Why Taxpayers Involved In Offshore Accounts, Crypto-Currency Or Cannabis Should Be Filing An Extension For Their 2018 Income Tax Returns.
Why Taxpayers Involved In Offshore Accounts, Crypto-Currency Or Cannabis Should Be Filing An Extension For Their 2018 Income Tax Returns.
If you did not report your offshore accounts, crypto currency income or cannabis income earned before 2018, you should hold off on filing your 2018 taxes and instead file an extension.
An extension is your way of asking the IRS for additional time to file your tax return. The IRS will automatically grant you an additional six months to file your return. While State Tax Agencies will also provide the same extension period, you need to check with your State to see if an extension must be filed with the State as well. California does not require that a State extension be filed as long as you timely file the Federal extension AND you will not owe any money to the State.
The deadline to file your 2018 individual income tax returns or request an extension of time to file the tax return is Monday, April 15, 2019 (although this year taxpayers in Maine and Massachusetts have until April 17th given legal holidays followed in those States). A timely filed extension will extend the filing deadline to Tuesday, October 15, 2019 thus giving you an extra six months to meet with tax counsel and determine how to address your pre-2018 tax reporting delinquencies and how to present your situation on your 2018 tax return.
While an extension gives you extra time to file your return, an extension does not give you extra time to pay your tax and if you do not pay what you owe with the extension, you will still be ultimately charged with late payment penalties when you file your tax return.
Offshore Accounts
The IRS announced on March 13, 2018 that it will begin to ramp down the 2014 Offshore Voluntary Disclosure Program (“OVDP”) and close the program on September 28, 2018. OVDP enabled U.S. taxpayers to voluntarily resolve past non-compliance related to unreported foreign financial assets and failure to file foreign information returns.
Where a taxpayer does not come forward into OVDP and has now been targeted by IRS for failing to file the Foreign Bank Account Reports (FBAR), the IRS may now assert FBAR penalties that could be either non-willful or willful. Both types have varying upper limits, but no floor. The first type is the non-willful FBAR penalty. The maximum non-willful FBAR penalty is $10,000. The second type is the willful FBAR penalty. The maximum willful FBAR penalty is the greater of (a) $100,000 or (b) 50% of the total balance of the foreign account. In addition the IRS can pursue criminal charges with the willful FBAR penalty. The law defines that any person who willfully attempts in any manner to evade or defeat any tax under the Internal Revenue Code or the payment thereof is, in addition to other penalties provided by law, guilty of a felony and, upon conviction thereof, can be fined not more than $100,000 ($500,000 in the case of a corporation), or imprisoned not more than five years, or both, together with the costs of prosecution (Code Sec. 7201).
For the non-willful penalty, all the IRS has to show is that an FBAR was not filed. Whether the taxpayer knew or did not know about the filing of this form is irrelevant. The non-willful FBAR penalty is $10,000 per account, per year and so a taxpayer with multiple accounts over multiple years can end up with a huge penalty.
Since 2009, the IRS Criminal Investigation has indicted 1,545 taxpayers on criminal violations related to international activities, of which 671 taxpayers were indicted on international criminal tax violations.
Crypto-Currency
Many taxpayers think that their crypto transactions would remain a secret forever. Digital exchanges are not broker-regulated by the IRS. Digital exchanges are not obligated to issue a 1099 form, nor are they obligated to report to the IRS calculate gains or cost basis for the trader. But that is now all changing sooner than you think!
As of March 16, 2018, the IRS has received information from Coinbase located in San Francisco which is the largest cryptocurrency exchange in the United States disclosing the names, addresses and tax identification numbers on 14,355 account holders. Coinbase pursuant to a Court Order issued by a Federal Magistrate Judge (United States v. Coinbase, Inc., United States District Court, Northern District Of California, Case No.17-cv-01431) had to produce the following customer information over the period of 2013 to 2015: (1) taxpayer ID number, (2) name, (3) birth date, (4) address, (5) records of account activity, including transaction logs or other records identifying the date, amount, and type of transaction (purchase/sale/exchange), the post transaction balance, and the names of counterparties to the transaction, and (6) all periodic statements of account or invoices (or the equivalent).
Furthermore, Coinbase starting with the 2017 tax years will be issuing 1099-K tax forms for some of its U.S. clients. The IRS will receive copies of these forms.
With only several hundred people reporting their crypto gains each year, the IRS suspects that many crypto users have been evading taxes by not reporting crypto transactions on their tax returns.
