Patrick Cox and Elizabeth Sheldon of Tax Defense Partners spoke at our September event in LA. They review, at a high level, why the cannabis industry is so different when it comes to taxes (280E, 263A, etc.), what to do to help avoid an audit, and when you are audited or have a tax problem, how you can resolve it.
After the event, I asked Elizabeth a few follow up questions. My notes, based on her answers, are below.
What are a few things Cannabis businesses can do to stay safe in case they eventually are audited? What are common mistakes?
1. Bookkeeping habits – just because you have no bank account, don’t be lax on your bookkeeping. Have records of money coming in and out, scans, copies of receipts, etc. to prove the deductions you’re taking. To begin most audits, the IRS looks at bank statements to start. But cannabis businesses don’t have a breadcrumb trail through bank accounts that most businesses have. So keep your receipts for every widget you bought, because you’ll have to prove it as a legitimate expense / deduction. When you don’t have the benefit of a bank account, you do have the benefit of your transaction receipts.
2. A lot of preparers may be good tax preparers but they don’t have experience in the cannabis industry. Because of case law (CHAMP and OLIVE) and 280E, there are a lot of deductions that are not available to cannabis business owner. The accountant treats you like any other business and your accounting won’t hold water in an audit and will result in additional penalties and interest assessments. You may wind up owing more because of their professional shortcomings.
A common mistake made by growers: if you have orchestrated a sale of product and hired an armored vehicle to deliver product to client, a typical CPA might think you can deduct this as a business expense (delivery fees) but a grower can’t take that because you’re “trafficking” an elicit substance.
A common mistake made by dispensary owners: the budtender can be deducted as a consult, especially if they are a medical professional, but at the cash register, the salary / wages of the person running the cash register can’t be deducted, because they’re trafficking a schedule 1 controlled substance. A typical CPA may think that it’s ok to roll that wage into employee expense.
What are some tactics businesses can use once they do get audited? Common things business owners may not know about their rights related to the IRS?
You have a right to representation. If you are not a tax professional who can explain tax returns to an IRS agent, hire a tax professional. Just because you had some deductions that cannot be written off under 280E, doesn’t mean that you have to give in and let them disallow all expenses, including those that don’t relate to 280E.
File Tax Court petitions because a revenue agent / auditor may not work with you whereas an IRS attorney/counsel will.Generally, IRS counsel is very anxious to resolve the case. they don’t want to go to court, they want to settle. So anything you can share with them to prove that something is an allowable expense (such as proving that your budtender is a registered nurse and you’re taking an employee expense related to consultation). Don’t give up just because the IRS says no. If you have good representation, and know you’re right, fight to the end to get every legitimate deduction.The balance due notice from the IRS is not the end point, but the starting point.
Once an audit is completed and the IRS assesses any penalties, fight the penalties. There are lots of opportunities to bring that initial balance owed down.
Can you give some details of case law that has shaped cannabis Tax law? E.g. the outcome for the cannabis industry of CHAMP? OLIVE?
The CHAMP case is the seminal case in this space right now.The walk away for tax professionals in the cannabis industry were twofold:First, diversifying services will help offset otherwise disallowed expenses.That is, CHAMP was recognized more as a care giving business than a dispensary.As such, the expenses for the caregiving arm of CHAMP were allowed.The other arm gave us some guidance under Cost of Goods Sold, or COGS, as allowable expenses.
The Olive case, while decided against the dispensary, was helpful in flushing out the COGS expenses.It also suggested that the federal courts were going to give CHAMP some weight, even though tax court decisions are not binding on the federal circuit courts.So Olive was very helpful.
Growers, Brands / Manufacturers (edibles, vape pens), Dispenaries – who can deduct more COGS? Can you give some examples of the COGS each group can and cannot deduct?
Tax professionals should be reviewing business structure and deciding on a per client basis, what deductions are allowable.