Why It Is Important To Tell The Difference Between A Hobby And A Business For Tax Purposes

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Your “hobby business” could land you in Tax Court – avoid IRS pitfalls by how you structure your small business.

A hobby is any activity that a person pursues because they enjoy it and with no intention of making a profit. People operate a business with the intention of making a profit.  Many enterprising people successfully develop a hobby into a going concern and actually receive income from it. That income must always be reported and taxes paid on that money regardless of your situation. If you leave that hobby as a hobby, under the tax law, you are not allowed to deduct any of the losses incurred by activity in that hobby but any income from a hobby must be reported on Schedule 1, Form 1040, line 8. That is the reason most people turn their hobbies into businesses once they start making money.

Factors To Consider When Determining Whether An Activity Is A Business Or A Hobby.

The IRS considers the following factors to make this determination:

  • The taxpayer carries out activity in a businesslike manner and maintains complete and accurate books and records.
  • The taxpayer puts time and effort into the activity to show they intend to make it profitable.
  • The taxpayer depends on income from the activity for their livelihood.
  • The taxpayer has personal motives for carrying out the activity such as general enjoyment or relaxation.
  • The taxpayer has enough income from other sources to fund the activity.
  • Losses are due to circumstances beyond the taxpayer’s control or are normal for the startup phase of their type of business.
  • There is a change to methods of operation to improve profitability.
  • Taxpayer and their advisor have the knowledge needed to carry out the activity as a successful business.
  • The taxpayer was successful in making a profit in similar activities in the past.
  • Activity makes a profit in some years and how much profit it makes.
  • The taxpayer can expect to make a future profit from the appreciation of the assets used in the activity.

All factors, facts, and circumstances with respect to the activity must be considered. No one factor is more important than another.

Exception When Hobby Losses Are Deductible.

By showing that your pursuit of your “hobby” is an activity engaged in for profit, you may be able to deduct those years where you incurred losses if you meet certain presumptions.

For activities not involving the breeding, training, showing, or racing of horses, the presumption is that you business is an activity engaged in for profit where you show annual net income from an activity for 3 or more of the taxable years in the period of 5 consecutive taxable years which ends with the most recent taxable year.  So if for the first three years your activity has incurred losses, you must show net income in years four and five (even if only $1.00 in each year) in order to still be able to deduct the first three years of losses.

For activities involving the breeding, training, showing, or racing of horses, the presumption will work in the same fashion except you must show annual net income from an activity for 2 or more of the taxable years in the period of 7 consecutive taxable years which ends with the most recent taxable year.

Challenges In U.S. Tax Court.

Despite these presumptions, the IRS does not always see your hobby as a viable business, and that is where tax difficulties arise. There are a number of court cases where the question of hobby or business has been decided for the particular business by the IRS, and under challenge, the cases end up in Tax Court. Here are five cases that landed in Tax Court worth discussing.

  1. Fishing: In Busbee v. Commissioner, T.C. Memo 2000-182, this taxpayer decided to hold fishing tournaments. These tournaments required him to promote the activity through flyers, speaking engagements, and other marketing efforts. He had to recruit participants and sponsors. He intended his hobby of fishing tournaments to supplement his retirement income as he developed it into a business. Through the process, he became an expert in bass fishing. The Tax Court considered all of this, and allowed his business.

In Peacock v. Commissioner, T.C. Memo 2002-122, this taxpayer began tournament fishing in his retirement. Sailing everywhere on his personal yacht, he and his wife fished specifically for the pleasure of participating in the tournament, especially when these tournaments were in exotic locales. In this case, the Tax Court decided this was not a business but a hobby for the activity was not “motivated primarily by the pursuit of profit”.  What probably hurt their case, even subtly, was the fact that they had just sold a business and were now millionaires.

  1. Golfing: In William James Courville v. Commissioner, T.C. Memo 1996-134, an optical engineer, after 30 years of employment, was laid off. He decided to become a professional golfer, but took only 4 golf lessons while a “professional”. He did not qualify for the senior tour, and ended up with no income from this activity. However, he did submit a Schedule C, listing expenses totaling over $16,000. The Tax Court declared that he “failed to establish that his golfing activity was carried on with the actual and honest objective of making a profit”.
  2. Track and field coaching: In Parks v. Commissioner, T.C. Memo 2012-105, the taxpayer began his professional career as a writer of freelance articles on the sport of track and field. Over a number of years, he owned a track and field magazine, coached at a number of different locations, studied with one of the foremost experts in the industry, then basically tried to establish himself and his trainees as credible within the field. By 2006, this man had a winning contestant who qualified for the Olympic trials, and by 2009, that contestant signed the taxpayer coach to a lucrative contract as his exclusive coach, and things only got better for the taxpayer. However, in a tax period of 9 years, the coach showed only a $43 profit, so the IRS claimed hobby not business. The Tax Court considered the case in great detail and decided primarily (although not all points) for the taxpayer, saying his income was growing and he had great potential for success. They did not see track and field as a typical hobby, and that did work to the taxpayer’s benefit.
  3. Writing: There is an infamous case which always gives people a chuckle, and that is the man who decided to write about prostitution. Vitale v. Commissioner, T.C. Memo 1999-131. Ralph Louis Vitale, Jr., in 1999, claimed on his tax return that he was in the business of writing about prostitution. When this taxpayer began his “research” four years before his retirement, he was still a full-time employee. Over the course of time, he visited a large number of brothels doing his “research” and always paying for services in cash (no records kept). He did keep a journal detailing each of his visits and expenses, and eventually developed a manuscript from his notes. Vitale submitted his manuscript to a vanity publisher, paying $4,375 to publish it. All tolled, after he received $2,600 in royalties, the publisher went bankrupt. Subsequently, the book rights were returned to him, and he again began marketing his book throughout the industry. The IRS said this was just a hobby and disallowed Vitale’s deductions. So Vitale went to Tax Court.  At first, the Tax Court felt that the taxpayer had a profit motive and overruled the IRS, even though the court also made comments about the “recreational” qualities of the contents of his book. The court did like his record-keeping and marketing and felt it showed his professionalism. But then the Tax Court disallowed all of his deductions, for the taxpayer could prove none of them (remember the cash payments?).  Nevertheless, the court did not penalize this taxpayer in any way, saying that he had made a reasonable attempt to comply with the law.

The U.S. Tax Court weighs “profit motive” most heavily in each of their decisions. Profit is a key decider when considering whether an activity is hobby or business. Is your hobby truly for profit or only for pleasure? That is foremost and basic premise that the Tax Court considers.

What Should You Do?

There seem to be two “hobbies” that trigger audits most frequently and those are horses or yachts. Both are money pits, and so if people can figure out a way to make a business out of them, that will provide either tax deductions and/or income to cover the high expenses of each. The IRS knows this, and is very strict when applying the rules to these activities. When structuring these, pay very close attention to business start-up details.

Regardless, if you follow good business practices when converting your hobby into a business, you have a greater chance of convincing the IRS it is a real business. Your business records must be up-to-date and accurate, and your business plan must lay out a course for creating profit from your activity in the future. That written business plan can be a real asset if you end up in Tax Court versus the IRS.

Don’t Take The Chance And Lose Everything You Have Worked For.

Protect yourself. If you are selected for an audit, stand up to the IRS by getting representation. Tax problems are usually a serious matter and must be handled appropriately so it’s important to that you’ve hired the best lawyer for your particular situation. The tax attorneys at the Law Offices Of Jeffrey B. Kahn, P.C. located in Orange County (Irvine), San Diego County (Carlsbad) and elsewhere in California are highly skilled in handling tax matters and can effectively represent at all levels with the IRS and State Tax Agencies including criminal tax investigations and attempted prosecutions, undisclosed foreign bank accounts and other foreign assets, and unreported foreign income. Additionally, if you are involved in cannabis, check out what a cannabis tax attorney can do for you.  And if you are involved in crypto currency, check out what a bitcoin tax attorney can do for you.

Justice Department Shuts Down Brooklyn Tax Return Preparation Business

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Justice Department Shuts Down Brooklyn Tax Return Preparation Business

Recently, the U.S. Justice Department (“DOJ”) successfully secured injunctions from U.S Federal District Court for the Eastern District of New York barring Keith Sang, Kashana Sang, Tareek Lewis, Kimberly Brown and their business K&L Accounting Inc. from preparing tax returns.

