T.C. 1981), the Tax Court decided that Jeffrey Edmonson, self-employed in the trade or business of selling amphetamines, cocaine, and cannabis, was permitted to deduct his business expenses resulting from his trade. Discomforted by this outcome, the following year Congress enacted I.R.C. §280E, disallowing all deductions and credits for amounts paid or incurred in the illegal trafficking in drugs listed in the Controlled Substances Act.

Under I.R.C. §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. Cannabis, including medical cannabis, is a controlled substance. While I.R.C. §280E disallows cannabis-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).

I.R.C. Section 280E IRS Tax Audits

It is no surprise that cannabis businesses are proliferating as more States legalize cannabis and make available licenses to grow, manufacture, distribute and sell cannabis. The IRS recognizes this and it is making these cannabis businesses face Federal income tax audits. IRC §280E is at the forefront of all IRS cannabis tax audits and enforcement of §280E could result in unbearable tax liabilities.

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.

Step One: Incurred And Paid The Expense.

For example, if you claim a $5,000 purchase expense from a cannabis 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 cannabis business, you would not have any of these supporting documents but the IRS may accept the equivalent in electronic form.

Step Two: Deductibility Of The Expense.

Next you must prove that an expense is actually tax deductible. For a cannabis businesses this is challenging because of the I.R.C. §280E limitation; however a cannabis business can still deduct its Cost Of Goods Sold (“COGS”). Cost of goods sold are the direct costs attributable to the production of goods.

For a cannabis reseller this includes the cost of cannabis itself and transportation used in acquiring cannabis. To the extent greater costs of doing business can be legitimately included in COGS that will that result in lower taxable income. You can be sure the IRS agents in audits will be looking closely at what is included in COGS.

Appealing An I.R.C. Section 280E IRS Tax Audit

Now if your cannabis IRS tax audit is not resolved, the results may be challenged. After the Revenue Agent has concluded the tax examination, the agent will issue a copy of the examination report explaining the agent’s proposed changes along with notice of your appeals rights. Pay attention to the type of letter that is included as it will dictate the appeals process available to you.

The “30-day letter”

The “30-day letter” gives you the right to challenge the proposed adjustment in the IRS Office Of Appeals. To do this, you need to file a Tax Protest within 30 days of the date of the notice. The Appeals Office is the only level of appeal within the IRS and is separate from and independent of the IRS office taking the action you disagree with. Conferences with Appeals Office personnel are held in an informal manner by correspondence, by telephone, or at a personal conference.

The “Notice Of Deficiency”

If the IRS does not adopt your position, it will send a notice proposing a tax adjustment (known as a statutory notice of deficiency). The statutory notice of deficiency gives you the right to challenge the proposed adjustment in the United States Tax Court before paying it. To do this, you need to file a petition within 90 days of the date of the notice (150 days if the notice is addressed to you outside the United States). If you filed your petition on time, the court will eventually schedule your case for trial at the designation place of trial you set forth in your petition. Prior to trial you should have the opportunity to seek a settlement with IRS Area Counsel and in certain cases, such settlement negotiations could be delegated to the IRS Office Of Appeals. If there is still disagreement and the case does go to trial, you will have the opportunity to present your case before a Tax Court judge. The judge after hearing your case and reviewing the record and any post-trial briefs will render a decision in the form of an Opinion. It could take as much as two years after trial before an Opinion issued. If the Opinion is not appealed to a Circuit Court Of Appeals, then the proposed deficiency under the Opinion is final and your account will be sent to IRS Collections.

IRS Area Counsel are experienced trial attorneys working for the IRS whose job is to litigate cases in the U.S. Tax Court and look out for the best interests of the Federal government. So to level the playing field, it would be prudent for a taxpayer to hire qualified tax counsel as soon as possible to seek a mutually acceptable resolution without the need for trial, and if that does not happen, to already have the legal expertise in place to vigorously defend you at trial.

What Should You Do?

While more States are legalizing cannabis, risks to the cannabis industry still exist. Considering the risks of cannabis you need to protect yourself and your investment. Level the playing field and gain the upper hand by engaging the cannabis tax attorneys at the Law Offices Of Jeffrey B. Kahn, P.C. located in Orange County (Irvine), the Inland Empire (including Ontario and Palm Springs) and other California locations. We can come up with solutions and strategies to these risks and protect you and your business to maximize your net profits. And if you are involved in crypto currency, check out what a bitcoin tax attorney can do for you.

cannabis business banking law

Getting Harder For Legal Cannabis To Find Banking.

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Even though more and more states are allowing the sale of cannabis at the medical and/or recreational level, it is still a business that deals essentially in cash only. Why? Because most traditional banks refuse to deal with any cannabis businesses.  This forces cannabis businesses to seek alternative financial institutions, smaller banks and credit unions that are willing to work with cannabis businesses so that these businesses can pay their expenses and even taxes in a manner more safe and secure than delivering stacks of $20 bills.

Five states (Arizona, Mississippi, Montana, New Jersey and South Dakota) on November 3, 2020 passed new medical or recreational cannabis laws.  South Dakota voters adopted legalization of both medical and recreational cannabis.  Arizona, Montana and New Jersey voters adopted expansion of cannabis legalization to recreational use.  Mississippi voters adopted legalization of medical cannabis use.  This adds to an existing group of 11 states and Washington, D.C. that have legalized recreational cannabis, and adds to an existing group of 33 states that have legalized it for medical purposes.

Nevertheless, cannabis companies still operate in a legal grey area because cannabis remains illegal under Federal law. Federal law classifies cannabis as a Schedule 1 drug, meaning it has “currently no accepted medical use”. Treating cannabis no differently than heroin, the Federal government has entrusted the Treasury Department with the authority and responsibility to monitor bank activity to make sure that activities which are illegal under Federal law are not utilizing the banking channels and functions that are normally available.

