The Internal Revenue Service is after cannabis companies in Colorado, sparking uncertainty and unease among cannabis businesses. The newest audits are focusing on Form 8300, which is the form used to report cash transactions of $10,000 or more. The IRS is investigating large cash transactions which have been processed by these businesses for evidence of money laundering and under-reporting of business income. While some marijuana-related businesses in Colorado have already been able to settle their Form 8300 audits, other business owners are dealing with audits from the IRS regarding Section 280E. This article is intended to help marijuana related business mitigate their potential exposure to an IRS audit.
For cannabis companies, an IRS audit doesn't only come along with the risk of having to pay additional tax liabilities, the businesses may also be hit with fraud or other criminal charges because cannabis is still considered to be an illegal drug under federal statutes. Generally, businesses that earn $200,000 can expect to be audited at a higher rate than businesses that earn less than this amount. Underreporting your income is one of the top IRS red flags and with cannabis-related businesses dealing in cash, it is fairly easy for these businesses to come under the scrutiny of the IRS. Until the law changes, every cannabis company is at a substantially higher risk of being audited by the IRS than other types of business. As a result, it is extremely important for your business to follow these best practices so that you can reduce your chances of being audited. 1. Maintain Careful Records and Copies. The more your business makes, the higher the chances are of an audit. This is because you are likely to be required to file Form 8300 for multiple transactions that were conducted. In addition, if your business takes large deductions for cost of goods sold (COGS), the IRS may wish to examine your deductions more closely. Make sure that you maintain copies of all filed tax forms and receipts for all of the items that you claimed as a part of your COGS deductions. 2. Make Sure to File on Time. While it may seem obvious that you should file your returns on time, it can be difficult to keep up with the forms and due dates for marijuana-related businesses since the rules seem to change each year. Having a qualified tax professional prepare your taxes can help you keep on top of the legal requirements for your business. Here are the annual deadlines that companies should be aware of: ● Corporation income tax returns (Forms 1120 and 1120-S) are due by March 15th for S corporations and April 17, 2017 for C corporations. ● Partnership tax returns (Form 1065) are due by March 15, 2017. 3.Comply With All State Laws. Make sure that you have properly disclosed all of the activities of your business and any related party interest to your lawyer and CPA to ensure that your business is in compliance with state law. To find out more about the laws that apply to cannabis-related businesses in each state, go to: ● Alaska: Alcohol & Marijuana Control Office ● Washington: Washington State Liquor and Cannabis Board ● Oregon: Oregon Department of Revenue Marijuana Tax Program ● Colorado: Colorado Department of Revenue: Marijuana Taxes ● California: California Board of Equalization: Marijuana Being in violation of state law puts your business at a much greater risk of audit because the federal government's current policy is to investigate cannabis-related businesses that violate both federal and state laws. No matter how many precautions you take, there is absolutely no guarantee that your business won't be audited by the IRS. However, using the tips above can lessen your chances but you should still make sure to maintain, thorough, well-organized records just in case. If you have any additional questions, please feel free to contact us. If you own or plan to own a cannabis business, it’s important to know that getting financial support from most banks will be difficult to do—but resources are available to help. We’ve put together a quick checklist for things to consider when trying to set up banking with your Marijuana business.