Cannabis
With the proliferation of licensed cannabis businesses sprouting in the State Of California in 2018, a lot of cannabis business will be filing tax returns with the IRS starting this year. But beware, the IRS is well aware that successful cannabis businesses don’t just sprout overnight and now that your business is on the radar screen you can bet that the IRS will be inquiring how you accumulated all that cash before 2018.
Cannabis is categorized as a Schedule I substance under the Controlled Substances Act. While more than half of the states in the U.S. have legalized some form of medicinal marijuana, and several others have passed laws permitting recreational cannabis use, under federal drug laws the sale of cannabis remains illegal.
Despite the disparity and Federal and State law, marijuana businesses still have to pay taxes.
Generally, businesses can deduct ordinary and necessary business expenses under I.R.C. §162. This includes wages, rent, supplies, etc. However, in 1982 Congress added I.R.C. §280E. Under §280E, taxpayers cannot deduct any amount for a trade or business where the trade or business consists of trafficking in controlled substances…which is prohibited by Federal law. Marijuana, including medical marijuana, is a controlled substance. What this means is that dispensaries and other businesses trafficking in marijuana have to report all of their income and cannot deduct rent, wages, and other expenses, making their marginal tax rate substantially higher than most other businesses.
A cannabis business that has not properly reported its income and expenses and not engaged in the planning to minimize income taxes can face a large liability proposed by IRS reflected on a Notice Of Deficiency or tax bill. Likewise, where a taxpayer over the years has accumulated cash from cannabis sales and never reported any income to the IRS, you are looking at a serious problem.
Penalties For Filing A False Income Tax Return Or Under-reporting Income
Failure to report all the money you make is a main reason folks end up facing an IRS auditor. Carelessness on your tax return might get you whacked with a 20% penalty. But that’s nothing compared to the 75% civil penalty for willful tax fraud and possibly facing criminal charges of tax evasion that if convicted could land you in jail.
Criminal Fraud – The law defines that any person who willfully attempts in any manner to evade or defeat any tax under the Internal Revenue Code or the payment thereof is, in addition to other penalties provided by law, guilty of a felony and, upon conviction thereof, can be fined not more than $100,000 ($500,000 in the case of a corporation), or imprisoned not more than five years, or both, together with the costs of prosecution (Code Sec. 7201).
The term “willfully” has been interpreted to require a specific intent to violate the law (U.S. v. Pomponio, 429 U.S. 10 (1976)). The term “willfulness” is defined as the voluntary, intentional violation of a known legal duty (Cheek v. U.S., 498 U.S. 192 (1991)).
And even if the IRS is not looking to put you in jail, they will be looking to hit you with a big tax bill with hefty penalties.
Civil Fraud – Normally the IRS will impose a negligence penalty of 20% of the underpayment of tax (Code Sec. 6662(b)(1) and 6662(b)(2)) but violations of the Internal Revenue Code with the intent to evade income taxes may result in a civil fraud penalty. In lieu of the 20% negligence penalty, the civil fraud penalty is 75% of the underpayment of tax (Code Sec. 6663). The imposition of the Civil Fraud Penalty essentially doubles your liability to the IRS!
What Should You Do?
Individual taxpayers can file an extension using Form 4868. Extensions can also be filed online, which has the benefit that you’ll receive a confirmation code from the IRS notifying you that your extension was received. Then you should promptly contact tax counsel. Don’t delay because once the IRS has targeted you for investigation – even if its is a routine random audit – it will be too late voluntarily come forward. Let the tax attorneys at the Law Offices Of Jeffrey B. Kahn, P.C. located in Orange County (Irvine), San Francisco Bay Area (including San Jose and Walnut Creek) and offices elsewhere in California get you set up with a plan that may include being qualified into a voluntary disclosure program to avoid criminal prosecution, seek abatement of penalties, and minimize your tax liability. If you are involved in cannabis, check out what else a cannabis tax attorney can do for you.
U.S. Territory Of Guam Expands Legalized Cannabis To Include Recreational Use.
Guam is a U.S. territory in the Pacific Ocean of just around 165,000 people but it has made huge head-waves by being becoming the second American jurisdiction to legalize the sales of recreational cannabis through a legislature (the first U.S. jurisdiction to do so was the Northern Mariana Islands – click here for our previous blog). Previously, only medical-use cannabis was legal.
Democratic Governor Lou Leon Guerrero signed the Cannabis Industry Act (the “Act”) into law on April 4, 2019 stating “We must regulate this illicit drug that is the most widely used drug in our society. We have to take it and control it, monitor its use and effects, benefit from its medicinal efforts, and allow our people to live in a safer environment”.
Possession, Sales, and Home Cultivation All Legalized.