K&L Accounting Inc. of Brooklyn, New York

The Tax Division of the DOJ announced that on February 26, 2022, a federal court in the Eastern District of New York issued a preliminary injunction against four Brooklyn tax return preparers and their business.

The civil complaint filed in the case seeks to permanently bar Keith Sang, Kashana Sang, Tareek Lewis, Kimberly Brown and their business K&L Accounting Inc. from preparing tax returns. The preliminary injunction bars the defendants from any involvement in the preparation of federal tax returns during the pendency of this case. Keith Sang, Kashana Sang, Lewis and the business made no objection to the injunction. Brown opposed it.

The complaint alleges that the defendants’ tax return preparation schemes include preparation of individual income tax returns that (1) contain false or exaggerated itemized deductions (for example, unreimbursed employee expenses and charitable donations), (2) false filing statuses, such as improper “head of household” elections, (3) fraudulent and/or fictitious business income and/or expenses, (4) returns that falsify customer’s self-employment income to bring the customer into the “sweet spot” for the maximum available earned income tax credit, and (5) false losses on forms that report supplemental income or loss. The complaint alleges that, each year, K&L is responsible for preparing over 2,000 tax returns for customers, and that Keith Sang, whose electronic tax filing privileges were revoked years ago, has taken numerous steps to disguise his involvement with the tax return preparation, while he continues to prepare returns and supervise others working at K&L.

In granting the preliminary injunction, the court found that defendants engaged in concerted and conscious steps to evade IRS enforcement; that they, acting as a unit, repeatedly filed tax returns understating taxpayer liabilities since at least 2016; and that their past efforts demonstrated that they would continue hampering IRS enforcement unless prohibited from acting as federal tax return preparers during the litigation.

Actions by DOJ help support IRS’ campaigns to fight refund fraud and identity theft. 

“Identity theft is a pervasive crime and stopping it remains a top priority of the IRS,” said IRS Commissioner Chuck Rettig. “The IRS, with the help of our Security Summit partners, continues to make progress in this area, but we need to continue our significant efforts to protect taxpayers and assist those who have been a victim of identity theft. We are fighting this problem with enhanced systems, smarter technology and the efforts of our dedicated workforce, including Criminal Investigation. We will retain our relentless, vigorous pursuit of those who prey upon others in this arena”.

The Office of the Chief of IRS Criminal Investigation (“CI”) has previously stated that “Millions of taxpayers put their trust in tax professionals to prepare accurate and lawful returns. Unfortunately, a few bad apples take advantage of that trust for their own greed and profit. CI’s special agents are highly skilled at unraveling fraudulent schemes. With our partners in other agencies and the private sector, we are dismantling these crooked enterprises and enforcing our tax laws.”

What Should You Do?

Whether you are a victim of identity theft or the perpetrator of identity theft, it is important that you seek legal counsel as soon as possible to preserve your rights and/or mitigate your losses.  The tax attorneys of 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 elsewhere in California know exactly what to say and how to handle issues with the IRS as well as State Tax Agencies.  Our experience and expertise not only levels the playing field but also puts you in the driver’s seat as we take full control of resolving your tax problems. Also, if you are involved in cannabis, check out what our cannabis tax attorney can do for you.  Additionally, if you are involved in crypto currency, check out what a bitcoin tax attorney can do for you.Top of Form

IRS Looking For Taxpayers To Report Gig Economy Income, Virtual Currency Transactions, And Foreign Source Income And Assets

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IRS Looking For Taxpayers To Report Gig Economy Income, Virtual Currency Transactions, And Foreign Source Income And Assets

Chances are you are involved in one of these areas –

  1. Income from the Gig Economy,
  2. Dealing with Virtual Currency, or
  3. Having Foreign Source Income And Assets.

If so, pay particular attention to what the IRS will be looking for on your 2021 income tax return.

Gig economy earnings are taxable

Generally, income earned from the gig economy is taxable and must be reported to the IRS. The gig economy is activity where people earn income providing on-demand work, services or goods. Often, it’s through a digital platform like an app or website. Taxpayers must report income earned from the gig economy on a tax return, even if the income is:

  • From part-time, temporary or side work,
  • Not reported on an information return form – like a Form 1099-K, 1099-MISC, W-2 or other income statement or
  • Paid in any form, including cash, property, goods or virtual currency.

TAX TIP – If you incurred expenses to produce this income, those expenses should be reported on your tax return so you do not pay more in tax than what the law requires.

Virtual currency reporting and tax requirements

Again for 2021, there is a question at the top of Form 1040 and Form 1040-SR asking about virtual currency transactions. All taxpayers filing these forms must check the box indicating either “yes” or “no.” A transaction involving virtual currency includes, but is not limited to:

  • The receipt of virtual currency as payment for goods or services provided;
  • The receipt or transfer of virtual currency for free (without providing any consideration) that does not qualify as a bona fide gift;
  • The receipt of new virtual currency as a result of mining and staking activities;
  • The receipt of virtual currency as a result of a hard fork;
  • An exchange of virtual currency for property, goods or services;
  • An exchange/trade of virtual currency for another virtual currency;
  • A sale of virtual currency; and
  • Any other disposition of a financial interest in virtual currency.

If an individual disposed of any virtual currency that was held as a capital asset through a sale, exchange or transfer, they should check “Yes” and use Form 8949 to figure their capital gain or loss and report it on Schedule D (Form 1040).

If they received any virtual currency as compensation for services or disposed of any virtual currency they held for sale to customers in a trade or business, they must report the income as they would report other income of the same type (for example, W-2 wages on Form 1040 or 1040-SR, line 1, or inventory or services from Schedule C on Schedule 1).

TAX TIP – Make sure to report the basis of any virtual currency disposed of which will reduce your gain so you do not pay more in tax than what the law requires.

Reporting Foreign Source Income

A U.S. citizen or resident alien’s worldwide income is generally subject to U.S. income tax, regardless of where they live. They’re also subject to the same income tax filing requirements that apply to U.S. citizens or resident aliens living in the United States.

U.S. citizens and resident aliens must report unearned income, such as interest, dividends, and pensions, from sources outside the United States unless exempt by law or a tax treaty. They must also report earned income, such as wages and tips, from sources outside the United States. An income tax filing requirement generally applies even if a taxpayer qualifies for tax benefits, such as the Foreign Earned Income Exclusion or the Foreign Tax Credit, which substantially reduce or eliminate U.S. tax liability. These tax benefits are only available if an eligible taxpayer files a U.S. income tax return.

TAX TIP – Make sure you file a tax return on a timely basis to claim these benefits. If both your tax home and abode are outside the United States and Puerto Rico, you have until June 15, 2022 to file your tax return or file an extension (to October 15, 2022).  Those serving in the military outside the U.S. and Puerto Rico on the regular due date of their tax return also have until June 15, 2022 to file your tax return or file an extension (to October 15, 2022).

Reporting required for foreign accounts and assets

Federal law requires U.S. citizens and resident aliens to report their worldwide income, including income from foreign trusts and foreign bank and other financial accounts. In most cases, affected taxpayers need to complete and attach Schedule B to their tax return. Part III of Schedule B asks about the existence of foreign accounts, such as bank and securities accounts, and usually requires U.S. citizens to report the country in which each account is located.

In addition, certain taxpayers may also have to complete and attach to their return Form 8938, Statement of Foreign Financial Assets. Generally, U.S. citizens, resident aliens and certain nonresident aliens must report specified foreign financial assets on this form if the aggregate value of those assets exceeds certain thresholds. See the instructions for this form for details.

Further, separate from reporting specified foreign financial assets on their tax return, taxpayers with an interest in, or signature or other authority over foreign financial accounts whose aggregate value exceeded $10,000 at any time during 2020, must file electronically with the Treasury Department a Financial Crimes Enforcement Network (FinCEN) Form 114, Report of Foreign Bank and Financial Accounts (FBAR). Because of this threshold, the IRS encourages taxpayers with foreign assets, even relatively small ones, to check if this filing requirement applies to them. The form is only available through the BSA E-filing System website.

TAX TIP – The deadline for filing the annual Report of Foreign Bank and Financial Accounts (FBAR) is the same as that of Form 1040. FinCEN grants filers who missed the original deadline an automatic extension until October 15, 2022, to file the FBAR. There is no need to request this extension.

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?

