By Rachel Gillette and James Mann , Partners
On March 30th , 2020 the Treasury Inspector General for Tax Administration (TIGTA) released a report — “The Growth of the Marijuana Industry Warrants Increased Compliance Efforts and Additional Guidance .”[1]
The report focused on three states, but the IRS and state officials refused to share with the Treasury Department inspectors any information pertaining to the identification of underreporting or non-filers in California and Oregon — as a result of this stonewall, the report only looks at Washington State audits in detail. In Washington State alone, however, the results are extraordinary — for the most recent period, cannabis return examinations resulted in 336% more revenue per return than non-cannabis examinations and 340% greater return for dollars per hour IRS agents spent on returns.
When TIGTA selected random cannabis returns for scrutiny in California, Oregon and Washington, it found cannabis-related tax return errors in 59% of the returns examined in California, Washington, and Oregon.
As a result of the report, the IRS has agreed to implement a national compliance initiative project for cannabis businesses, and it was recommended the IRS “leverage State marijuana business lists to identify noncompliant taxpayers”.
The IRS agreed to make greater use of the state-level publicly available information and federal/state information sharing agreements to do a better job of targeting cannabis taxpayer. The implication is clear: many more cannabis business audits are coming.
TIGTA also highlighted the impact of a new provision of the tax code, specifically the idea advanced by “two practitioners…[who] have identified the potential unintended consequences of IRC Section 471(c) that appears to allow small marijuana businesses to include non-cost of goods sold expenses in their cost of goods sold and potentially avoid the application of IRC Section 280E.” For a number of reasons, we believe they are referring to the authors of this blog post. See our further discussion in a previous blog post. Of course, the consequences of the Small Business Accounting Method Reform and Simplification Act are entirely intended — small business cannabis taxpayers are entitled to use its provisions just as much as other small business owners, and arguably even more due to the punitive impact of Section 280E and the general overregulation of cannabis enterprises.
RECOMMENDATIONS
Cannabis taxpayers should expect increased audit scrutiny — review tax returns carefully before filing and review accounting methods for tax optimization.
Cannabis small businesses (less than $25 million in gross receipts average for 3 previous years) should explore changes to accounting methods using Section 471(c).
The report underlines the idea that there remains a great deal of confusion about the correct tax return preparation for Section 280E enterprises, and we strongly suggest that you consult with legal counsel to assess the returns filed and potential tax exposure. Also, if your business is audited by the IRS, we strongly encourage you to consult with experienced legal counsel as many accountants representing taxpayers may not be fully apprised of the extent of taxpayers’ rights in these examinations.
[1] https://www.treasury.gov/tigta/auditreports/2020reports/202030017fr.pdf
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