In 2014, the United States Department of the Treasury’s Financial Crimes Enforcement Network (FinCEN) issued guidance for financial institutions on this matter. Their goal was to clarify the expectations of the Bank Secrecy Act—which requires financial institutions to detect and prevent money laundering—in light of recent state initiatives to legalize marijuana. By looking at FinCEN’s guidelines for financial institutions, marijuana-related business owners can get a good idea of what they need to do in order to give themselves the best chance of receiving financial support from these institutions. Below are some things to keep in mind: Have you submitted an application and supporting documents for a state license? It is imperative that you obtain the proper state license to operate if you wish to receive any financial support. Financial institutions want to be sure that you are legally allowed to operate your business, otherwise they could face consequences for funding your business. Are you duly licensed through the local authorities? Occasionally, local jurisdictions require further licensing or have restrictions on marijuana-related businesses altogether. Be sure that in addition to your state license, you also are legally allowed to operate locally and licensed if needed. Have you properly vetted other parties you do business with? If you are doing business with other cannabis-related parties, you will want to vet them to make sure they are properly licensed and documented as well. Any affiliation with an unlicensed or improperly maintained third party could reflect poorly on you. Have you properly vetted your employees? In a similar vein to vetting any businesses you associate with, you also will want to ensure that your employees have no previous criminal records, especially those relating to money laundering or illegal drug trafficking. Do you have a policy in place for the products you will sell and customers you will serve? It is important to thoroughly document the type of business you do, as there are big differences depending on whether you sell or produce medical marijuana as opposed to recreational marijuana. Keep track of everything your business does in some way. Do you have a good understanding of your business’ reputation? Stay on top of current rulings and regulations so as not to fall out of compliance with authorities on a state or local level. Do you fully understand the Cole Memorandum and your state’s laws? Having an understanding of what is legally expected of you is imperative, because if you violate a state law or the Cole Memorandum in any way, financial institutions have every right to immediately pull their support and report your business. Can you demonstrate a legitimate source of significant outside investments? This is something that all businesses should do, regardless of whether they are marijuana-related or not. Financial institutions are more open to providing financial support if they can see that other institutions or investors have faith in your business. Summary: Because of the Bank Secrecy Act, failing to follow any of these guidelines might result in worse than just losing financial support. Depending on the severity of the situations, it may be the financial institution’s responsibility to report you and your business, resulting in being shut down and, possibly, legal ramifications. In the end, it is your responsibility to be diligent and transparent about your business’ operations if you wish to obtain or continue receiving financial support from an institution. If you have any questions with regards to this, please don’t hesitate to contact us. Many cannabis-related businesses would like to take deductions for the costs related to their business activities. However, the tax code, Internal Revenue Code (“IRC”), has some very specific provisions regarding the businesses that are permitted to take cost of goods sold (COGS) deductions and which expenses may be included. COGS is at the core of all marijuana related businesses as its one of the key factors to reducing your taxable income.
Although figuring out which deductions are permitted can be tricky, it's in your best interest to claim all of the deductions that your business is allowed. COGS is a important deductions that marijuana-related businesses are allowed and can have a considerable effect on the effective tax rate for your business. Consider the following examples: Example 1. For a business with gross receipts totaling $776,772, a business with a high COGS could deduct $435,829, leaving a gross income of $340,953. Thanks to these allowed deductions, this business paid taxes on $340,953 instead of on $776,772. As a result, the business’s effective tax rate was 44% of its final earnings. Example 2. For a business with gross receipts totaling $776,772 and a low COGS with only $50,000 in COGS deductions, the gross income of the business was $726,772. Therefore, this business would pay taxes on $726,772. For this business, the effective tax rate was 94% of its final earnings. Simply taking COGS deductions rendered a 50% difference in the effective tax rate of each of these two businesses! As a result, claiming deductions for COGS could mean substantial tax savings for your business. Here is a quick guide to help you understand what COGS deductions are permitted for your cannabis-related business. Cannabis-related Businesses and Claiming COGS Although, cannabis-related businesses are currently illegal under federal law, every business in this industry is still obligated to pay federal income tax on its taxable income because IRC § 61(a) does not differentiate between income that has been earned from legal sources and income that has been earned from illegal sources. In 1982, Congress enacted § 280E, which prohibits deductions and credits for businesses trafficking in controlled substances. However, in a later case, Californians Helping to Alleviate Medical Problems, Inc., v. Commissioner, 128 T.C. 173 (2007) (“CHAMP”), the government acknowledged that § 280E does not prohibit a taxpayer from claiming COGS. In other cases involving non-medical