Financial Crimes Enforcement Network (“FinCEN”)

FinCEN is a bureau of the U.S. Department of the Treasury. The Director of FinCEN is appointed by the Secretary of the Treasury and reports to the Treasury Under-Secretary for Terrorism and Financial Intelligence. FinCEN’s mission is to safeguard the financial system from illicit use and combat money laundering and promote national security through the collection, analysis, and dissemination of financial intelligence and strategic use of financial authorities.

FinCEN carries out its mission by receiving and maintaining financial transactions data; analyzing and disseminating that data for law enforcement purposes; and building global cooperation with counterpart organizations in other countries and with international bodies.

FinCEN exercises regulatory functions primarily under the Currency and Financial Transactions Reporting Act of 1970, as amended by Title III of the USA PATRIOT Act of 2001. Under this authority the Secretary of the Treasury is to issue regulations requiring banks and other financial institutions to take a number of precautions against financial crime, including the establishment of AML programs and the filing of reports that have been determined to have a high degree of usefulness in criminal, tax, and regulatory investigations and proceedings, and certain intelligence and counter-terrorism matters. This authority has been delegated to FinCEN.

The basic concept underlying FinCEN’s core activities is “follow the money.” As FinCEN believes that the primary motive of criminals is financial gain, and they leave financial trails as they try to launder the proceeds of crimes or attempt to spend their ill-gotten profits. FinCEN shares the information it receives and analyzes with other law enforcement agencies to investigate and hold accountable a broad range of criminals, including perpetrators of fraud, tax evaders, and narcotics traffickers. More recently, the techniques used to follow money trails also have been applied to investigating and disrupting terrorist groups, which often depend on financial and other support networks.

Reporting Of Cash Payments

The Bank Secrecy Act (“BSA”) enacted in 1970 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.

Cannabis-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. 

Why Banks Are Reluctant To Deal With Cannabis Businesses

Under the Obama administration, then-Deputy Attorney General James Cole issued a memo, known as the Cole Memorandum that clarified the Justice Department’s stance on cannabis. The memo, from August 29, 2013, asserted that, for the most part, the Justice Department would not enforce the cannabis ban in states that had legalized it. Following that spirit, on February 14, 2014 the Treasury Department issued its own guidance through FinCEN on how banks could provide services to the cannabis industry without violating Federal Law.  As long as banks complied with this guidance, they could avoid the threat of federal prosecution and make themselves available to provide banking and financial services to cannabis businesses.

But under the Trump administration, the Justice Department led by former Attorney General Jeff Sessions rescinded the Cole memo, calling marijuana “a dangerous drug” and asserting that “marijuana activity is a serious crime”. The Treasury Department led by Treasury Secretary Steve Mnuchin has yet to revoke the FinCEN guidance which although that guidance referenced the Cole memo multiple times, the guidance still remains a part of the framework by which banks and other financial institutions can make themselves available to do business with the cannabis industry.

Today’s Banking Challenge

Despite more states legalizing cannabis, a tiny fraction of banks and alternative financial institutions are willing to work with cannabis companies.  As of September 30, 2020 FinCEN issued a report stating that there were 677 banks and credit unions that filed reports saying they were working with cannabis clients.  Unfortunately this number is down from 695 in the last fiscal quarter ending in June and 711 for the quarter preceding that.

What Should You Do?

It is best to be proactive and engage an experienced board certified tax attorney-CPA in your area who is highly skilled in the different legal, banking and tax issues that cannabis businesses face.  Let the cannabis tax attorneys of the Law Offices of Jeffrey B. Kahn, P.C. located in Orange County (Irvine), the Inland Empire (including Ontario and Palm Springs) and other California locations protect you and maximize your net profits.  Also, if you are involved in crypto currency, check out what a bitcoin tax attorney can do for you.

 

Federal Court Of Appeals Rules That Cannabis Is Just Like Any Other Industry Subject To IRS Audits

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On October 20, 2020, the U.S. Court of Appeals for the 10th Circuit issued its opinion ruling against a group of Colorado cannabis dispensaries and their affiliates that includes The Green Solution Retail Inc., The Green Solution LLC, Infuzionz, LLC, Green Earth Wellness Inc., TGS Management LLC, S-Type Armored LLC, IVXX Infuzionz LLC, Medicinal Wellness Center LLC, Medicinal Oasis LLC, and other individuals who together and separately brought lawsuits challenging IRS examination action instituted against them.

The IRS has been targeting cannabis businesses for audits and these taxpayers were looking to show that these audits should not proceed by making the following arguments:  (1) that the IRS investigation is quasi-criminal, exceeds the Agency’s authority, and is being conducted for an illegitimate purpose; (2) that even if the investigation had a legitimate purpose, the information sought is irrelevant; and (3) that the investigation is in bad faith and constitutes an abuse of process because (a) the IRS may share the information collected with federal law enforcement agents, (b) the IRS summonses are overly broad and require the creation of new reports, (c) the dispensaries have a reasonable expectation of privacy in the data they tender to state regulatory authorities, and (d) those state authorities cannot provide the requested information without violating Colorado law.

The Court which has jurisdiction over Colorado is familiar with these arguments as over the last several years, multiple Colorado cannabis dispensaries have challenged the IRS’s ability to investigate and impose tax consequences upon them.  The Court’s ruling was completely in favor of the IRS as the Court struck down each of the plaintiffs’ arguments especially noting that plaintiffs failed to show any evidence contradicting the IRS’ rationale for investigating, and noted that the agency had so far not made any recommendations for prosecution.

IRS Releases Tax Guidance For The Cannabis Industry

The Internal Revenue Service released updated guidance on tax policy for the cannabis industry.  The new guidance briefly covers the rules for income reporting, cash payment options, estimating tax payments and keeping financial records.

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.  Although cannabis remains federally illegal, taxpayers in this business activity must still report this income and still have an obligation to pay taxes and properly report transactions.

The IRS guidance states “A key component in promoting the highest degree of voluntary compliance on the part of taxpayers is helping them understand and meet their tax responsibilities while also enforcing the law with integrity and fairness to all.”

