By De Lon Harris
CL-21-28, September 27, 2021
Tackling complex tax compliance issues is something I take great pride in doing as part of my job as the Commissioner for the Small Business/Self Employed (SB/SE) Examination division. I also see it as my responsibility to make sure my organization helps taxpayers navigate those complex issues and provides the tools that we have available for them to be successful and compliant business owners.
One such evolving and complex issue my organization has been focused on is the tax implications for the rapidly growing cannabis/marijuana industry. The specific rules and regulations regarding how it is taxed at the federal level provides the IRS an opportunity to promote voluntary compliance, not only through audits, but also through outreach and education. At last count, 36 states plus the District of Columbia have legalized marijuana for recreational or medicinal use, or both. These states, such as California, Washington and Colorado provide tax guidance for businesses and we strongly encourage industry members to remain compliant with state taxes as well. And while there are 14 states that still ban cannabis use, we expect both unlicensed and licensed marijuana businesses to grow.
It’s tricky from a business perspective, because even though states are legalizing marijuana and treating its sale as a legal business enterprise, it’s still considered a Schedule 1 controlled substance under federal law. That means a cannabis/marijuana business has additional considerations under the law, creating unique challenges for members of the industry. Specifically, these businesses are often cash intensive since many can’t use traditional banks to deposit their earnings. It also creates unique challenges for the IRS on how to support these new business owners and still promote tax compliance.
While IRS Code Section 280E is clear that all the deductions and credits aren’t allowed for an illegal business, there’s a caveat: Marijuana business owners can deduct their cost of goods sold, which is basically the cost of their inventory. What isn’t deductible are the normal overhead expenses, such as advertising expenses, wages and salaries, and travel expenses, to name a few.
I understand this nuance can be a challenge for some business owners, and I also realize small businesses don’t always have a lot of resources available to them. That’s why I’m making sure the IRS is doing what it can to help businesses with our new Cannabis/Marijuana Initiative.
The goal of this initiative is to implement a strategy to increase voluntary compliance with the tax law while also identifying and addressing non-compliance. I believe this will positively impact filing, payment and reporting compliance on the part of all businesses involved in the growing, distribution and sales of cannabis/marijuana.
How will we do it? Here are some of the strategic activities:
We’ll ensure training and job aids are available to IRS examiners working cases so they can conduct quality examinations (audits) consistently throughout the country.
We’ll make sure there is coordination and a consistent approach by the IRS to the cannabis/marijuana industry.
We’re going to find ways to identify non-compliant taxpayers.
We’ll collaborate with external stakeholders to increase an awareness of tax responsibilities to improve compliance.
And we’ll give taxpayers access to information on how to properly comply with the filing requirements.
I’m very focused on the success of this strategy because it’s very important for business owners to understand that under our nation’s tax laws, and specifically Internal Revenue Code 61, all income is taxable, even if someone is running a business that’s considered illegal under federal law.
I also want to point out that there is no difference in paying income taxes or employment taxes. You still must file your income taxes and you still have to file your employment taxes, and if it’s a cash-intensive business, you still have to make arrangements to pay your tax obligations.
This is a truly groundbreaking effort for our agency. I’m proud of the work my organization has done to provide much-needed educational tips, guidance and more information on our Marijuana Industry page, IRS.gov/marijuana, which includes links to information on:
IRC Section 280E
Cash payment options
Reporting large cash receipts
Keeping good records
We’ve also posted frequently asked questions on IRS.gov to answer questions commonly asked by those in the cannabis/marijuana industry.
Our strategy is not limited to pushing information out via our website in the hope that business owners will find it. I’ve made it a priority for my SB/SE organization to engage with the cannabis/marijuana industry through speaking events and other outreach. I have done three of these types of events over the last year, and what I have heard is a genuine desire to comply with the tax laws regarding the industry. Through this extended outreach, we hope to help small business owners and others fully understand the unique tax rules before there are any compliance issues.