You know that at the Law Offices Of Jeffrey B. Kahn, P.C. we are always thinking of ways that our clients can save on taxes. If you are selected for an audit, stand up to the IRS by getting representation. Tax problems are usually a serious matter and must be handled appropriately so it’s important to that you’ve hired the best lawyer for your particular situation. The tax attorneys at the Law Offices Of Jeffrey B. Kahn, P.C. located in Orange County (Irvine), the San Francisco Bay Area (including San Jose and Walnut Creek) and elsewhere in California are highly skilled in handling tax matters and can effectively represent at all levels with the IRS and State Tax Agencies including criminal tax investigations and attempted prosecutions, undisclosed foreign bank accounts and other foreign assets, and unreported foreign income. Also if you are involved in cannabis, check out what a cannabis tax attorney can do for you and if you are involved in crypto-currency, check out what a Bitcoin tax attorney can do for you.

Can Cannabis Help College Students Be More Motivated?

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According to a report published by the American Psychological Association in the journal Experimental and Clinical Psychopharmacology, new analysis out of the University Of Memphis contradicts the perception among the general public that cannabis leads to amotivation and diminished effortful behavior.

The study examined the relation between cannabis use and effort-related decision making in a sample of 47 college students. Specifically, 25 students using cannabis (68% meeting criteria for Cannabis Use Disorder) and 22 students not using cannabis completed the Effort Expenditure for Rewards Task (EEfRT).  The EEfRT is a behavioral assessment given by psychologists.

The report stated: “Contrary to the amotivational syndrome hypothesis, college students using more cannabis were more likely to select the high-effort choice option, regardless of the reward magnitude, probability, and expected value of the overall reward. Although there was not a significant difference between cannabis use groups, there was a medium sized effect, lending consistent support for an association between cannabis use and greater high-effort choices.”

Researchers summarized in their impact statement in the report that that cannabis use by college students is associated with a greater likelihood of selecting high effort trials and that more studies with larger sample groups should be pursued.

Developments like this contradict the basis of classification of cannabis under Federal law which makes cannabis illegal.

The Anti-Federal U.S. Climate

The Federal Controlled Substances Act (“CSA”) 21 U.S.C. § 812 classifies marijuana as a Schedule 1 substance with a high potential for abuse, no currently accepted medical use in treatment, and lack of accepted safety for use under medical supervision. Although you can still face federal criminal charges for using, growing, or selling weed in a manner that is completely lawful under California law, the federal authorities in the past have pulled back from targeting individuals and businesses engaged in medical marijuana activities. This pull back came from Department of Justice (“DOJ”) Safe Harbor Guidelines issued in 2013 under what is known as the “Cole Memo”.

The Cole Memo included eight factors for prosecutors to look at in deciding whether to charge a medical marijuana business with violating the Federal law:

  • Does the business allow minors to gain access to marijuana?
  • Is revenue from the business funding criminal activities or gangs?
  • Is the marijuana being diverted to other states?
  • Is the legitimate medical marijuana business being used as a cover or pretext for the traffic of other drugs or other criminal enterprises?
  • Are violence or firearms being used in the cultivation and distribution of marijuana?
  • Does the business contribute to drugged driving or other adverse public health issues?
  • Is marijuana being grown on public lands or in a way that jeopardizes the environment or public safety?
  • Is marijuana being used on federal property?

Since 2013, these guidelines provided a level of certainty to the marijuana industry as to what point could you be crossing the line with the Federal government.  But on January 4, 2018, then Attorney General Jeff Sessions revoked the Cole Memo.  Now U.S. Attorneys in the local offices throughout the country retain broad prosecutorial discretion as to whether to prosecute cannabis businesses under federal law even though the state that these businesses operate in have legalized some form of marijuana.

Joyce-Blumenauer Amendment (previously referred to as the Rohrabacher-Farr Amendment)

The medical use of cannabis is legal (with a doctor’s recommendation) in 37 states and Washington DC. Those 37 states being Alabama, Alaska, Arizona, Arkansas, California, Colorado, Connecticut, Delaware, Florida, Hawaii, Illinois, Louisiana, Maine, Maryland, Massachusetts, Michigan, Minnesota, Mississippi, Missouri, Montana, Nevada, New Hampshire, New Jersey, New Mexico, New York, North Dakota, Ohio, Oklahoma, Oregon, Pennsylvania, Rhode Island, South Dakota, Utah, Vermont, Virginia, Washington and West Virginia.

The medical use of cannabis is also legal in the territories of the Northern Mariana Islands, Guam and Puerto Rico

Six tribal nations also legalized cannabis use – those 6 tribes being the Flandreau Santee Sioux Tribe (South Dakota), Oglala Lakota Sioux Tribe (South Dakota), Suquamish Tribe (Washington state), Squaxin Island Tribe (Washington state), Eastern Band of Cherokee Indians (North Carolina) and St. Regis Mohawk Tribe (New York).

Building on the DOJ’s issuance of the Cole Memo, in 2014 the House passed an amendment to the yearly federal appropriations bill that effectively shields medical marijuana businesses from federal prosecution. Proposed by Representatives Rohrabacher and Farr, the amendment forbids federal agencies to spend money on investigating and prosecuting medical marijuana-related activities in states where such activities are legal.

The amendment states that:

NONE OF THE FUNDS MADE AVAILABLE UNDER THIS ACT TO THE DEPARTMENT OF JUSTICE MAY BE USED, WITH RESPECT TO ANY OF THE STATES OF ALABAMA, ALASKA, ARIZONA, ARKANSAS, CALIFORNIA, COLORADO, CONNECTICUT, DELAWARE, FLORIDA, GEORGIA, HAWAII, ILLINOIS, INDIANA, IOWA, KENTUCKY, LOUISIANA, MAINE, MARYLAND, MASSACHUSETTS, MICHIGAN, MINNESOTA, MISSISSIPPI, MISSOURI, MONTANA, NEVADA, NEW HAMPSHIRE, NEW JERSEY, NEW MEXICO, NEW YORK, NORTH CAROLINA, NORTH DAKOTA, OHIO, OKLAHOMA, OREGON, PENNSYLVANIA, RHODE ISLAND, SOUTH CAROLINA, TENNESSEE, TEXAS, UTAH, VERMONT, VIRGINIA, WASHINGTON, WEST VIRGINIA, WISCONSIN, AND WYOMING, OR WITH RESPECT TO THE DISTRICT OF COLUMBIA, GUAM, OR PUERTO RICO, TO PREVENT ANY OF THEM FROM IMPLEMENTING THEIR OWN LAWS THAT AUTHORIZE THE USE, DISTRIBUTION, POSSESSION, OR CULTIVATION OF MEDICAL MARIJUANA.

This action by the House is not impacted by the change of position by the DOJ. However, unless this amendment gets included in each succeeding federal appropriations bill, the protection from Federal prosecution of medical marijuana businesses will no longer be in place.  Fortunately, Congress has included this amendment but yet has changed any of the tax or banking laws that pose challenges to the cannabis industry.

Clearly, to avail yourself of the protections of the amendment, you must be on the medical cannabis side and you must be in complete compliance with your State’s medical cannabis laws and regulations. You may not be covered under the amendment if you are involved in the recreational cannabis side even if legal in the State you are operating.

What Should You Do?

Given the illegal status of cannabis under Federal law you need to protect yourself and your marijuana business from all challenges created by the U.S. government.  Although cannabis is legal in California, that is not enough to protect you. 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.

Tips On Holding Cryptocurrency In An IRA To Defer Taxation

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Tips On Holding Cryptocurrency In An IRA To Defer Taxation

Cryptocurrency was not well known and confusing for the general public to get comfortable with but with innovations in the industry starting in 2017, cryptocurrency is becoming more widely known and accepted as a means to do business. One of those innovations increasing the popularity of cryptocurrency is the introduction of a multi-currency wallet that holds Bitcoin Cash and Bitcoin Core in a non-custodial fashion. The wallet known as the “Bitcoin.com Wallet” allows users to store their private keys themselves which avoids the funds to be held by any third party. Since this wallet which became available in August 2017, it is believed that there are now over 81 million wallet users in 2022.

Taxation Of Cryptocurrency

Although both the general public and the crypto community refer to bitcoin, altcoin, etc. as “virtual currencies”, the IRS in 2014 issued Notice 2014-21 stating that it treats them as property for tax purposes. Therefore, selling, spending and even exchanging crypto for other tokens all likely have capital gain implications. Likewise, receiving it as compensation or by other means will be ordinary income.