marijuana or other Schedule I controlled substances, the Tax Court recognized that § 280E does not disallow adjustments to gross receipts for COGS. Chief Counsel Advice (CCA) 201504011 As a result of these rulings, the IRS determined that marijuana-related businesses could claim certain COGS deductions. On Jan. 23, 2015, the IRS Office of Chief Counsel issued Chief Counsel Advice (CCA) 201504011 to clarify that although deductions may not be claimed for trafficking marijuana, the CCA allows a cost-of-sales deduction for indirect production-related business expenses. The memo concluded that although marijuana-related businesses are permitted to determine COGS, they must do so using the § 280E as it was enacted in 1982 and § 471, which makes the provision for the use of inventories to determine business income. When §280E was enacted in 1982, an ‘inventoriable cost’ referred to any costs that could be capitalized to inventories under §471. Capitalization simply means delaying the recognition of an expense by treating the item as a fixed asset rather than recognizing the cost in the period that it was incurred. Capitalization is generally only used by companies that operate on the accrual basis of accounting. In addition, the IRS concluded that these businesses are not permitted to calculate COGS using the more recent IRS regulations which can be found in § 263A, which permitted the inclusion of additional expenses, namely purchasing, handling and storage expenses, and service costs. In order to claim any of the permitted deductions, the items must be “ordinary and necessary” within the meaning of § 162. IRC § 162 is one of the most important sections in the tax code because it defines what a deduction is. The IRC requires six different elements to claim an item as a business expense in order to claim a deduction. These elements are that the cost is: 1. Ordinary and necessary; 2. In carrying on; 3. A trade or business activity; 4. That it is an expense; and 5. That it was paid or incurred during the taxable year for which the return will be filed. The IRS findings explain what a deduction is and which expenses could be considered as COGS. Finally, it should be noted that the IRS concluded that the IRS has broad authority to require the marijuana-related business to change its method of accounting and to challenge the deductions claimed. What Expenses Can Be Considered as COGS? The IRS has made specific provisions for marijuana resellers versus producers. For Resellers CCA 201504011 clarified that, for resellers, the costs that they incur that are otherwise nondeductible under § 280E may not be deducted as COGS. These costs that are non-deductible are those that are directly related to the trafficking of marijuana. For resellers, this means that only the invoice price of purchased cannabis, less any trade or other discounts, as well as, the transportation and other costs necessary to gain possession of the inventory can be considered as COGS. For Producers For cannabis-production businesses, there are significantly more opportunities to claim items as COGS. Production-related wages, rents, and repair can be considered as COGS upon the sale of the inventory for accrual-basis taxpayers and immediately for cash-basis taxpayers that are cannabis-production businesses. However, marketing and general business expenses remain nondeductible. Indirect production costs that may be considered as COGS include: ● Repair expenses, ● Maintenance, ● Utilities, ● Rent, ● Indirect labor and production supervisory wages, including basic compensation, overtime pay, vacation and holiday pay, sick leave pay (other than payments pursuant to a wage continuation plan under section 105(d)), shift differential, payroll taxes and contributions to a supplemental unemployment benefit plan, ● Indirect materials and supplies, ● Tools and equipment not capitalized, and ● Costs of quality control and inspection, only if these costs are incident to and necessary for the production of cannabis. If these expenses are not related to cannabis production then they are nondeductible. The IRS has also permitted producers to claim some additional COGS deductions, as long as the company makes sure to produce financial statements that are in accordance with Generally Accepted Accounting Principles (GAAP). These expenses include: ● Taxes deductible under § 164, other than state, local, and foreign income taxes; ● Depreciation and depletion; ● Deductible employee benefits, including pension and certain profit sharing contributions, workers' compensation expenses, stock bonus plans, premiums on life and health insurance, and miscellaneous employee benefits such as safety, medical treatment, cafeteria, recreational facilities, and membership dues; ● Costs pertaining to strikes, rework labor, scrap, and spoilage; ● Administrative expenses related to production; ● Officers' salaries related to production; and ● Insurance costs related to production. While the provisions of the tax code do give some cannabis-related businesses the opportunity for some tax breaks, the IRS does not allow such businesses to take the same deductions as businesses in other industries. However, the repeal of § 280E of the IRC could make the burden lesser for cannabis-related businesses who have reported tax liabilities of up to 70% of their income. In addition, these rules could change at any time. Until the law changes, it is important for all businesses in this industry to establish proper record keeping in order to meet IRS requirements. If you have any questions, please feel free to contact us. The Financial Crimes Enforcement Network (“FinCEN”), a bureau of the U.S. Department of the Treasury that is responsible for receiving, maintaining, and analyzing the financial transactions data of businesses for law enforcement purposes, has issued guidance in order to clarify the Bank Secrecy Act (“BSA”) expectations for financial institutions which seek to provide banking services to marijuana-related businesses. The BSA requires U.S. financial institutions to assist U.S. government agencies to detect and prevent money laundering.