This update appears to be in response to a Treasury Department report that was released in April 2020 where the Treasury Department’s Inspector General For Tax Administration had criticized IRS for failing to adequately advise taxpayers in the marijuana industry about compliance with federal tax laws. And it directed the agency to “develop and publicize guidance specific to the marijuana industry.”

Cannabis Businesses Face Higher Taxes

A topic of interest to the cannabis industry is that it is largely deprived of tax benefits extended to businesses in other industries. 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.

  • 280E does not, however, prohibit a participant in the marijuana industry from reducing its gross receipts by its properly calculated cost of goods sold to determine its gross income. The IRS guidance acknowledges that “taxpayers who sell marijuana may reduce their gross receipts by the cost of acquiring or producing marijuana that they sell, and those costs will depend on the nature of the business.” However, the guidance affirms that “a marijuana dispensary may not deduct, for example, advertising or selling expenses. It may, however, reduce its gross receipts by its cost of goods sold, as calculated pursuant to Internal Revenue Code section 471.”

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.

Cannabis Businesses Face 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 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 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.  So it is best to be proactive and engage an experienced cannabis tax attorney in your area who is highly skilled in the different legal and tax issues that cannabis businesses face.  Let the cannabis tax attorneys of the Law Offices Of Jeffrey B. Kahn, P.C. located in Orange County (Irvine), Northern California (San Francisco Bay Area and Sacramento) and other California locations protect you and maximize your net profits.  And if you are involved in crypto currency, check out what a bitcoin tax attorney can do for you.

 

Election 2020: The Results Are In And Cannabis Is Declared The Winner!

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On November 3, 2020, voters in five states (Arizona, Mississippi, Montana, New Jersey and South Dakota) passed new medical or recreational cannabis laws.  South Dakota voters adopted legalization of both medical and recreational cannabis.  Arizona, Montana and New Jersey voters adopted expansion of cannabis legalization to recreational use.  Mississippi voters adopted legalization of medical cannabis use.

These Measures Add To The Growing Trend In Legalizing Cannabis Across The United States.

Medical marijuana is legal in 33 states.

The medical use of cannabis is legal (with a doctor’s recommendation) in 33 states and Washington DC. Those 33 states being Alaska, Arizona, Arkansas, California, Colorado, Connecticut, Delaware, Florida, Hawaii, Illinois, Maine, Louisiana, Maryland, Massachusetts, Michigan, Minnesota, Missouri, Montana, Nevada, New Hampshire, New Jersey, New Mexico, New York, North Dakota, Ohio, Oklahoma, Oregon, Pennsylvania, Rhode Island, Utah, Vermont, Washington and West Virginia. The medical use of cannabis is also legal in the territories of the Northern Mariana Islands, Guam and Puerto Rico.

Recreational marijuana is legal in 11 states.

Eleven states and Washington DC, have legalized marijuana for recreational use — no doctor’s letter required — for adults over the age of 21. Those eleven states being Alaska, California, Colorado, Illinois, Maine, Massachusetts, Michigan, Nevada, Oregon, Vermont and Washington and the territory of Guam.

Conflict With Federal Law.

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.

Higher Taxes Still Remain

While the developments listed above are favorable for cannabis business, it still remains to be seen whether the Federal government will respond favorably and 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 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.  So it is best to be proactive and engage an experienced cannabis tax attorney in your area who is highly skilled in the different legal and tax issues that cannabis businesses face.  Let the cannabis tax attorneys of the Law Offices Of Jeffrey B. Kahn, P.C. located in Orange County (Irvine), the Inland Empire (Ontario and Palm Springs) and other California locations protect you and maximize your net profits.  And if you are involved in crypto currency, check out what a bitcoin tax attorney can do for you.

Inyo County Sheriff’s Department Shuts Down Massive Illegal Cannabis Farms Located In The California Wilderness

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Anyone conducting business in cannabis surely knows that 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. So the risk is apparent that at any time Federal authorities could come and shut you down but don’t think that just because cannabis is legal in California, you do not have to worry about the State.

California law mandates that you can only sell cannabis if you have obtained a license to do so. These licenses being issued by the BCC. If you don’t have a license, then selling cannabis or transporting it in order to sell it is still a crime under H&S Code §11360.

Illegal Cannabis Growing Sites in Inyo County

The Inyo County Sheriff’s Office in Bishop, California announced in a news release on August 20, 2020 that on three separate days (July 24, August 18, and August 19) the Inyo County Sheriff’s Department with assistance from the Drug Enforcement Agency (DEA), U.S. Air Force National Guard Unit, U.S. Forest Service, Bureau of Land Management (BLM), California Department of Fish and Wildlife and the California Department of Justice (DOJ) CAMP Team No. 3 and 4, eradicated 42,306 illegal marijuana plants from three locations off public lands within Inyo County. Authorities estimate the street value to be between $84,612,000 and $169,224,000.

Inyo County is southeast of Yosemite National Park and home to the Owens River Valley. Spanning 10,192 square miles, it is California’s second largest county, after San Bernardino County. About half of that average is within Death Valley National Park.

The Sheriff’s Office stated that cannabis cultivation can cause extreme damage to ecosystems. As part of the illegal cultivation process, growers are responsible for using miles of plastic tubing and diverting water from natural sources for crop irrigation. The use of banned herbicides and pesticides is also common practice. Additionally, cannabis cultivation sites often contain large amounts of trash and create fire hazards in wildland areas. Reclamation will be conducted through BLM and U.S. Forest Service.

Law enforcement officers continue to investigate the grow site. No arrests have been made at this time.

Statewide Commitment To Enforcement

In a previous blog we wrote about Governor Gavin Newsom’s promise made in February 2019 to deploy the California National Guard against marijuana grows in California. Multijurisdictional task forces have long been deployed against marijuana grows in California as we noted in the following blogs:

  • Click here on a raid that occurred in Riverside County.
  • Click here on a raid that occurred in Kern County
  • Click here on a raid that occurred in the City of Santa Rosa in Sonoma County.
  • Click here on a raid that occurred in the City of Carpinteria in Santa Barbara County.
  • Click here on a raid that occurred in Riverside County.
  • Click here on a raid that occurred in the City of Buellton.