Some would think that if bitcoin is property, trades should be tax deferred under the like-kind changes rues of IRC section 1031. Under that theory someone who owned Bitcoin could diversify their holdings into Ethereum or Litecoin, and plausibly tell the IRS it created no tax obligations. Unfortunately, the Tax Cuts & Jobs Act of 2017 does away with that loophole making it clear that “like kind exchanges” which lets people swap an asset for a similar one without triggering a tax obligation are not available for non-real estate assets.

While bitcoin receives most of the attention these days, it is only one of hundreds of cryptocurrencies. Everything discussed with regard to bitcoin taxation applies to all cryptocurrencies.

Here are the basic tax rules on specific cryptocurrency transactions:

  • Trading cryptocurrencies produces capital gains or losses, with the latter being able to offset gains and reduce tax.
  • Exchanging one token for another — for example, using Ethereum to purchase an altcoin — creates a taxable event. The token is treated as being sold, thus generating capital gains or losses.
  • Receiving payments in cryptocurrency in exchange for products or services or as salary is treated as ordinary income at the fair market value of the coin at the time of receipt.
  • Spending cryptocurrency is a tax event and may generate capital gains or losses, which can be short-term or long-term. For example, say you bought one coin for $500. If that coin was then worth $700 and you bought a $700 gift card, there is a $200 taxable gain. Depending on the holding period, it could be a short- or long-term capital gain subject to different rates.
  • Converting a cryptocurrency to U.S. dollars or another currency at a gain is a taxable event, as it is treated as being sold, thus generating capital gains.
  • Air drops are considered ordinary income on the day of the air drop. That value will become the basis of the coin. When it’s sold, exchanged, etc., there will be a capital gain.
  • Mining coins is considered ordinary income equal to the fair market value of the coin the day it was successfully mined.
  • Initial coin offerings do not fall under the IRS’s tax-free treatment for raising capital. Thus, they produce ordinary income to individuals and businesses alike.

So How Do The Rules Apply When Holding Cryptocurrency In An IRA?

IRC section 408(m) generally prohibits the investment of assets of an IRA (and any self-directed qualified plan account) in certain “collectibles” including precious metals; however, there are exceptions for certain coins and bullion.

The U.S. Tax Court reaffirmed the physical possession rule in, McNulty v. Commissioner of Internal Revenue, No. 1377-19 (U.S.T.C. Nov. 18, 2021), and this ruling could have a big impact on some cryptocurrency account holders.

In McNulty, the taxpayers (husband and wife) established a self-directed individual retirement account (IRA) under IRC section 408 and directed assets held in the IRA to invest in a single-member limited liability company (LLC). Mr. McNulty was the manager of the LLC that her IRA invested in. She directed the LLC to purchase American Eagle (AE) coins and took physical possession of the coins. IRS contended that the year she received physical custody of the AE coins resulted in a taxable distribution equal to the cost of the AE coins. The Tax Court agreed with IRS.

The Tax Court stated:

“Independent oversight by a third-party fiduciary to track and monitor investment activities is one of the key aspects of the statutory scheme. When coins or bullion are in the physical possession of the IRA owner (in whatever capacity the owner may be acting), there is no independent oversight that could prevent the owner from invading her retirement funds. This lack of oversight is clearly inconsistent with the statutory scheme. Personal control over the IRA assets by the IRA owner is against the very nature of an IRA.”

The Tax Court’s focus on the “taxpayer’s control” of an IRA asset can have far reaching implications for self-directed IRA’s beyond bullion coins.  In the case of cryptocurrency, holding cryptocurrency in a cold wallet that is controlled by the IRA owner would provide the IRA owner with “unfettered control”.  A cold wallet can be detached from the internet. Hardware wallets and paper wallets are both cold wallet options. Hardware wallets use a physical medium — typically in the shape of a USB stick — to store the wallet’s private keys, making them de facto unreachable to hackers or other malicious parties.

So if you are looking to invest in cryptocurrency through a self-directed IRA, it is best to hold your cryptocurrency on a licensed and insured crypto exchange in the name of the IRA to avoid the impact of the physical possession rule of IRC section 408(m).

IRS Suspicion Of Noncompliant Taxpayers In Cryptocurrency

The IRS has not yet announced a specific tax amnesty for people who failed to report their gains and income from Bitcoin and other virtual currencies but under the existing Voluntary Disclosure Program, non-compliant taxpayers can come forward to avoid criminal prosecution and negotiate lower penalties.

The IRS suspects that many cryptocurrency users have been evading taxes by not reporting crypto transactions on their tax returns given the millions of wallets already issued.

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?

Especially now that like-exchange treatment is prohibited on non-real estate transactions that occur after 2017, now is the ideal time to be proactive and come forward with voluntary disclosure to lock in your deferred gains through 2017, eliminate your risk for criminal prosecution, and minimize your civil penalties.  Don’t delay because once the IRS has targeted you for investigation – even it’s is a routine random audit – it will be too late voluntarily come forward. Let a bitcoin tax attorney 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 elsewhere in California get you qualified into a voluntary disclosure program to avoid criminal prosecution, seek abatement of penalties, and minimize your tax liability.  Also, if you are involved in cannabis, check out what a cannabis tax attorney can do for you.

How Israel’s Kibbutzim Is Capitalizing On Global Medical Cannabis Production

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Israel’s communal farms known as “kibbutzim” have been on the brink of extinction as Israel’s economy becomes more capitalist but some kibbutzim are thriving thanks to the addition of a new crop … cannabis.

Since 2016 when the Israeli government established a regulatory framework, dozens of kibbutzim in Israel have become active growers of cannabis. There are 270 kibbutzim and it is estimated that at least a third of them will be involved in cannabis.  Application to grow cannabis is made to the Israeli Ministry of Health.

The cannabis space set aside by kibbutzim depends whether production capacity is added to cultivation space which reportedly starts at 4,000 square meters and can be as high as 200,000 square meters.  A lot of this activity is in collaboration with private and public cannabis companies.

Under Israeli law, companies that generate more than 25% of their revenues through exports enjoy various tax exemptions and benefits and when adding the benefits of large swaths of land, unused building facilities and inexpensive labor that these Kibbutzim have, you can see why there is such a big interest in tapping these farms.

Israel’s Global Dominance In Medical Cannabis

Most people would be surprised to hear that Israel is the global leader in medical cannabis research. Not a surprise here considering that Israel is already known as an agricultural heavyweight and first allowed patients with qualifying conditions to use cannabis in the early 1990’s. Additionally, Israel does not have the federal law prohibition we have to endure. Israel’s embrace to allow for medical cannabis and medical cannabis research has opened the doors to allow scientists to conduct research without the fear of interruption by the government. The Israelis have been so successful in developing high quality cannabis strains that you cannot get anywhere else that they are posed to export this crop which some analysts believe could bring in as much as $4 billion in yearly revenue and improve the quality of ongoing medical research involving cannabis.  Also, in 2020 its government authorized the exports of medical cannabis which the government figures will contribute to the growth of this industry.

Now You Can Invest In Israeli Cannabis Companies.

The Jerusalem Post reported that the Tel Aviv Stock Exchange launched on December 28, 2020 a new index for nine medical cannabis companies.  The new index includes nine companies that are “primarily engaged in the fields of research, cultivation, sale or production and marketing of medical cannabis products”.  The index has a relatively low market cap of 1.7 billion shekels ($529 million) and is expected to serve as a “benchmark for active mutual funds that offer exposure to this emerging and growing sector”.

The Growing Trend Of American States And Indian Tribes In Legalizing Cannabis.

Medical marijuana is legal in 37 states.

The medical use of cannabis is legal (with a doctor’s recommendation) in 37 states and Washington DC. Those 37 states being Alabama, Alaska, Arizona, Arkansas, California, Colorado, Connecticut, Delaware, Florida, Hawaii, Illinois, Louisiana, Maine, Maryland, Massachusetts, Michigan, Minnesota, Mississippi, Missouri, Montana, Nevada, New Hampshire, New Jersey, New Mexico, New York, North Dakota, Ohio, Oklahoma, Oregon, Pennsylvania, Rhode Island, South Dakota, Utah, Vermont, Virginia, 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 18 states.

