Cannabis Industry Tax

October 24, 2019

The cannabis industry is still relatively new and, as a consequence, it still has many tax issues to be resolved. Medical and recreational marijuana businesses are still dealing with a lot of uncertainty concerning tax preparation. There’s uncertainty about how to classify and deduct certain expenses, or whether these companies are eligible for the same kinds of tax relief as companies in other industries. Today, we will focus on the tax issues affecting the marijuana industry. This is an important area of tax inquiry. Cannabis companies need to avoid problems with the Internal Revenue Service, otherwise they will be in for a great deal of stress. Hopefully our posts can provide some level of help in this area.  

In October 2017, the U.S. tax court issued an opinion in the case of Feinberg v. Commissioner. As we will see, this case brought to the fore a number of significant questions related to marijuana taxes. Although the cannabis company in this case did not prevail, this case contains an important lesson which other cannabis companies should commit to memory. Let’s look at the facts of this case and then discuss its significance for the cannabis industry as a whole. 

IRS Audit Produced Tax Deficiency 

The taxpayer in this case was a legalized medical marijuana dispensary called Total Health Concepts, LLC. The dispensary had its tax returns from the years 2009 to 2011 audited by the IRS. In its audit, the IRS reclassified certain expenses originally claimed as below-the-line adjustments. These expenses yielded a greater allowance than originally taken when reclassified as cost of goods sold expenses. However, the audit also disallowed certain expenses altogether which weren’t reclassified in this way. As a consequence of these changes, the IRS audit found tax deficiencies on the individual tax returns of the members of the company. The cannabis company contested the results of the IRS audit on several grounds. The matter then came before the U.S. Tax Court for resolution. 

Cannabis Company Failed to Contradict IRS Audit 

The cannabis business tried to remove the case from the tax court altogether by raising several objections. For instance, the business argued that the IRS didn’t have the authority to determine whether the business committed a violation of federal law outside of the tax code. The business also claimed that application of Section 280E was unconstitutional. None of the company’s objections was successful and the case ultimately went to trial. At trial, the cannabis business failed to provide documentation which contradicted the report produced by the IRS in its audit. The cannabis company submitted an “expert report” in its defense, but this report was unsuccessful in overturning the findings of the IRS. The allowance for cost of goods sold determined by the IRS report was upheld by the tax court. Consequently, the tax deficiency was also upheld and the company was held liable to pay tax.  

The Basic Lesson of Feinberg v. Commissioner 

The basic lesson of this case is that cannabis companies need to start keeping adequate records of their business expenses. The taxpayer in the Feinberg case would likely have prevailed had simply kept records to substantiate its below-the-line expenses. The issue of Section 280E did not come up, because the taxpayer failed to document its business expenses. The record reviewed by the tax court did not provide enough evidence to show that the taxpayer was in fact selling medical marijuana.

This means that the illegality of marijuana would not have been an issue had the taxpayer simply provided adequate documentation regarding its expenses. Given the status of marijuana at the federal level, cannabis companies may still need to grapple with certain tax issues, such as Section 280E, in the future. But, no matter which tax perks cannabis companies may or may not be eligible for, good record keeping will always be paramount. Without good documentation, companies will face the same fate as Total Health Concepts faced in this case.  

Evolving Rules

As mentioned, cannabis companies are still in the process of resolving a lot of tax queries with the IRS. As with companies in any other industry, cannabis businesses should expect the IRS to interpret the tax code in its favor as it tries to generate as much tax money as possible. We’ve seen this same phenomenon in the cryptocurrency industry, in which currency has been classified as personal property for tax purposes.  

Reach Out to MC&C for Additional Information

If you’re in the Cannabis industry and have fallen into tax debt, give us a call. At Mackay, Caswell & Callahan, P.C., our attorneys work with the federal government to resolve tax debt. We’re also knowledgeable about New York state income and sales tax debt. Whatever the type, dealing with tax debt of any sort is not pleasant. We understand the psychological and emotional toll it takes, and also the level of complexity involved in the tax system. So, if you need assistance, don’t hesitate to reach out and we will respond to your query immediately. Contact us and one of our top New York City tax attorneys will reply right away.  

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