Penalties For Selling Cannabis Without A License.

For most defendants, unlicensed sale or transport for sale of cannabis is a misdemeanor punishable by up to six months in county jail and/or a fine of up to $1,000. For defendants under 18, it is an infraction. Also, giving away or transporting for sale up to 28.5 grams of cannabis without a license is an infraction.

But the sale/transport for sale of cannabis without a license to do so is a felony for the following defendants:

  1. Defendants who have a prior conviction for one of a list of particularly serious violent felonies, including murder, sexually violent offenses, sex crimes against a child under 14, or gross vehicular manslaughter while intoxicated, or a sex crime that requires them to register as a sex offender;
  2. Defendants who have two or more prior convictions for H&S Code §11360 sale/transportation of cannabis;
  3. Defendants who knowingly sold, attempted to sell, or offered to sell or furnish cannabis to someone under 18; or
  4. Defendants who imported or attempted or offered to import into California, or transported or attempted/offered to transport out of California for sale, more than 28.5 grams of cannabis or more than four grams of concentrated cannabis.

In any of these scenarios, black market sale or transportation for sale of cannabis under H&S Code §11360 is punishable anywhere from two to four years in jail.

Transporting cannabis without intent to sell it, or giving cannabis away, is not a crime in California so long as BOTH of the following are true:

  1. You transport or give away not more than 28.5 grams of cannabis or eight grams of concentrated cannabis, and
  2. Any people you give cannabis to are 21 years of age or older.

What Should You Do?

You can count on other county governments coordinating resources and making comprehensive strikes on unlicensed and illegal cannabis operations for the safety of the public.

Both civil and criminal penalties will apply to unlicensed operators so it is imperative that anyone cultivating, manufacturing or distributing cannabis on a commercial basis in California seeks a local and state license for their operations immediately, if they have not already done so. Protect yourself and your investment by engaging a cannabis tax attorney at the Law Offices Of Jeffrey B. Kahn, P.C. located in Orange County (Irvine), the Inland Empire (including Ontario and Palm Springs) and other California locations. We can come up with tax solutions and strategies and protect you and your business and to maximize your net profits. Also, if you are involved in crypto currency, check out what a bitcoin tax attorney can do for you.

U.S. Appeals Court Rejects California Cannabis Business’ Tax Dispute Due To Mailing Mix-Up

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Two California-based cannabis companies had their petition thrown out of appeals court after it was delivered to court a day late by an unapproved delivery service. Organic Cannabis Foundation and Northern California Small Business Assistants (“NCSB”) were challenging a nearly $2 million combined tax bill at the U.S. 9th Circuit Court of Appeals based in San Francisco.

Appealing I.R.C. §280E Audits

Both Organic Cannabis Foundation and NCSB had been audited by the IRS.  The IRS stated that these businesses are subject to Section 280E which doesn’t allow tax deductions related to cannabis because it is still federally prohibited. According to appellate-court documents, Organic Cannabis Foundation owed $1.1 million in taxes and $225,855 in penalties and NCSB owed $531,707 in taxes and $106,341 in penalties.

When the IRS reaches a final decision in an examination, it will issue a Notice Of Deficiency which starts a 90-day period to file a petition with the U.S. Tax Court to appeal such a decision.  For Organic Cannabis Foundation and NCSB, their petition to the Notice Of Deficiency was due to the U.S. Tax Court in Washington DC on April 22, 2015. According to court records, the petition was delivered via FedEx “First Overnight” at 7:35am April 23, 2015.  Having received the petition one day late, the U.S. Tax Court ruled that the petition for a review of the IRS decision lacked jurisdiction because it came after the petition filing deadline.  The taxpayers appealed this verdict to the U.S. 9th Circuit Court of Appeals; however, the Appeals court upheld the Tax Court’s initial verdict.

The “IRS mailbox rule” states that: “If any return, claim, statement, or other document required to be filed…on or before a prescribed date under authority of any provision of the internal revenue laws is, after…such date, delivered by United States mail to the agency, officer, or office with which such return, claim, statement, or other document is required to be filed,…the date of the United States postmark stamped on the cover in which such return, claim, statement, or other document…is mailed shall be deemed to be the date of delivery…” I.R.C. §7502.

In other words, this IRS mailbox rule confirms that a tax document is timely filed with the IRS even though it is not physically delivered to the IRS in time, as long as it is delivered by an approved delivery service.  Using the U.S. Postal Service at the time was an approved service (and still is).  Although FedEx Priority Overnight and FedEx Standard Overnight were approved by the IRS at that time, court documents state that it wouldn’t be until May 5, 2015, two weeks after the late delivery, that FedEx First Overnight was designated as an approved service.

Since a timely postmark is crucial, filing a petition in the U.S. Tax Court by certified or registered mail with the U.S. Postal Service can provide taxpayers with assurance of a timely filing regardless of when the petition is received by the U.S. Tax Court in Washington DC.

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

We previously reported in our blog that the Trump Administration organized a committee of federal agencies from across the government to combat public support for marijuana and cast state legalization measures in a negative light while attempting to portray the drug as a national threat. The IRS appears to be following the agenda of the Trump Administration when it comes to Cannabis and has formed special audit groups that are tasked with conducting cannabis tax audits on medical and recreational cannabis businesses.

While the sale of cannabis is legal in California as well as in a growing number of states, cannabis remains a Schedule 1 narcotic under Federal law, the Controlled Substances Act (“CSA”) 21 U.S.C. § 812. As such businesses in the cannabis industry are not treated like ordinary businesses. Despite state laws allowing cannabis, it remains illegal on a federal level but cannabis businesses are obligated to pay federal income tax on 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

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 I.R.C. §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. Cannabis, including medical marijuana, is a controlled substance. What this means is that dispensaries and other businesses trafficking in cannabis 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.