Eighteen states and Washington DC, have legalized marijuana for recreational use — no doctor’s letter required — for adults over the age of 21. Those 18 states being Alaska, Arizona, California, Colorado, Connecticut, Illinois, Maine, Massachusetts, Michigan, Montana, Nevada, New Jersey, New Mexico, New York, Oregon, Vermont, Virginia and Washington and the territories of the Northern Mariana Islands and Guam.

Recreational marijuana is legal in 6 tribal nations.

Six Tribal nations have legalized marijuana for recreational use.  Those 6 tribes being the Flandreau Santee Sioux Tribe (South Dakota), Oglala Lakota Sioux Tribe (South Dakota), Suquamish Tribe (Washington state), Squaxin Island Tribe (Washington state), Eastern Band of Cherokee Indians (North Carolina) and St. Regis Mohawk Tribe (New York).

In Contrast – Look At The Anti-Federal U.S. Climate

The Federal Controlled Substances Act (“CSA”) 21 U.S.C. § 812 classifies marijuana as a Schedule 1 substance with a high potential for abuse, no currently accepted medical use in treatment, and lack of accepted safety for use under medical supervision. Although you can still face federal criminal charges for using, growing, or selling weed in a manner that is completely lawful under California law, the federal authorities in the past have pulled back from targeting individuals and businesses engaged in medical marijuana activities. This pull back came from Department of Justice (“DOJ”) Safe Harbor Guidelines issued in 2013 under what is known as the “Cole Memo”.

The Cole Memo included eight factors for prosecutors to look at in deciding whether to charge a medical marijuana business with violating the Federal law:

  • Does the business allow minors to gain access to marijuana?
  • Is revenue from the business funding criminal activities or gangs?
  • Is the marijuana being diverted to other states?
  • Is the legitimate medical marijuana business being used as a cover or pretext for the traffic of other drugs or other criminal enterprises?
  • Are violence or firearms being used in the cultivation and distribution of marijuana?
  • Does the business contribute to drugged driving or other adverse public health issues?
  • Is marijuana being grown on public lands or in a way that jeopardizes the environment or public safety?
  • Is marijuana being used on federal property?

Since 2013, these guidelines provided a level of certainty to the marijuana industry as to what point could you be crossing the line with the Federal government.  But on January 4, 2018, former Attorney General Jeff Sessions revoked the Cole Memo.  Now U.S. Attorneys in the local offices throughout the country retain broad prosecutorial discretion as to whether to prosecute cannabis businesses under federal law even though the state that these businesses operate in have legalized some form of marijuana.

Rohrabacher-Farr Amendment

Building on the DOJ’s issuance of the Cole Memo, in 2014 the House passed an amendment to the yearly federal appropriations bill that effectively shields medical marijuana businesses from federal prosecution. Proposed by Representatives Rohrabacher and Farr, the amendment forbids federal agencies to spend money on investigating and prosecuting medical marijuana-related activities in states where such activities are legal.

The amendment states that:

NONE OF THE FUNDS MADE AVAILABLE UNDER THIS ACT TO THE DEPARTMENT OF JUSTICE MAY BE USED, WITH RESPECT TO ANY OF THE STATES OF ALABAMA, ALASKA, ARIZONA, ARKANSAS, CALIFORNIA, COLORADO, CONNECTICUT, DELAWARE, FLORIDA, GEORGIA, HAWAII, ILLINOIS, INDIANA, IOWA, KENTUCKY, LOUISIANA, MAINE, MARYLAND, MASSACHUSETTS, MICHIGAN, MINNESOTA, MISSISSIPPI, MISSOURI, MONTANA, NEVADA, NEW HAMPSHIRE, NEW JERSEY, NEW MEXICO, NEW YORK, NORTH CAROLINA, NORTH DAKOTA, OHIO, OKLAHOMA, OREGON, PENNSYLVANIA, RHODE ISLAND, SOUTH CAROLINA, TENNESSEE, TEXAS, UTAH, VERMONT, VIRGINIA, WASHINGTON, WEST VIRGINIA, WISCONSIN, AND WYOMING, OR WITH RESPECT TO THE DISTRICT OF COLUMBIA, GUAM, OR PUERTO RICO, TO PREVENT ANY OF THEM FROM IMPLEMENTING THEIR OWN LAWS THAT AUTHORIZE THE USE, DISTRIBUTION, POSSESSION, OR CULTIVATION OF MEDICAL MARIJUANA.

This action by the House is not impacted by the change of position by the DOJ. However, unless this amendment gets included in each succeeding federal appropriations bill, the protection from Federal prosecution of medical marijuana businesses will no longer be in place.  Fortunately, Congress has included this amendment but yet has changed any of the tax or banking laws that pose challenges to the cannabis industry.

Clearly, to avail yourself of the protections of the amendment, you must be on the medical cannabis side and you must be in complete compliance with your State’s medical cannabis laws and regulations. You may not be covered under the amendment if you are involved in the recreational cannabis side even if legal in the State you are operating.

U.S. Tax Law Unfavorable To Cannabis

The Internal Revenue Code treats businesses in the cannabis 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.

U.S. Banking Law Unfavorable To Cannabis

Cannabis-related businesses operate in an environment of cash transactions as many banks remain reluctant to do business with many in the marijuana industry.  A tiny fraction of banks and alternative financial institutions are willing to work with cannabis companies.

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.

IRS Making It Easier For Taxpayers To Come Into The Voluntary Disclosure Program

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IRS Making It Easier For Taxpayers To Come Into The Voluntary Disclosure Program

A tax crime is complete on the day the false return was filed.

It is a federal crime for anyone to knowingly and willfully file an income tax return that he or she knows to be false in some material way. 26 U.S.C. § 7207 provides:

Any person who willfully delivers or discloses to the Secretary any list, return, account, statement, or other document, known by him to be fraudulent or to be false as to any material matter, shall be fined not more than $10,000 ($50,000 in the case of a corporation), or imprisoned not more than 1 year, or both. Any person required pursuant to section 6047 (b), section 6104(d), or subsection (i) or (j) of section 527 to furnish any information to the Secretary or any other person who willfully furnishes to the Secretary or such other person any information known by him to be fraudulent or to be false as to any material matter shall be fined not more than $10,000 ($50,000 in the case of a corporation), or imprisoned not more than 1 year, or both.

In filing false tax return cases, the Government does not need to prove that it has been deprived of any tax by reason of such filing of the false return; even if it is shown that additional taxes may be due, the person can still be held accountable because they willfully filed a false tax return.

Avoiding Criminal Prosecution By Submitting To Voluntary Disclosure

The Voluntary Disclosure Practice is a longstanding practice of IRS Criminal Investigation of taking timely, accurate, and complete voluntary disclosures into account in deciding whether to recommend to the Department of Justice that a taxpayer be criminally prosecuted.  It enables noncompliant taxpayers to resolve their tax liabilities and minimize their chances of criminal prosecution.  When a taxpayer truthfully, timely, and completely complies with all provisions of the voluntary disclosure practice, the IRS will not recommend criminal prosecution to the Department of Justice.  However, if the IRS has initiated a civil examination, regardless of whether it relates to undisclosed foreign accounts or undisclosed foreign entities, the taxpayer will not be eligible to come in under the IRS’s Voluntary Disclosure Practice.

Required Elements Of A Qualified Disclosure

IRS administrative practice recognizes that a taxpayer may still avoid prosecution by voluntarily disclosing a tax violation, provided that there is a qualifying disclosure that is (1) timely and (2) voluntary. A disclosure within the meaning of the practice means a communication that is truthful and complete, and the taxpayer cooperates with IRS personnel in determining the correct tax liability. Cooperation also includes making good faith arrangements to pay the unpaid tax and penalties “to the extent of the taxpayer’s actual ability to pay”.

Timely.

A disclosure is timely if it is received before the IRS has begun an inquiry that is (1) “likely to lead to the taxpayer” and (2) the taxpayer is reasonably thought to be aware” of that inquiry; or the disclosure is received before some triggering or prompting event has occurred (1) that is known by the taxpayer and (2) that triggering event is likely to cause an audit into the taxpayer’s liabilities.

Voluntary.

