Cannabis 280E Audits Incoming
Do You Know What To Expect?

Tax expert and IRS trial lawyer Nick Richards has issued a warning for the cannabis commerce industry – 280E audits are on the way. According to Richards, recent changes in IRS policy could lead to audits and subsequent fines and collected taxes that would amount to millions.

What Is Section 280E?

26 U.S. Code Section 280E is the federal statute that states that a business engaging in the trafficking of a Schedule I or II controlled substance, such as cannabis, is barred from taking tax deductions or credits.

In layman’s terms, cannabis entrepreneurs are required to pay taxes on all of their revenue without the benefit of being able to use business expenses to reduce their taxable income.

Why Does Section 280E Apply To Cannabis Retailers?

While it has been argued that 280E shouldn’t apply to legal cannabis companies, in two key court cases in 2018, Tax Court ruled against:

• Harborside (Oakland, California) argued that 280E shouldn’t apply, but lost when the Tax Court ruled that it applies to any Schedule 1 narcotics, even those legalized by state governments (such as cannabis).
• Alternative Health Care (Los Angeles, California) attempted to circumvent 280E taxes by hiring a management company to handle their storefront. When they lost, the precedent was set that 280E would also apply to third parties included in the profit chain.

Will This Only Affect Cannabis Retailers?

No – the change in policy will also allow for 280E audits of ancillary management companies, such as those that lease property to cannabis businesses, landlords, and anyone else that directly profits from cannabis sales.

How Will Audits Be Carried Out?

An IRS program, known as the Compliance Initiative Project, is tasked with auditing the state-legal cannabis industry. It was originally meant to only examine businesses in Colorado, but as states have continued to legalize cannabis, its scope has been expanded.

This program uses an audit technique guide based on the Colorado cannabis industry, which will help auditors to consider what could be years of missing tax forms that are required for cash payments of more than $10,000, which could mean penalties amounting to millions of dollars.

What Can You Do To Prepare?

• Incorporate: Always a smart move for those trying to limit tax burdens, small businesses should consider becoming a Corporation or Limited Liability Corporation. In the case of 280E, the former is the smarter choice. 280E disallows deductions and creates “phantom income” that flows through to owners and creates personal income tax, meaning owners of LLCs get taxed on income they never received.
• Document Absolutely Everything: Don’t let a single expense go by without documenting it. In an audit, you’ll need to detail your cost of goods sold, and if you can’t prove what you claim with documentation, you’ll be at risk of fines.
• Categorize Your Employees: Specifically assigning roles to each employee allows for more accurate reporting on wages, and lower risk of fines.
• Work With The Experts: In addition to consulting a tax attorney like Richards, make sure every aspect of your business is supported by an expert in their field. That includes your IT, especially given how crucial it is to your documentation and compliance. Partner with Veo Verde to have your compliance practices double-checked and supported by the right technology.

 

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