IRS Guidance On Cannabis.

The IRS issued a memo to provide guidance to its agents on conducting audits of cannabis businesses addressing whether an IRS agent can require a taxpayer trafficking in a Schedule 1 controlled substance to change its tax accounting to conform to I.R.C. §280E.

Not surprisingly that the IRS ruled that IRS agents have the authority to change a cannabis business’ method of accounting so that pursuant to I.R.C. §280E costs which should not be included in inventory are not included in Costs Of Goods Sold (“COGS”) and remain non-deductible for income tax purposes.

Cannabis Tax Audits & Litigation.

It is no surprise that cannabis businesses are proliferating as more States legalize cannabis and make available licenses to grow, manufacture, distribute and sell cannabis. The IRS recognizes this and it is making these cannabis businesses face Federal income tax audits. IRC §280E is at the forefront of all IRS cannabis tax audits and enforcement of §280E could result in unbearable tax liabilities.

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.

Step One: Incurred And Paid The Expense.

For example, if you claim a $5,000 purchase expense from a cannabis 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 cannabis business, you would not have any of these supporting documents but the IRS may accept the equivalent in electronic form.

Step Two: Deductibility Of The Expense.

Next you must prove that an expense is actually tax deductible. For cannabis businesses this is challenging because of the I.R.C. §280E limitation. Recall that under I.R.C. §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. What this means is that dispensaries and other businesses trafficking in cannabis 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 cannabis business can still deduct its Cost Of Goods Sold (“COGS”). Cost of goods sold are the direct costs attributable to the production of goods. For a cannabis reseller this includes the cost of cannabis itself and transportation used in acquiring cannabis. To the extent greater costs of doing business can be legitimately included in COGS that will that result in lower taxable income. You can be sure the IRS agents in audits will be looking closely at what is included in COGS. Working with a cannabis tax attorney can ensure that you receive the proper treatment of COGS versus ordinary and necessary expenses resulting in the lowest possible income tax liability.

In addition to IRS audits, state cannabis audits are also complex and thorough and generally include all taxes specific and nonspecific to the cannabis business. Potentially at risk is the cannabis license that enables the business to operate. State audits will focus on records regarding sales and use tax, excise taxes, and seed-to-sale tracking records.

Now if your cannabis IRS tax audit is not resolved, the results may be challenged and litigated in the U.S. Tax Court or Federal District Court. The U.S. Tax Court has jurisdiction to hear disputes over federal income taxes before final assessment and collections while the Federal District Court generally requires taxpayers to first pay the liability then seek repayment through a refund request.

Tips For Cannabis Tax Return Preparation

Here are some tips for cannabis businesses to follow in the preparation of their 2019 tax returns.

  • Reconcile Your Books Before Closing Your Books. Incomplete books can cause delays and add unnecessary complexities.
  • Utilize A Cannabis Tax Professional. Engage a tax professional who has experience in the cannabis industry. Such a professional would be familiar with the intricacies of IRC Sec. 280E and relevant cases to make the proper presentation on the tax return in a manner that would support the smaller tax liability possible.
  • Justify Your Numbers As If An IRS Audit Is A Certainty. Don’t wait to receive a notice from IRS that the tax return is selected for examination.  That can be one or two years away.  Instead make it a point to put together the backup to you numbers now while everything is fresh. 

What Should You Do?

Ultimately it is the tax risk with IRS that could put any cannabis business “out of business” so you need to protect yourself and your investment. Level the playing field and gain the upper hand by engaging the cannabis tax attorneys at the Law Offices Of Jeffrey B. Kahn, P.C. located in Orange County (Irvine), Northern California (Sacramento and San Francisco) and other California locations. We can come up with tax solutions and strategies and protect you and your business and to maximize your net profits.  Also, if you are involved in crypto-currency, check out what a Bitcoin tax attorney can do for you.

Arizona Electorate Gets Approval To Put On The Ballot A Measure to Legalize Recreational Cannabis – If You Can’t Beat Them, Then Join Them!

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Arizona Secretary of State Katie Hobbs tweeted that her office “has certified the signatures submitted by the Smart and Safe Arizona initiative. After review, the petition exceeded the minimum requirement with approximately 255,080 valid signatures and will be placed on the General Election ballot as Prop. 207.” The campaign had submitted 420,000 signatures to officials in July, they needed 237,645.

Currently only medical marijuana is legal in Arizona.  In 2016, Arizona voters rejected recreational use legalization in the state with 52% of the vote.  Now this November 2020 voters will have the opportunity again to consider this measure.

The U.S. Is Seeing A Growing Trend In Legalizing Cannabis.

Medical marijuana is legal in 33 states.

The medical use of cannabis is legal (with a doctor’s recommendation) in 33 states and Washington DC. Those 33 states being Alaska, Arizona, Arkansas, California, Colorado, Connecticut, Delaware, Florida, Hawaii, Illinois, Maine, Louisiana, Maryland, Massachusetts, Michigan, Minnesota, Missouri, Montana, Nevada, New Hampshire, New Jersey, New Mexico, New York, North Dakota, Ohio, Oklahoma, Oregon, Pennsylvania, Rhode Island, Utah, Vermont, Washington and West Virginia. The medical use of cannabis is also legal in the territories of the Northern Mariana Islands, Guam and Puerto Rico.

Recreational marijuana is legal in 11 states.

Eleven states and Washington DC, have legalized marijuana for recreational use — no doctor’s letter required — for adults over the age of 21. Those ten states being Alaska, California, Colorado, Illinois, Maine, Massachusetts, Michigan, Nevada, Oregon, Vermont and Washington and the territory of Guam.

Conflict With Federal Law

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.