Voluntari­ness is tested by the following factors: (1) how far the IRS has gone in determin­ing the tax investigation potential of the taxpayer; (2) the extent of the taxpayer’s knowledge or awareness of the Service’s interest; and (3) what part the triggering event played in prompting the disclosure (where the disclosure is prompted by fear of a triggering event, it is not truly a voluntary disclosure).

No voluntary disclosure can be made by a taxpayer if an investigation by the Service has already begun. Therefore, once a taxpayer has been contacted by any Service function (whether it be the Service center, office examiner, revenue agent, or a special agent), the taxpayer cannot make a qualifying voluntary dis­closure under IRS practice.

A voluntary disclosure can be made even if the taxpayer does not know that the Service has selected the return for examination or investigation may be too restrictive. Consequently, if there is no indi­cation that the Service has started an examination or investigation, Tax Counsel may send a letter to the Service stating that tax returns of the taxpayer have been found to be incorrect and that amended returns will be filed as soon as they can be accurately and correctly prepared. This approach has the advantage of putting the taxpayer on record as making a voluntary dis­closure at a time when no known investigation is pending. However, neither the taxpayer nor the lawyer can be completely certain that the volun­tary disclosure will prevent the recommendation of criminal prosecution.

Form 14457, Voluntary Disclosure Practice Preclearance Request and Application

Form 14457 has been revised by IRS permitting taxpayers who may face criminal prosecution for willful violation of tax law to voluntarily disclose information to the IRS that they failed to previously disclose.

Updates and additions to this form include:

  • IRS Criminal Investigation now accepts photocopies, facsimiles and scans of taxpayer signatures. Previously, Part II of Form 14457 had to be mailed.
  • An expanded section for reporting virtual currency.
  • A penalty structure for employment tax and estate and gift issues.
  • A check-box for inability to pay in full.

Doug O’Donnell, Deputy Commissioner Services and Enforcement stated “This is an important form and process for people who recognize it’s better to step forward and address their tax situations head-on, before facing IRS enforcement action.  The revised form includes a number of updates, and we encourage people to review the guidelines and consult a trusted tax professional.”

“Quiet Disclosure”

Where no IRS examination or investigation is pending a taxpayer’s alternative is the preparation and filing of delinquent or amended returns. Such action is called a “Quiet Disclosure”.  The advantage of filing delinquent or amended returns without a communication drawing attention to them is that the returns may not even be examined after being received at the Service Center. In such an event, the taxpayer not only will have made a voluntary disclosure but will have avoided an examination as well. The disadvantage is that during the time the returns are being prepared, the taxpayer may be contacted by the Service and a voluntary disclosure prevented.  Another disadvantage is that the IRS could use the filed amended income tax returns to constitute an admission that the correct income and tax were willfully not reported and institute criminal prosecution.

What Should You Do?

There is no set formula as to whether a taxpayer should pursue a Voluntary Disclosure or Quiet Disclosure.  It really depends on a case by case basis which is why you are best served by consulting with a criminal tax attorney expert in evaluating these matters.  Your financial well being, as well as your personal freedom may depend on the right answers. If you or your accountant even suspects that you might be subject to a criminal or civil tax fraud penalty, tax attorneys of 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 elsewhere in California can determine how to respond to these inquiries and formulate an effective strategy.  Also, if you are involved in cannabis, check out what our cannabis tax attorney can do for you.  Additionally, if you are involved in crypto currency, check out what a bitcoin tax attorney can do for you.Top of Form

 

Funding Limits On Federal Prosecutions Of State-Legal Medical Cannabis

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On February 4, 2022, the Congressional Research Service (“CRS”) issued a report on how different federal courts across the country are interpreting a spending bill rider that has generally shielded state medical cannabis programs from interference by the Department of Justice (“DOJ”).

The Growing Trend In Legalizing Cannabis.

Medical marijuana is legal in 37 states.

The medical use of cannabis is legal (with a doctor’s recommendation) in 37 states and Washington DC. Those 37 states being Alabama, Alaska, Arizona, Arkansas, California, Colorado, Connecticut, Delaware, Florida, Hawaii, Illinois, Louisiana, Maine, Maryland, Massachusetts, Michigan, Minnesota, Mississippi, Missouri, Montana, Nevada, New Hampshire, New Jersey, New Mexico, New York, North Dakota, Ohio, Oklahoma, Oregon, Pennsylvania, Rhode Island, South Dakota, Utah, Vermont, Virginia, 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 18 states.

Eighteen states and Washington DC, have legalized marijuana for recreational use — no doctor’s letter required — for adults over the age of 21. Those 18 states being Alaska, Arizona, California, Colorado, Connecticut, Illinois, Maine, Massachusetts, Michigan, Montana, Nevada, New Jersey, New Mexico, New York, Oregon, Vermont, Virginia and Washington and the territories of the Northern Mariana Islands and Guam.

Recreational marijuana is legal in 6 tribal nations.

Six Tribal nations have legalized marijuana for recreational use.  Those 6 tribes being the Flandreau Santee Sioux Tribe (South Dakota), Oglala Lakota Sioux Tribe (South Dakota), Suquamish Tribe
(Washington state), Squaxin Island Tribe (Washington state), Eastern Band of Cherokee Indians
(North Carolina) and St. Regis Mohawk Tribe (New York).

The Anti-Federal U.S. Climate

The Federal Controlled Substances Act (“CSA”) 21 U.S.C. § 812 classifies marijuana as a Schedule 1 substance with a high potential for abuse, no currently accepted medical use in treatment, and lack of accepted safety for use under medical supervision.

Joyce-Blumenauer Amendment (previously referred to as the Rohrabacher-Farr Amendment)

In 2014 the House passed an amendment to the yearly federal appropriations bill that effectively shields medical marijuana businesses from federal prosecution. Proposed by Representatives Rohrabacher and Farr, the amendment forbids federal agencies to spend money on investigating and prosecuting medical marijuana-related activities in states where such activities are legal.

The amendment states that:

NONE OF THE FUNDS MADE AVAILABLE UNDER THIS ACT TO THE DEPARTMENT OF JUSTICE MAY BE USED, WITH RESPECT TO ANY OF THE STATES OF ALABAMA, ALASKA, ARIZONA, ARKANSAS, CALIFORNIA, COLORADO, CONNECTICUT, DELAWARE, FLORIDA, GEORGIA, HAWAII, ILLINOIS, INDIANA, IOWA, KENTUCKY, LOUISIANA, MAINE, MARYLAND, MASSACHUSETTS, MICHIGAN, MINNESOTA, MISSISSIPPI, MISSOURI, MONTANA, NEVADA, NEW HAMPSHIRE, NEW JERSEY, NEW MEXICO, NEW YORK, NORTH CAROLINA, NORTH DAKOTA, OHIO, OKLAHOMA, OREGON, PENNSYLVANIA, RHODE ISLAND, SOUTH CAROLINA, TENNESSEE, TEXAS, UTAH, VERMONT, VIRGINIA, WASHINGTON, WEST VIRGINIA, WISCONSIN, AND WYOMING, OR WITH RESPECT TO THE DISTRICT OF COLUMBIA, GUAM, OR PUERTO RICO, TO PREVENT ANY OF THEM FROM IMPLEMENTING THEIR OWN LAWS THAT AUTHORIZE THE USE, DISTRIBUTION, POSSESSION, OR CULTIVATION OF MEDICAL MARIJUANA.

This appropriations rider by the House is subject to renewal each year by Congress and while this has been renewed each year it has not extended to recreational cannabis.  Furthermore, Congress yet has changed any of the tax or banking laws that pose challenges to the cannabis industry.

Divergence Of Opinion Among The Federal Courts

On its face, the appropriations rider bars DOJ from taking legal action against the states directly in order to prevent them from promulgating or enforcing medical marijuana laws. In addition, federal courts have interpreted the rider to prohibit certain federal prosecutions of private individuals or organizations that produce, distribute, or possess marijuana in accordance with state medical marijuana laws. In those cases, criminal defendants have invoked the rider before trial, seeking the dismissal of their indictments or injunctions barring prosecution. By contrast, courts have generally declined to apply the rider outside the context of initial criminal prosecutions. The two Federal circuits that have taken up this issue are the 1st and 9th circuits.