These updates have been made because there is has much confusion among the nation’s financial institutions on how to legally conduct business with marijuana-related businesses. As of 2016, certain marijuana-related activities have been legalized in 25 states and the District of Columbia. The Cole Memo At the same time, the U.S. Department of Justice Deputy Attorney General James M. Cole issued a memorandum (the "Cole Memo"), to provide guidance to federal prosecutors concerning marijuana enforcement under the Controlled Substances Act (“CSA”), which makes it illegal under federal law to manufacture, distribute, or dispense marijuana. The memo reiterates Congress’s determination that marijuana is a dangerous drug and that the illegal distribution and sale of marijuana is a serious crime that provides a significant source of revenue to large-scale criminal enterprises, gangs, and cartels. The U.S. Justice Department has offered assurances that it will not pursue criminal charges against marijuana-related businesses that are operating legally under state law. However, this non-enforcement stance has not guaranteed any protection for financial institutions. Guidance for Financial Institutions The FinCEN guidance clarifies how financial institutions can work with marijuana-related businesses while also making sure that their policies are inline with the marijuana enforcement activities of the U.S. Department of Justice under the CSA. Financial institutions have been advised under the BSA to conduct due diligence for each customer to determine the risks of providing services to such business. The due diligence should include a thorough review of the business's registration and licensing with state authorities. Financial institutions are also required to monitor these business on an ongoing basis and file suspicious activity reports ("SARs") where warranted. Three types of SARs may be filed, namely: ●“Marijuana Limited” SAR Filing. This report should be filed by the financial institution solely because the business is a marijuana-related entity and not because the business has violated state law or one of the Cole Memo priorities. ●“Marijuana Priority” SAR Filing. This report should be filed by the financial institution primarily in the case that the business violates state law or the priorities of the Cole Memo. ●“Marijuana Termination” SAR Filing. This report should be filed in the event that the financial institution wants to terminate the relationship with the business due to suspicion that illegal activity is taking place and to maintain the anti-money laundering compliance program of the financial institution. Currency Transaction Reports ("CTRs") and Form 8300 are also required by FinCEN's regulations for financial institutions that offer services to any business that engages in marijuana-related activity. Despite these updated guidelines, the fact that marijuana is still illegal under federal law but has been legalized in certain states has made almost all financial institutions outright reject doing business with marijuana-related businesses. What Are the Banking Alternatives for Dispensary Owners? At present, the majority of dispensaries are forced to pay their employees and vendors in cash while customers use an ATMs to obtain cash for purchases because of the conflicting laws for financial institutions. However, there is hope that the law may change in the near future. The H.R.2029 - Consolidated Appropriations Act, 2016 bill, recently signed by President Obama, has a single sentence contained within the bill that says that the Department of Justice may not use money appropriated to it to prevent states from implementing laws regarding medical marijuana. However, banking reform was not specifically included within the bill. In the meantime, alternative banking options are emerging for marijuana-related businesses that have been turned down by banks or do not meet the requirements of major financial institutions. Marijuana-related businesses can use online business directories and other industry resources to find payment solutions. A number of payment processors have stepped up to provide transaction processing without the cash. Cashless ATMs for marijuana-related businesses are available from payment processors including Meta Payment Systems, Best Point of Banking, GreenStar Payment Solutions, Medical Cannabis Payment Solutions, and First American Merchant Funding. Despite the fact that cryptocurrencies have been used in black market purchases of marijuana, they may also soon be used to help dispensary owners collect payments from customers. Cryptocurrencies, including Bitcoins, and PotCoins, are emerging as viable options for legal marijuana-related businesses. |