The federal penalties for possession of any amount of marijuana are as follows:

  • First Offense– Misdemeanor involving up to one year of incarceration and $1,000 in fines
  • Second Offense– Misdemeanor punishable by 15 days to 2 years behind bars and $2,500 in fines
  • Third and subsequent offenses– Misdemeanor or felony punishable by 90 days to 3 years of incarceration and fines of up to $5,000.

The penalties for the sale of marijuana depend on the amount of marijuana you have been accused of selling or attempting to sell:

  • Less than 50 kilograms– Felony punishable by up to 5 years in prison and/or up to $250,000 in fines
  • 50 to 99 kilograms– Felony punishable by up to 20 years in prison and/or fines of up to $1,000,000
  • 100 to 999 kilograms– Felony involving 5 to 40 years incarceration and/or fines of up to $2,000,000
  • 1000 kg and up– Felony carrying a sentence of 10 years to life in prison and/or up to $4,000,000 in fines

As for the cultivation of marijuana, the federal authorities punish it on the basis of the number of plants you were caught growing:

  • Less than 50 plants– Felony punishable by up to 5 years in prison and/or up to $250,000 in fines
  • 50 to 99 plants– Felony punishable by up to 20 years in prison and/or up to $1,000,000 in fines
  • 100 to 999 plants– Felony carrying a 5 to 40-year prison sentence and/or fines of up to $5,000,000
  • 1,000 plants or more– Felony involving 10 years to life in prison and/or fines of up to $10,000,000

With aggravating factors such as a trafficking activity that results in an injury or death, a sale within 1,000 feet of a school, or a case involving five grams sold to a minor, the above penalties may increase dramatically.

But until Federal law changes, the cannabis industry will still have to bear the followings risks and challenges:

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 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.  And if you are involved in crypto currency, check out what a bitcoin tax attorney can do for you.

Twelve Illegal Cannabis Retailers Served Tax Warrants in Greater Los Angeles

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The California Department of Tax and Fee Administration (CDTFA) oversees the reporting and collection of taxes for the California cannabis industry.  On July 8, 2020 the CDTFA announced that over the past several weeks twelve illegal cannabis retailers in Los Angeles and San Bernardino counties were served tax warrants with the assistance of the California Highway Patrol (CHP).

The CDTFA seized nearly a million dollars in illegal cannabis products that will be destroyed and approximately one hundred thousand dollars in cash that will be applied to tax liabilities. The investigation was a joint effort between CDTFA investigators and the CHP.  Section 34016 of the California Revenue and Taxation Code (R&T Code) allows such government and policing officials to conduct inspections at any place at which cannabis or cannabis products are sold to purchasers, cultivated, or stored, or at any site where evidence of activities involving evasion of tax may be discovered.

Penalties For Refusing Inspection.

R&T Code Section 34016 provides that any person who fails or refuses to allow an inspection shall be guilty of a misdemeanor. Each offense shall be punished by a fine not to exceed $5,000, or imprisonment not exceeding one year in a county jail, or both the fine and imprisonment.

Additionally, upon discovery by the board or a law enforcement agency that a licensee or any other person possesses, stores, owns, or has made a retail sale of cannabis or cannabis products, without evidence of tax payment or not contained in secure packaging, the board or the law enforcement agency shall be authorized to seize the cannabis or cannabis products.

Lastly, any person who renders a false or fraudulent report is guilty of a misdemeanor and subject to a fine not to exceed $1,000 for each offense, or imprisonment not exceeding one year in a county jail, or both the fine and imprisonment.

Penalties For Selling Cannabis Without A License.

All commercial cannabis activity in California must be conducted on a premises with a valid license issued by the appropriate state cannabis licensing authority. Manufacturing, distributing or selling cannabis goods without a state license or at a location that is not licensed is a violation of state law.

For most defendants, unlicensed sale or transport for sale of cannabis is a misdemeanor punishable by up to six months in county jail and/or a fine of up to $1,000. For defendants under 18, it is an infraction. Also, giving away or transporting for sale up to 28.5 grams of cannabis without a license is an infraction.

But the sale/transport for sale of cannabis without a license to do so is a felony for the following defendants:

  1. Defendants who have a prior conviction for one of a list of particularly serious violent felonies, including murder, sexually violent offenses, sex crimes against a child under 14, or gross vehicular manslaughter while intoxicated, or a sex crime that requires them to register as a sex offender;
  2. Defendants who have two or more prior convictions for H&S Code §11360 sale/transportation of cannabis;
  3. Defendants who knowingly sold, attempted to sell, or offered to sell or furnish cannabis to someone under 18; or
  4. Defendants who imported or attempted or offered to import into California, or transported or attempted/offered to transport out of California for sale, more than 28.5 grams of cannabis or more than four grams of concentrated cannabis.

In any of these scenarios, black market sale or transportation for sale of cannabis under H&S Code §11360 is punishable anywhere from two to four years in jail.

Transporting cannabis without intent to sell it, or giving cannabis away, is not a crime in California so long as BOTH of the following are true:

  1. You transport or give away not more than 28.5 grams of cannabis or eight grams of concentrated cannabis, and
  2. Any people you give cannabis to are 21 years of age or older.

How This Impacts The Black Market

The CDTFA Investigations Bureau administers the tax enforcement and criminal investigations program. The Bureau plans, organizes, directs, and controls all criminal investigative activities for the various tax programs administered by the CDTFA. Its goals are to deter tax evasion, identify new tax fraud schemes, and actively investigate and assist in the prosecution of crimes committed by individuals violating the laws administered by the CDTFA.

Any person who willfully evades or attempts to evade the reporting, assessment or payment of the cultivation tax, the cannabis excise tax, or the sales tax that would otherwise be due is guilty of cannabis and sales tax evasion and violators are subject to fines and/or jail time.

CDTFA Director Nick Maduro states that “The CDTFA’s collaboration with the CHP is an important deterrent to tax evasion”.  He further states that “Tax evasion unfairly shifts the burden onto all other taxpayers and makes it tough for those businesses that are playing by the rules to survive.” It should be clear that with the State taking such enforcement action against illegal cannabis operators, the State is hoping to eradicate non-compliant operators.

