Webinar Takeaways: IRS Cannabis Taxes and Enforcement
On April 13th, I moderated a webinar about cannabis taxes called “IRS Enforcement of Cannabis Operators is Here – What Do We Do Now?“. Cannabis taxes should scare anyone in the industry, but federal incomes taxes under I.R.C. 280E probably take the cake when it comes to general anxiety. Our webinar featured Ani Gaylan and Jonathan Kalinski who are both tax attorneys from Los Angeles, representing clients in the cannabis industry facing 280E audits and controversy cases. Jonathan even handles the criminal aspect when the IRS comes calling. If you didn’t attend the webinar, below are the key takeaways about cannabis taxes and the IRS.
It’s not a matter of “if” but “when” for audits on cannabis taxes
Ani and Jonathan both agree that the IRS is ramping up its pursuit of audits against cannabis businesses. In case you forgot, I.R.C. 280E dictates that, if you traffic in a schedule I or II controlled substance (and cannabis is in schedule I), you cannot take normal business deductions or credits. You only get Costs of Goods Sold (“COGS”). The effective corporate income tax rate then for cannabis businesses is sky high, unless those businesses can capture more COGS.
The IRS has a handy, user-friendly online resource to help cannabis companies with reporting their cannabis taxes, but it is clear that agents are more aggressively pursuing cannabis businesses in the form of audits. Both Ani and Jonathan have seen a significant uptick in IRS cannabis tax audits, and that’s unlikely to change anytime soon since (1) the IRS realized awhile back that it was potentially leaving money on the table under I.R.C. 280E given that lots of cannabis commerce is still all cash; and (2) we now have more data than ever on who’s running a cannabis business and where they’re at in the country (including filed tax returns and suspicious activity reports with financial institutions). As far as back as 2021 (and probably earlier), the IRS has been training its agents with specific regard to cannabis tax audits (as shown by MJbiz Daily’s 2021 FOIA request).
A cannabis tax audit is not your run-of-the-mill audit
Information document requests (“IDRs”) from the IRS are very different for a cannabis businesses than any other business. For example, in a cannabis audit, the IRS will ask for any bank account or credit card used in the operation of the business. This doesn’t happen in a standard audit. The other major difference is that the IRS will want to get in front of a cannabis businesses immediately, including meeting in person and touring the cannabis facility. Both Ani and Jonathan echoed the fact that you’ll want legal counsel ASAP for any IRS interview (some of which can last up to 3-4 hours). Your document retention and organization also needs to be top-flight (with a bookkeeper and/or accountant in tow) to successfully handle an IRS interview as part of an audit.
The IRS has summons power
Sometimes, cannabis businesses think that, just because they’re violating the Controlled Substances Act, they have a license to violate other federal laws. Not so. If cannabis businesses think they can clam up and/or not produce the requested information or documents pursuant to an IDR, they have another thing coming. This is because the IRS has summons power: the IRS can and will demand your presence and your documentation production, which you must comply accordingly or you’re going to be in big trouble with the Department of Justice.
If you don’t comply with these broad IRS powers, you can fully expect penalties and maybe even criminal investigation and prosecution depending on the facts surrounding the audit. The summons power also applies to third parties implicated in the cannabis trafficking (including ancillary businesses). So, timely and fully cooperate with your IDRs accordingly.
Don’t make up documents when it comes to cannabis taxes
It goes without saying that you should never lie to the IRS. However, you also shouldn’t make up documents to satisfy an IDR request. Per Ani and Jonathan, you won’t get in trouble if you don’t have a document on the list. You will suffer, though, if you start making up or backdating documents (like cash logs) to get through an IDR.
The DOJ can prosecute for more than tax evasion
Tax evasion always comes to mind when people think of IRS criminal investigation and prosecution. However, during the webinar, Jonathan pointed out that that’s really just the tip of the iceberg. Depending on what you’re doing when it comes to hiding your money from the IRS, you could also face a conspiracy charge or charges for structuring, or fraud, among other non-tax related criminal charges.
The webinar revealed that these audits are actually not public information. In fact, there are severe penalties if the government breaches confidentiality. Administrative appeals from the results of an audit also aren’t public information. However, if after the appeal, you petition the U.S. tax court, things become public due to those filings. Any recorded government liens resulting from tax liabilities will also be made public (the liens, not the liabilities).
In the end, cannabis companies should timely pay all taxes owed to the IRS under I.R.C. 280E. The IRS is not an agency with which you want to get cute or experiment. While the cannabis industry is oftentimes a “ask for forgiveness” industry, when it comes to federal income taxes, this is not one of those times.