In United States v. McIntosh (9th Cir, 2016), the U.S. Court of Appeals for the Ninth Circuit considered the circumstances in which the appropriations rider bars CSA prosecution of marijuana-related activities. The court held that the rider prohibits the federal government only from preventing the implementation of those specific rules of state law that authorize the use, distribution, possession, or cultivation of medical marijuana. DOJ does not prevent the implementation of [such rules] when it prosecutes individuals who engage in conduct unauthorized under state medical marijuana laws. Individuals who do not strictly comply with all state-law conditions regarding the use, distribution, possession, and cultivation of medical marijuana have engaged in conduct that is unauthorized, and prosecuting such individuals does not violate [the rider]. Relying on McIntosh, the Ninth Circuit has issued several decisions allowing federal prosecution of individuals who did not “strictly comply” with state medical marijuana laws, notwithstanding the appropriations rider, and several district courts have followed that reasoning.

In United States v. Bilodeau (1st Cir., 2022), the U.S. Court of Appeals for the First Circuit also considered the scope of the appropriations rider. The defendants in Bilodeau were registered with the State of Maine to produce medical marijuana, but DOJ alleged that they distributed large quantities of marijuana to individuals who were not qualifying patients under Maine law, including recipients in other states. Following indictment for criminal CSA violations, the defendants sought to invoke the appropriations rider to bar their prosecutions. They argued that the rider “must be read to preclude the DOJ, under most circumstances, from prosecuting persons who possess state licenses to partake in medical marijuana activity.” DOJ instead urged the court to apply the Ninth Circuit’s standard, allowing prosecution unless the defendants could show that they acted in strict compliance with state medical marijuana laws. The First Circuit declined to adopt either of the proposed tests. As an initial matter, the court agreed with the Ninth Circuit that the rider means “DOJ may not spend funds to bring prosecutions if doing so prevents a state from giving practical effect to its medical marijuana laws.” However, the panel declined to adopt the Ninth Circuit’s holding that the rider bars prosecution only in cases where defendants strictly complied with state law. The court noted that the text of the rider does not explicitly require strict compliance with state law and that, given the complexity of state marijuana regulations, “the potential for technical noncompliance [with state law] is real enough that no person through any reasonable effort could always assure strict compliance.” Thus, the First Circuit concluded that requiring strict compliance with state law would likely chill state-legal medical marijuana activities and prevent the states from giving effect to their medical marijuana laws. On the other hand, the court also rejected the defendants’ more expansive reading of the rider, reasoning that “Congress surely did not intend for the rider to provide a safe harbor to all caregivers with facially valid documents without regard for blatantly illegitimate activity.” Ultimately, while the First Circuit held that the rider bars CSA prosecution in at least some cases where the defendant has committed minor technical violations of state medical marijuana laws, it declined to “fully define [the] precise boundaries” of its alternative standard. On the record before it, the court concluded that “the defendants’ cultivation, possession, and distribution of marijuana aimed at supplying persons whom no defendant ever thought were qualifying patients under Maine law” and that a CSA conviction in those circumstances would not “prevent Maine’s medical marijuana laws from having their intended practical effect.”

What Should You Do?

Clearly, to avail yourself of the protections of the amendment, you must be on the medical cannabis side and you must be in strict compliance with your State’s medical cannabis laws and regulations. You may not be covered under the amendment if you are involved in the recreational cannabis side even if legal in the State you are operating.

Given the illegal status of cannabis under Federal law you need to protect yourself and your marijuana business from all challenges created by the U.S. government.  Although cannabis is legal in California, that is not enough to protect you. 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.

IRS To Consolidate Processing Centers Despite Huge Backlog Of Unanswered Taxpayer Inquiries

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IRS To Consolidate Processing Centers Despite Huge Backlog Of Unanswered Taxpayer Inquiries

On February 7, 2022 the Treasury Inspector General For Tax Administration (“TIGTA”) issued a report evaluating the IRS’s efforts to close the Fresno California Tax Processing Center and its continued planned closure of the Austin Texas Tax Processing Center.

The IRS entered this filing season with several million original and amended returns filed by individuals and businesses that have not been processed due to challenges of the COVID pandemic.  Yet despite the IRS facing a huge backlog, it continues with its September 2016 plan to consolidate Tax Processing Centers to two end-state sites (Kansas City, Missouri, and Ogden, Utah).

The IRS says that this consolidation is warranted because tax return projections show that electronic filing will continue to increase, resulting in decreased paper processing operations at the Tax Processing Centers. As a result, the IRS continues its Tax Processing Center consolidations and will end its Submission Processing operations in Fresno, California, by September 2021 and Austin, Texas, by September 2024. At the end of this consolidation process, two Tax Processing Center locations, Kansas City and Ogden, will remain.

What TIGTA Found –

As of August 2021, TIGTA estimates that the IRS is facing a total staffing deficiency in its Submission Processing function of around 2,598 employees. Although the IRS has several initiatives underway to help address its hiring shortages, to date these approaches have not been successful. Further, the hiring shortfalls have been exacerbated since the COVID pandemic and are resulting in millions of tax returns not being timely processed, refunds not being timely issued, and taxpayers not timely receiving assistance with their tax account issues.

In addition, the transfer of work not directly related to the processing of tax returns further hampers the Submission Processing function’s ability to deliver its core mission of processing tax returns and addressing tax accounts. For example, the Fresno Tax Processing Center transferred work related to three specialty programs to the Kansas City and Ogden Tax Processing Centers, each of which had and continue to have millions of returns not processed and other account work remaining unworked. This specialty program work requires resources which could otherwise be directed to process the backlogged work.

Finally, outdated mail processing equipment is contributing to the loss of millions of dollars in revenue and the inefficient use of limited resources. This places its operations at risk for inefficient and untimely execution of tax return processing. For example, this outdated equipment cannot properly detect remittances. In Calendar Year 2021 alone, the IRS reports $56 million in lost opportunity costs due to untimely check deposits. Yet the cost to replace or rebuild the current equipment is only a fraction of those lost costs, ranging from $360,000 to $650,000.

TIGTA’s Recommendations to IRS

TIGTA made six recommendations for improvements, including that the IRS postpone the closure of the Austin Tax Processing Center until hiring and backlog shortages are addressed.

Here are the recommendations and IRS’ responses …

# TIGTA Recommendation IRS Response
1 Allocate adequate funding to support Submission Processing function transition of its clerical staff to the new, higher graded position descriptions.

 

 The IRS agreed with this recommendation and has submitted a request for approximately $39 million under the Fiscal Year 2024 budget formulation process to provide a permanent increase in annual funding levels that will support the cost of upgrading the positions and maintaining them at the higher level. IRS management is also evaluating options and the associated trade-offs involved to upgrade the position descriptions from existing appropriations. Additionally, management stated that the recent 2.2% increase to the General Schedule Base Pay Scale, plus the adjustment for locality pay, raised a portion of the affected employees above the $15 per hour rate, which should alleviate some of the pressure of competing with outside employers for workers.

 
2 Postpone any further steps for closing the Austin Tax Processing Center until hiring shortages and backlogs of work at end-state sites are adequately addressed.

 

 The IRS disagreed with this recommendation. IRS management stated that the Submission Processing Center Consolidation revalidation is ongoing and a decision on the Austin consolidation will be made once the revalidation is completed. This decision will then be communicated to all Submission Processing employees.

 
3 Identify and implement interim solutions that will address the resource constraints currently being placed on the Submission Processing function due its backlog.

 

 The IRS agreed with this recommendation and plans to continue meeting with stakeholders on a regular basis to identify interim solutions that accommodate resource needs. IRS management also plans to continue pursuing potential opportunities for automation of data entry into the Treasury Financial Crimes Enforcement Network web portal throughout Fiscal Year 2022.

 
4 Ensure that timely advancements are made to the digital platform of Forms 3949-A, Information Referral To Report Suspected Tax Law Violations By A Person Or A Business, to develop automatic routing of the forms directly to the business units to alleviate the Submission Processing workload.

 

 The IRS agreed with this recommendation and plans to identify those capabilities required to support the implementation of automatic routing of Forms 3949-A directly to business units.

 
5 Evaluate the placement of USDA transcript work if the IRS does not meet its automation targets or the inventories do not continue to decline as anticipated.

 

 The IRS agreed with this recommendation. IRS management shares weekly updates with executive leadership to inform them of the program’s status and confirm proper placement of the USDA transcript program. As of September 20, 2021, automation for the USDA program is shown to be fully paperless, and 3,078 counties have suspended mailing Form CCC-941, Commodity Credit Corporation Average Adjusted Gross Income (AGI) Certification and Consent to Disclosure of Tax Information, requests to the IRS. IRS management has also suspended mailing reject notices to the USDA in lieu of electronic delivery. As anticipated, the inventories declined to the point that all electronic USDA inventory is current and timely.