What Should You Do?

Both civil and criminal penalties will apply to unlicensed operators so it is imperative that anyone cultivating, manufacturing or distributing cannabis on a commercial basis in California seeks a local and state license for their operations immediately, if they have not already done so. Protect yourself and your investment by engaging a cannabis tax attorney at the Law Offices Of Jeffrey B. Kahn, P.C. located in Orange County (Irvine), the Los Angeles Metro Area and other California locations. We can come up with tax solutions and strategies and protect you and your business and to maximize your net profits. Also, if you are involved in crypto currency, check out what a bitcoin tax attorney can do for you.

How To Handle Losses Due to Theft To Reduce California Cannabis Taxes and Sales & Use Tax

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With the recent wave of break-ins and robberies to local dispensaries in particular, cannabis business should not overlook this opportunity to save taxes.

Cannabis Excise Tax for Cannabis Retailers

As a cannabis retailer, you are required to pay the cannabis excise tax (15%) to your distributor based on the average market price of the cannabis or the cannabis products sold or transferred to you. However, if you already paid the cannabis excise tax to your distributor and the associated cannabis or cannabis products were subsequently stolen from you, you may request a refund of the tax from your distributor, and provide your distributor with documentation substantiating the theft. Examples of documentation include, but are not limited to, police reports, insurance claims, etc. (see additional information below). When a refund is issued to you, your distributor is required to provide you with a receipt that indicates the amount of cannabis excise tax refunded.

Cannabis Excise Tax for Distributors

As a distributor, you are required to collect the cannabis excise tax from cannabis retailers that you supply with cannabis or cannabis products. The cannabis excise tax does not apply to cannabis or cannabis products that you sell or transfer to a cannabis retailer that is subsequently stolen from the retailer. When a theft of cannabis or cannabis products from a retailer occurs, and the cannabis excise tax was already paid to you, the retailer can request a refund from you for the cannabis excise tax paid to you. For your records, and for any claim for refund you may file, you should obtain documentation from the cannabis retailer that supports the theft. You are required to provide the cannabis retailer with a receipt or similar documentation that indicates the amount of the cannabis excise tax returned to the retailer.

For cannabis excise tax that you already reported and paid to the California Department of Tax and Fee Administration (CDTFA), and subsequently returned to the cannabis retailer due to theft, you may report the amount returned on your next cannabis tax return, on the line labeled “Less excess excise tax collected, if any”. Alternatively, you may submit a CDTFA-101, Claim for Refund, for the excess cannabis excise tax you paid to the CDTFA and later returned to the cannabis retailer. You will need to provide the supporting documentation of the loss that the retailer provided to you.

Cultivation Tax for Distributors

The cultivation tax is due on cannabis that enters the commercial market (that is, it passes the required testing and quality assurance review) even if the cannabis is subsequently lost due to theft. However, the cultivation tax is not due on cannabis stolen before the cannabis entered the commercial market. If you collected the cultivation tax on cannabis that never entered the commercial market, you are required to return the cultivation tax to the originating cultivator. If the cultivation tax cannot be returned to the cultivator, you must report and pay the cultivation tax to the CDTFA.

Sales and Use Tax

You are required to pay sales tax on all taxable sales despite the theft of cash. Losses of merchandise due to theft are not deductible for sales and use tax purposes (as no sale occurred). However, since the loss of merchandise from theft may affect your cost of goods sold, you should maintain documentation in case of an audit.

Documentation

Proper documentation must be kept to support any losses due to theft. Acceptable forms of documentation for sales and use tax, cannabis excise tax, and cultivation tax may include police reports, insurance claims, and/or reports from private investigating agencies. Cannabis inventory losses should be recorded in the California Cannabis Track-and-Trace (CCTT) system.

No Relief For Losses Due To Theft Of Cash

Although the CDTFA is allowing for reimbursements to Distributors for refunds to retailers and operators related to stolen cannabis products, the CDTFA has specifically stated that there is no exemption or deduction of the cannabis excise tax for the loss of proceeds due to theft of cash.  Arguably, under certain circumstances such theft loss should still be available to take for Federal & State income taxes.

What Should You Do?

Start your marijuana business on the right track.  Protect yourself and your investment by engaging the cannabis tax attorneys at the Law Offices Of Jeffrey B. Kahn, P.C. located in Orange County (Irvine), Los Angeles County and other California locations. We can come up with tax solutions and strategies and protect you and your business and to maximize your net profits. Also, if you are involved in crypto currency, check out what a bitcoin tax attorney can do for you.

 

Why Taxpayers Involved In Offshore Accounts, Crypto Currency Or Cannabis Should Be Filing An Extension For Their 2019 Income Tax Returns

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Why Taxpayers Involved In Offshore Accounts, Crypto Currency Or Cannabis Should Be Filing An Extension For Their 2019 Income Tax Returns

If you did not report your offshore accounts, crypto currency income or cannabis income earned before 2019, you should hold off on filing your 2019 taxes and instead file an extension.

An extension is your way of asking the IRS for additional time to file your tax return. The IRS will automatically grant you an additional time to file your return. While State Tax Agencies will also provide the same extension period, you need to check with your State to see if an extension must be filed with the State as well.  For example, California does not require that a State extension be filed as long as you timely file the Federal extension AND you will not owe any money to the State.

The deadline to file your 2019 individual income tax returns or request an extension of time to file the tax return is Wednesday, July 15, 2020 (normally would have been April 15th but extended due to COVID-19).  A timely filed extension will extend the filing deadline to Thursday, October 15, 2020 thus giving you an extra three months to meet with tax counsel and determine how to address your pre-2019 tax reporting delinquencies and/or exposure and how to present your situation on your 2019 tax return.

While an extension gives you extra time to file your return, an extension does not give you extra time to pay your tax and if you do not pay what you owe with the extension, you will still be ultimately charged with late payment penalties when you file your tax return.

