Increased Tax Audits Most Likely Coming to The Cannabis Industry

by Roger Tower on April 6, 2020

The rapid growth of the regulated cannabis industry has raised concerns for the U.S Treasury Department who recently released a report indicating that the Internal Revenue Service (IRS) will most likely increase audits in the marijuana industry nationwide. 

For the cannabis industry, taxes have always been a complicated world. Marijuana continues to be classified as a Scheduled I controlled substance in the Controlled Substances Act and due to federal restrictions, cannabis businesses have very limited banking access and tax regulations are unclear. 

“The IRS lacks guidance to taxpayers and tax professionals in the marijuana industry. Such guidance would improve awareness of tax filing requirements for taxpayers in this industry, such as the correct application of Section 280E and 471(c), which would reduce the burden of tracking inventory for certain small businesses” the report states. 

Internal Revenue Code (I.R.C.) Section 280E prohibits the tax deduction of expenses by companies who traffic federally illegal drugs, including marijuana. Which means that cannabis businesses have to report all of their income but cannot deduct expenses such as rent or wages. 

Report Findings

The Treasury of Inspector General for Tax Administration (TIGTA) performed an audit emphasizing on legal marijuana operations.

The new report, released to the public on March 30th, revealed a study that showed possible millions of dollars in unpaid taxes and forecasted over $200 million over a five year period.

TIGTA audited 90 random marijuana businesses in Washington and determined that 26 percent involved underreported income or non-filing tax returns for 2016. 

Report Recommendations for the IRS

The TIGTA report recommends that the IRS: 

• Develop a comprehensive compliance approach for marijuana businesses. 
• Develop and publicize guidance specific to the marijuana industry. 
• Leverage publicly available information at the State level and expand the use of existing Fed/State agreements to identify non-filers and unreported income in the marijuana industry. 
• increase educational outreach towards unbanked taxpayers making cash deposits regarding the unbanked relief policies available.

The IRS responded that “whether it pursues taxpayers in the marijuana industry depends on priorities and available resources.” 

With all of the confusion regarding taxes, specifically the enforcement of I.R.C. 280E, it’s not surprising that the IRS is likely to perform a wave of audits for legal cannabis businesses.

There Might be Possibility for Exemption 

This is where I.R.C. Section 471(c) comes in – an exemption for certain small businesses with less that $25 million in gross receipts. 

This section of the Internal Revenue Code is particularly interesting to cannabis businesses because it would not subject them to the impacts of I.R.C. Section 280E. 

While it is unclear what will happen in the immediate future, it is probably smart for legal cannabis businesses to brace themselves for a wave of possible tax audits. 

Some things that marijuana businesses can do to prepare for this is to always document everything from expenses to wages, to costs of goods sold and consult with legal tax experts.