 
6 Ensure that efforts to evaluate and purchase updated or new mail opening/sorting technology are timely executed.

 

 The IRS agreed with this recommendation and plans to take the actions necessary for the evaluation and purchase of a replacement for the equipment used for opening and sorting mail and ensure that those necessary actions are carried out timely. Because this procurement action is dependent on funding and is subject to competing priorities, IRS management will reevaluate continuing actions if implementation is not successful within three years.

 

An Opportunity For Taxpayers Who Owe The IRS

Do not think that if you owe the IRS your tax problem will disappear because of the measures being considered by the government. Instead you should be utilizing this valuable time to get yourself prepared so that when activity in this nation regains momentum, you are ready to make the best offer or proposal to take control of your outstanding tax debts.

As a prerequisite to any proposal to the IRS, you must be in current compliance. That means if you have any outstanding income tax returns, they must be completed and submitted to IRS.

Also, if you are required to make estimated tax payments, you must be current in making those payments. Fortunately, as we are now in 2022, taxpayers who expect to owe for 2021 should have their 2021 income tax returns done now so that the 2021 liability can be rolled over into any proposal and the requirement to make estimated tax payments will now start for 2021.

Remember that COVID does not alter the tax laws, so all taxpayers should continue to meet their tax obligations as normal. Individuals and businesses should keep filing their tax returns and making payments and deposits with the IRS, as they are required to do.

Also, the IRS will continue to take steps where necessary to protect all applicable statutes of limitations. In instances where statute expirations might be jeopardized during this period and a taxpayer is not agreeing to extend such, the IRS will issue Notices of Deficiency and pursue other similar actions to protect the interests of the government in preserving such statute.

The take away from this – use the Federal government’s downtime to your advantage to prepare for the future.

What Should You Do?

You know that at the Law Offices Of Jeffrey B. Kahn, P.C. we are always thinking of ways that our clients can save on taxes. If you are selected for an audit, stand up to the IRS by getting representation. Tax problems are usually a serious matter and must be handled appropriately so it’s important to that you’ve hired the best lawyer for your particular situation. The tax attorneys at the Law Offices Of Jeffrey B. Kahn, P.C. located in Orange County (Irvine), Los Angeles (including Long Beach and Ontario) and elsewhere in California are highly skilled in handling tax matters and can effectively represent at all levels with the IRS and State Tax Agencies including criminal tax investigations and attempted prosecutions, undisclosed foreign bank accounts and other foreign assets, and unreported foreign income. Also if you are involved in cannabis, check out what a cannabis tax attorney can do for you.  And if you are involved in cryptocurrency, check out what a bitcoin tax attorney can do for you.

IRS Continues To Expand Tax Relief From COVID

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IRS Continues To Expand Tax Relief From COVID

On February 9, 2022 the IRS announced additional relief for taxpayers suspending the mailing of certain enforcement letters.

IRS Coronavirus Tax Relief

The IRS has established a special section focused on steps to help taxpayers, businesses and others affected by the coronavirus and as information becomes available, the IRS will be updating this special page on its website.

The executive branch of the Federal government declared the coronavirus pandemic a national emergency. Therefore, under Sec. 7508A, the declaration of an emergency under the Robert T. Stafford Disaster Relief and Emergency Assistance Act, P.L. 100-707, the IRS is allowed to delay certain tax filing and payment deadlines.  While the IRS has not delayed the filing deadlines for 2021 tax returns, as part of ongoing efforts to provide additional help for people during this period the IRS is suspending more than a dozen additional letters, including the mailing of automated collection notices normally issued when a taxpayer owes additional tax, and the IRS has no record of a taxpayer filing a tax return.

Suspended IRS Notices

The IRS entered this filing season with several million original and amended returns filed by individuals and businesses that have not been processed due to challenges of the COVID pandemic.  With the IRS facing a huge backlog, it had to take this step to help avoid confusion for taxpayers and tax professionals.

The suspended notices include:

Individual Taxpayer Notices
Notice/Letter Number Title Description
CP80 Unfiled Tax Return This notice is generally sent when the IRS credited payments and/or other credits to a taxpayer’s account for the tax period shown on the notice, but the IRS hasn’t received a tax return for that tax period.
CP59 and CP 759 (Spanish) Unfiled Tax Return(s) – 1st Notice IRS sends this notice when there is no record of a prior year return being filed.
CP516 and CP616 (Spanish) Unfiled Tax Returns – 2nd Notice Request for information on a delinquent return as there is no record of a return filed.
CP518 and CP618 (Spanish) Final Notice – Return Delinquency This is a final reminder notice when there is no record of a prior year(s) return filed.
CP501 Balance Due – 1st Notice This notice is a reminder that there is an outstanding balance on a taxpayer’s accounts.
CP503 Balance Due – 2nd Notice This notice is the second reminder that a there is an outstanding balance on a taxpayer’s accounts.
CP504 Final Balance Due Notice – 3rd Notice, Intent to Levy The IRS sends this notice when a payment has not been received for an unpaid balance. This notice is a Notice of Intent to Levy (Internal Revenue Code Section 6331 (d)).
2802C Withholding Compliance letter This letter is mailed to taxpayers who have been identified as having under-withholding of Federal tax from their wages. This letter provides instructions to the taxpayer on how to properly correct their tax withholding.
Business Notices
CP259 and CP959 (Spanish) Return Delinquency IRS sends this notice when there is no record of a prior year return being filed.
CP518 and CP618 (Spanish) Final Notice – Return Delinquency This is a final reminder notice that we still have no record of a prior year tax return(s).

These automatic notices have been temporarily stopped until the backlog is worked through. The IRS says it will continue to assess the inventory of prior year returns to determine the appropriate time to resume the notices.

While the suspension of these notices started February 9th, some taxpayers may still receive these notices during the next few weeks as they were in the works of being sent or generated prior to today. Also, keep in mind that this suspension does not cover all IRS notices as many are legally required to be issued within a certain timeframe.

An Opportunity For Taxpayers Who Owe The IRS

Do not think that if you owe the IRS your tax problem will disappear because of the measures being considered by the government. Instead you should be utilizing this valuable time to get yourself prepared so that when activity in this nation regains momentum, you are ready to make the best offer or proposal to take control of your outstanding tax debts.

As a prerequisite to any proposal to the IRS, you must be in current compliance. That means if you have any outstanding income tax returns, they must be completed and submitted to IRS.

Also, if you are required to make estimated tax payments, you must be current in making those payments. Fortunately, as we are now in 2022, taxpayers who expect to owe for 2021 should have their 2021 income tax returns done now so that the 2021 liability can be rolled over into any proposal and the requirement to make estimated tax payments will now start for 2021.

Remember that COVID does not alter the tax laws, so all taxpayers should continue to meet their tax obligations as normal. Individuals and businesses should keep filing their tax returns and making payments and deposits with the IRS, as they are required to do.

Also, the IRS will continue to take steps where necessary to protect all applicable statutes of limitations. In instances where statute expirations might be jeopardized during this period and a taxpayer is not agreeing to extend such, the IRS will issue Notices of Deficiency and pursue other similar actions to protect the interests of the government in preserving such statute.

The take away from this – use the Federal government’s downtime to your advantage to prepare for the future.

What Should You Do?

You know that at the Law Offices Of Jeffrey B. Kahn, P.C. we are always thinking of ways that our clients can save on taxes. If you are selected for an audit, stand up to the IRS by getting representation. Tax problems are usually a serious matter and must be handled appropriately so it’s important to that you’ve hired the best lawyer for your particular situation. The tax attorneys at the Law Offices Of Jeffrey B. Kahn, P.C. located in Orange County (Irvine), Los Angeles (including Long Beach and Ontario) and elsewhere in California are highly skilled in handling tax matters and can effectively represent at all levels with the IRS and State Tax Agencies including criminal tax investigations and attempted prosecutions, undisclosed foreign bank accounts and other foreign assets, and unreported foreign income. Also if you are involved in cannabis, check out what a cannabis tax attorney can do for you.  And if you are involved in cryptocurrency, check out what a bitcoin tax attorney can do for you.