Offshore Accounts

Where a taxpayer does not come forward voluntarily though a Voluntary Disclosure Program and has now been targeted by IRS for failing to file the Foreign Bank Account Reports (FBAR), the IRS may now assert FBAR penalties that could be either non-willful or willful.  Both types have varying upper limits, but no floor.  The first type is the non-willful FBAR penalty.  The maximum non-willful FBAR penalty is $10,000.  The second type is the willful FBAR penalty.  The maximum willful FBAR penalty is the greater of (a) $100,000 or (b) 50% of the total balance of the foreign account.  In addition, the IRS can pursue criminal charges with the willful FBAR penalty.  The law defines that any person who willfully attempts in any manner to evade or defeat any tax under the Internal Revenue Code or the payment thereof is, in addition to other penalties provided by law, guilty of a felony and, upon conviction thereof, can be fined not more than $100,000 ($500,000 in the case of a corporation), or imprisoned not more than five years, or both, together with the costs of prosecution (Code Sec. 7201).

For the non-willful penalty, all the IRS has to show is that an FBAR was not filed.  Whether the taxpayer knew or did not know about the filing of this form is irrelevant.  The non-willful FBAR penalty is $10,000 per account, per year and so a taxpayer with multiple accounts over multiple years can end up with a huge penalty.

Since 2009, the IRS Criminal Investigation has indicted 1,545 taxpayers on criminal violations related to international activities, of which 671 taxpayers were indicted on international criminal tax violations.

Crypto Currency

Many taxpayers think that their crypto transactions would remain a secret forever.  Digital exchanges are not broker-regulated by the IRS. Digital exchanges are not obligated to issue a 1099 form, nor are they obligated to report to the IRS calculate gains or cost basis for the trader. But that is now all changing sooner than you think!

As of March 16, 2018, the IRS has received information from Coinbase located in San Francisco which is the largest cryptocurrency exchange in the United States disclosing the names, addresses and tax identification numbers on 14,355 account holders. Coinbase pursuant to a Court Order issued by a Federal Magistrate Judge (United States v. Coinbase, Inc., United States District Court, Northern District Of California, Case No.17-cv-01431) had to produce the following customer information over the period of 2013 to 2015: (1) taxpayer ID number, (2) name, (3) birth date, (4) address, (5) records of account activity, including transaction logs or other records identifying the date, amount, and type of transaction (purchase/sale/exchange), the post transaction balance, and the names of counterparties to the transaction, and (6) all periodic statements of account or invoices (or the equivalent).

Furthermore, Coinbase starting with the 2017 tax years will be issuing 1099-K tax forms for some of its U.S. clients.  The IRS will receive copies of these forms.

With only several hundred people reporting their crypto gains each year, the IRS suspects that many crypto users have been evading taxes by not reporting crypto transactions on their tax returns.

Cannabis

With the proliferation of licensed cannabis businesses sprouting in the State Of California since 2018, a continued stream of cannabis business will be filing tax returns with the IRS.  But beware, the IRS is well aware that successful cannabis businesses don’t just sprout overnight and now that your business is on the radar screen you can bet that the IRS will be inquiring how you accumulated all that cash before 2019.

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.

Despite the disparity and Federal and State law, marijuana businesses still have to pay taxes.

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 cannabis business that has not properly reported its income and expenses and not engaged in the planning to minimize income taxes can face a large liability proposed by IRS reflected on a Notice Of Deficiency or tax bill.  Likewise, where a taxpayer over the years has accumulated cash from cannabis sales and never reported any income to the IRS, you are looking at a serious problem.

Penalties For Filing A False Income Tax Return Or Under-reporting Income 

Failure to report all the money you make is a main reason folks end up facing an IRS auditor. Carelessness on your tax return might get you whacked with a 20% penalty. But that’s nothing compared to the 75% civil penalty for willful tax fraud and possibly facing criminal charges of tax evasion that if convicted could land you in jail.

Criminal Fraud – The law defines that any person who willfully attempts in any manner to evade or defeat any tax under the Internal Revenue Code or the payment thereof is, in addition to other penalties provided by law, guilty of a felony and, upon conviction thereof, can be fined not more than $100,000 ($500,000 in the case of a corporation), or imprisoned not more than five years, or both, together with the costs of prosecution (Code Sec. 7201).

The term “willfully” has been interpreted to require a specific intent to violate the law (U.S. v. Pomponio, 429 U.S. 10 (1976)). The term “willfulness” is defined as the voluntary, intentional violation of a known legal duty (Cheek v. U.S., 498 U.S. 192 (1991)).

And even if the IRS is not looking to put you in jail, they will be looking to hit you with a big tax bill with hefty penalties.

Civil Fraud – Normally the IRS will impose a negligence penalty of 20% of the underpayment of tax (Code Sec. 6662(b)(1) and 6662(b)(2)) but violations of the Internal Revenue Code with the intent to evade income taxes may result in a civil fraud penalty. In lieu of the 20% negligence penalty, the civil fraud penalty is 75% of the underpayment of tax (Code Sec. 6663). The imposition of the Civil Fraud Penalty essentially doubles your liability to the IRS!

What Should You Do?

Individual taxpayers can file an extension using Form 4868. Extensions can also be filed online, which has the benefit that you’ll receive a confirmation code from the IRS notifying you that your extension was received.  Then you should promptly contact tax counsel.  Don’t delay because once the IRS has targeted you for investigation – even if it is a routine random audit – it will be too late voluntarily come forward. Let the tax attorneys at the Law Offices Of Jeffrey B. Kahn, P.C. located in Orange County (Irvine), San Francisco Bay Area (including San Jose and Walnut Creek) and offices elsewhere in California get you set up with a plan that may include being qualified into a voluntary disclosure program to avoid criminal prosecution, seek abatement of penalties, and minimize your tax liability. If you are involved in cannabis, check out what else a cannabis tax attorney can do for you. Also, if you are involved in crypto currency, check out what a Bitcoin tax attorney can do for you.