By: Nick J. Richards, Esq. and Sabrina Strand, Esq .
Section 2301 of the CARES Act created a tax credit for employers who paid qualified wages during the coronavirus pandemic. The Employee Retention Tax Credit (ERC) was available to companies that were impacted by the coronavirus, and many cannabis companies were adversely impacted. Some were deemed “essential” and had to stay open during the pandemic despite the higher costs associated with continued operations during the pandemic and various restrictions that rendered it much more difficult to visit their stores. Many of these companies applied for the ERC and have received it.
Internal Revenue Code (IRC) Section 280E disallows all deductions and credits for amounts related to businesses “trafficking in controlled substances” (within the meaning of schedule I and II of the Controlled Substances Act). When the ERC first came out, there was a question as to whether it was available to cannabis companies because it creates a tax credit that Section 280E may disallow. There was also an argument that it didn’t apply to the ERC, because Section 280E is part of Section A of the IRC, which concerns income rather than employment taxes. At least one court now disagrees.
In Solstice Holdings Inc. v. U.S.1, the U.S. District Court held that the ERC was not available to cannabis companies. Specifically, the court held that Section 280E was not limited to Section A of the IRC because it did not specifically include any limit. IRC Section 7806(b) provides, “No inference, implication, or presumption of legislative construction shall be drawn or made by reason of the location or grouping of any particular section or provision or portion of this title.” As such – the court held that IRC Section 280E also disallows the tax credit that the ERC created. According to the court:
Nothing in the plain text of Section 280E limits its application to income tax credits. Other provisions in the Internal Revenue Code expressly limit the application of its sections to specific subtitles. See e.g. 26 U.S.C. § 62(a) (defining adjusted gross income “[f]or purposes of this subtitle”). That Congress did not so limit Section 280E suggests that it applies to preclude the ERC here.
The opinion is from the 9th Circuit and technically only applies to companies located in the 9th Circuit – California, Oregon, Washington, Alaska, Hawaii, Idaho, Montana, Nevada, and Arizona. That said, as the only opinion on this subject, the IRS may look to it as authority regardless of whether taxpayers are in one of the nine states located in the Circuit.
Adding salt to the wound, the “Big Beautiful Bill” includes a provision to extend the statute of limitations, for the IRS to audit ERC claims, from three years to six which, if passed, will open every ERC claim to challenge and potential claw-back. The new provision states:
EXTENSION OF LIMITATION ON ASSESSMENT
(1) IN GENERAL—Notwithstanding section 6501, the limitation on the time period for the assessment of any amount attributable to a credit claimed under this section shall not expire before the date that is 6 years after the latest of:
the date on which the original return which includes the calendar quarter with respect to which such credit is determined is filed
the date on which such return is treated as filed under section 6501(b)(2), or
the date on which the claim for credit 2 or refund with respect to such credit is made.
Compounding matters – employment taxes include “trust fund” liabilities and potential Trust Fund Recovery Penalties (TFRP) which owners and other “responsible” employees may be personally liable for. That said, liability under the TFRP is also limited to three years and so individuals may not be liable for earlier years.
The Bill also includes a provision to eliminate the ERC altogether which, together with the extension of the statute and other changes, are intended to fill budget shortfalls triggered by the extension of Trump era tax cuts for the wealthy and large corporations. As such, there has been significant push back from the tax community.
Cannabis companies and tax professionals stay tuned as this area continues to evolve. But, the IRS is already aware of the case and has raised it in recent discussions regarding the ERC.
Should you have questions about the ERC, a tax audit, ERC audit, or other tax issues, please contact Nick Richards at nick.richards@gmlaw.com .
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