By Elizabeth Figueroa and Michelle Shulman
In March 2020, the U.S. Treasury Department’s Inspector General for Tax Administration (TIGTA) published its long-awaited report on the growth of the marijuana industry in the United States. This 54-page report filled with graphs, charts, citations, and most importantly, recommendations, is a must-read for anyone in the marijuana industry. Why? It is not every day that a government agency shares its research about problems in the industry and foreshadows its plans for corrective actions.
The report’s title “The growth of the marijuana industry warrants increased tax compliance efforts and additional guidance” speaks for itself.
While 33 states plus the District of Columbia have legalized marijuana for recreational and/or medical use, its status as a Schedule 1 controlled substance by the Federal government presents untold challenges. Concerns for marijuana business owners include limited availability to financial institutions willing to bank the business and confusing potentially conflicting guidance from the IRS, among others.
Case in point: IRC Section 280E prohibits the deduction of expenses related to controlled substances; whereas IRC Section 471 allows for such deductions for businesses with $25 million or less in revenue (a 3-year average) and does not exclude 280E prohibited businesses. It can be argued that marijuana businesses that meet the $25 million threshold are allowed to include all expenses in determining their cost of goods sold (COGS) potentially voiding the impact of 280E and creating significant savings in their tax obligation.
Clients rely on our team of experienced financial professionals who understand the idiosyncrasies of this nascent industry and have broad experience in industry subsectors (e.g. cultivation, production, distribution, marketing, retail) to advise on successful business operations.
Details from the the TIGTA Report
TIGTA reviewed random samples of marijuana businesses in multiple states. They found deficiencies related to tax compliance and underreported income. For example, 59% were found to need likely adjustments that would have resulted in an estimated $242.6 million to the U.S. Treasury over five years. In one state, the report noted that the IRS missed $3.9 million in potential assessments in one year, projected at $19.3 over five years.
TIGTA recommendations include:
- develop a new compliance approach focused on using state data to identify non-compliant taxpayers;
- create guidance specific to the marijuana industry to track business examination results;
- improve awareness and understanding of Schedule 1 taxpayers’ responsibilities;
- provide specific guidance on the application of Section 471 with Section 280 for taxpayers that report Schedule 1 controlled substance activities;
- leverage available State tax information and work with states to identify non-filers and unreported or underreported income;
- increase educational outreach to unbanked taxpayers relating to penalty relief policies.
What’s next for the marijuana industry?
The timing of the TIGTA report combined with the historic national deficit should be a wakeup call for the entire industry. Unsurprisingly, there is intense pressure on the government and specifically IRS officials to find additional revenue. Marijuana businesses should use this time to prepare for what’s coming next from the IRS.
To do so, business owners and operators should ensure that systems are in place to properly document every possible expense related to your business.
In Florida where marijuana businesses must be vertically integrated, it is easier to capture expenses and apportion them properly since all aspects of production are operated by a single licensee. However, whether in Florida or horizontally integrated states like Colorado or California, the cost of goods sold analysis is never the same.
To create customized analyses and reports, the team at Daszkal Bolton examines every aspect of the client’s business operations from top to bottom, including speaking with staff at all levels, monitoring business processes, and reviewing the entire operational structure of the business.
We help clients forecast trends, develop financial models, and suggest consistent, defendable strategies for calculating expenses relating to the cost of goods sold. Our goal is to make sure clients are ready for the new guidance and escalation in audits expected from the IRS.
About the Authors
Michelle Shulman is a director in our tax practice and serves as Chair of Daszkal Bolton’s Cannabis Industry Group. Her primary focus is providing tax planning, projections, and compliance services for family-owned and emerging businesses.
Elizabeth Figueroa is as supervisor in our tax practice and is a member of Cannabis Industry Group.