Cannabis industry tax issues just got real
Matthew Price should have listened to his accountants.
The medical marijuana dispensary owner-operator in Oregon was sentenced to seven months in prison last month, in what appears to be the first federal sentencing of a legal cannabis business owner for tax crimes. Price, a co-owner of Cannabliss dispensaries, pleaded guilty to willfully failing to file income tax returns in connection with his cannabis stores, and did not file individual tax returns from 2011 to 2014 for income received from the dispensaries’ operations -- despite the advice of a number of CPAs who advised him during those years.
“As with any business, marijuana business owners must operate in strict compliance with the local, state and federal tax laws,” said Rachel Gillette, a partner and chair of Greenspoon Marder’s cannabis practice. For cannabis businesses, tax compliance is part of operating in a state-legal marketplace, and includes understanding IRC Section 280E and how it affects these companies and owners of flow-through marijuana entities. “A tax issue can cause big problems for marijuana businesses and business owners, as most states require license holders to be ‘tax-compliant’ in order to maintain the license,” Gillette said.
Code Section 280E prohibits the deduction of otherwise ordinary businesses expenses from gross income associated with the trafficking of Schedule I or Schedule II substances as defined by the Controlled Substances Act.
Specifically, the statute states: “No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances (within the meaning of Schedule I and II of the Controlled Substances Act) which is prohibited by federal law or the law of any state in which such trade or business is conducted.” (Internal Revenue Code Section 280E)
Cannabis retailers, therefore, are denied the deductions or credits normally available to businesses, since cannabis falls under the definition of a Schedule I substance – and therefore they should pay tax on their gross income.
The cannabis sector faces intense scrutiny from the IRS, as marijuana businesses are audited at greater rates than other businesses, according to Gillette. The IRS is aggressively applying the 1982 Tax Code provision Section 280E. Because many business owners and even tax accountants do not know how Sec. 280E applies, it often causes tax deficiencies for businesses and business owners, even with their best efforts.
Price was a member of the Oregon Liquor Control Commission’s Recreational Marijuana Technical Advisory Retail Subcommittee in 2015 and helped to advise the OLCC in adopting rules for the regulation of the industry.
“The prosecution serves as a reminder for people in the marijuana industry that they will be subject to heightened scrutiny by tax and regulatory authorities, and because of this they really need to be in strict compliance with local and federal tax filings and payments,” said Gillette.
The reason for the greater risk of audit is not because of the nature of the industry but because it is typified by a significant lack of banking, according to Gillette.
“Cannabis businesses are cash-intensive,” she said. “Many of them don’t have bank accounts. Banks are not keen on offering accounts to businesses that are not in compliance with federal law, even though it is legal in a particular state.”
“So cannabis businesses are underbanked,” she said. “In Colorado, only a handful will allow a marijuana business to open an account. There’s not nearly enough for all the licensed businesses to have an account, so many operate solely in cash. When that happens, there is likely to be additional audits.”
“If you’re a CPA and are helping a marijuana business be compliant, that’s OK,” she said. “But your clients should be reminded that they will be subject to increased scrutiny and they must focus on strict compliance with the law, including the tax law.”