Cannabis/marijuana business owners also need to understand that all cash-intensive businesses can be, and are, audited. I recommend business owners familiarize themselves with the cash business audit techniques guide and all the resources available on IRS.gov/marijuana.
Here are some other helpful tips to help cannabis/marijuana business owners:
Know your investors
There are thousands of people trying to get into the industry legitimately; however, there are some pitfalls with investors that business owners need to be aware of to make sure their investors don’t cause more harm than good. The social stigma and federal designation as an illegal substance have led to unregistered and “silent” financing and ownership arrangements within the industry. Individuals associated with these funding and ownership arrangements are often referred to as “beneficial owners.” A beneficial owner enjoys the benefits of ownership, but the property’s title or activity is in another name. This creates complex compliance challenges for the IRS and may contribute to a business’s failure to file a tax return or accurately report gross receipts. IRS examiners explore the potential for these arrangements during examination engagements.
Additionally, cannabis/marijuana business owners should be aware of nefarious investors who will try to put funds into these new businesses that could cause them to lose their entire business. For example, if one of these silent investors gives initial money, say $5,000 or $10,000, and it grows to where they can then claim ownership, these businesses can become complicit in laundering money for drug traffickers.
Ensure you’re licensed
Make sure you’re licensed for whatever your location requires. Cannabis/marijuana businesses are highly regulated by state and municipal regulatory agencies from a licensing, product development and movement perspective.
File and pay your taxes on time
As I mentioned earlier, even if your business operates with cash, you are still responsible for filing and paying your taxes on time.
The Internal Revenue Code doesn’t differentiate between income derived from legal sources and income derived from illegal sources. It’s all income and is taxable and must be reported on your tax return. However, because it’s a Schedule I controlled substance, Section 280E of the tax code applies, even if the business operates in a state that has legalized the sale of marijuana.
But Section 280E doesn’t prohibit a participant in the marijuana industry from reducing their gross receipts by properly calculating the cost of goods sold to determine its gross income. For example, a marijuana dispensary may not deduct advertising or selling expenses, but it may reduce its gross receipts by its cost of goods sold.
Cannabis businesses have no exemption from their employment tax obligations, and as with other small businesses, they often need to make quarterly tax payments. These business owners should always pay their taxes on time to avoid interest and penalties.
Our enforcement efforts in the industry indicate there are taxpayers operating in segments of the industry (growers, transporters, wholesalers and retailers/dispensaries) who fail to file U.S. tax returns. These business owners should be aware that non-filers are an IRS enforcement priority.
Another of our top enforcement priorities in the cannabis industry is the use of cryptocurrency. Those who use it need to understand that the IRS considers it property, and there are gains that are taxable. I highly recommend anyone using cryptocurrency in their business to work with a reputable exchanger.
Report your cash transactions
As I mentioned earlier, because marijuana is listed as a U.S. Schedule 1 drug, many businesses do not participate in the U.S. banking system and conduct transactions in cash.
If a business in the cannabis/marijuana industry receives more than $10,000 in cash in a single transaction or in related transactions, they must file Form 8300, Report of Cash Payments Over $10,000 Received in a Trade or Business PDF, within 15 days after receiving payment. Business owners really must be diligent about this.
It’s also important to note that some of our IRS Taxpayer Assistance Centers accept cash, but an appointment must be scheduled to make cash payments. The number to call to request an appointment is 844-545-5640.
Keep good records
I don’t think I can stress the importance of good record-keeping enough. All records, such as receipts, canceled checks and other documents that support an item of income, a deduction or a credit appearing on a return should be kept regardless of whether they’re tracked by hard copy or electronically. It’s important for a cannabis business to maintain records for all expenses, even those that are not legally deductible at the federal level, because good, well-organized records make it easier to prepare a tax return, track expenses, substantiate items reported on tax returns, and help provide answers if a return is selected for examination.
Since the unique circumstances of the cannabis industry can make tax preparation challenging, I hope that new and experienced business owners take my advice in this post and use our resources to ensure they understand their tax obligations and avoid penalties associated with non-compliance. We’re always here to help with tools, information and guidance.