The Act permits those age 21 or older to legally possess and transfer up to one ounce of marijuana flower and/or eight grams of concentrated cannabis. The measure, which took immediate effect, also permits adults to privately cultivate up to six cannabis plants (no more than three mature) in an “enclosed, locked space”. Public consumption of cannabis will remain a violation of law.
The Act creates a new regulatory board to draft rules governing the plant’s commercial production and retail sale. The board has a one-year timeline to adopt rules necessary to permit for the operation of licensed cannabis establishments.
Guam Follows A Growing Trend In Legalizing Cannabis.
Medical marijuana is legal in 33 states.
The medical use of cannabis is legal (with a doctor’s recommendation) in 31 states and Washington DC. Those 33 states being Alaska, Arizona, Arkansas, California, Colorado, Connecticut, Delaware, Florida, Hawaii, Illinois, Maine, Louisiana, Maryland, Massachusetts, Michigan, Minnesota, Missouri, Montana, Nevada, New Hampshire, New Jersey, New Mexico, New York, North Dakota, Ohio, Oklahoma, Oregon, Pennsylvania, Rhode Island, Utah, Vermont, Washington and West Virginia. The medical use of cannabis is also legal in the territories of the Northern Mariana Islands, Guam and Puerto Rico.
Recreational marijuana is legal in 10 states.
Ten states and Washington DC, have legalized marijuana for recreational use — no doctor’s letter required — for adults over the age of 21. Those ten states being Alaska, California, Colorado, Maine, Massachusetts, Michigan, Nevada, Oregon, Vermont and Washington and now the territory of Guam.
Conflict With Federal Law.
Under Federal law (Controlled Substances Act 21 U.S.C. 801) marijuana is designated as a Schedule I controlled substance due to the historical belief that it has a high potential for abuse, no currently accepted medical use in treatment, and lack of accepted safety for use under medical supervision.
Higher Taxes Still Remain
While the developments listed above are favorable for cannabis business, it still remains to be seen whether the Federal government will respond favorably and when favorable changes will be made to the Internal Revenue Code which treats businesses in the marijuana industry differently resulting in such business paying at least 3-times as much in taxes as ordinary businesses.
Generally, businesses can deduct ordinary and necessary business expenses under I.R.C. §162. This includes wages, rent, supplies, etc. However, in 1982 Congress added I.R.C. §280E. Under §280E, taxpayers cannot deduct any amount for a trade or business where the trade or business consists of trafficking in controlled substances…which is prohibited by Federal law. Marijuana, including medical marijuana, is a controlled substance. What this means is that dispensaries and other businesses trafficking in marijuana have to report all of their income and cannot deduct rent, wages, and other expenses, making their marginal tax rate substantially higher than most other businesses.
Reporting Of Cash Payments Still Remain
The Bank Secrecy Act of 1970 (“BSA”) requires financial institutions in the United States to assist U.S. government agencies to detect and prevent money laundering. Specifically, the act requires financial institutions to keep records of cash purchases of negotiable instruments, and file reports of cash purchases of these negotiable instruments of more than $10,000 (daily aggregate amount), and to report suspicious activity that might signify money laundering, tax evasion, or other criminal activities. The BSA requires any business receiving one or more related cash payments totaling more than $10,000 to file IRS Form 8300, Report of Cash Payments Over $10,000 Received in a Trade or Business.
The minimum penalty for failing to file EACH Form 8300 is $25,000 if the failure is due to an intentional or willful disregard of the cash reporting requirements. Penalties may also be imposed for causing, or attempting to cause, a trade or business to fail to file a required report; for causing, or attempting to cause, a trade or business to file a required report containing a material omission or misstatement of fact; or for structuring, or attempting to structure, transactions to avoid the reporting requirements. These violations may also be subject to criminal prosecution which, upon conviction, may result in imprisonment of up to 5 years or fines of up to $250,000 for individuals and $500,000 for corporations or both.
Marijuana-related businesses operate in an environment of cash transactions as many banks remain reluctant to do business with many in the marijuana industry. Like any cash-based business the IRS scrutinizes the amount of gross receipts to report and it is harder to prove to the IRS expenses paid in cash. So it is of most importance that the proper facilities and procedures be set up to maintain an adequate system of books and records.
How Do You Know Which Cannabis Tax Attorney Is Best For You?
Given that cannabis is still illegal under existing Federal law you need to protect yourself and your marijuana business from all challenges created by the U.S. government. While cannabis is legal in California, that is not enough to protect you. It’s coming down that the biggest risk is TAXES. So it is best to be proactive and engage an experienced cannabis tax attorney in your area who is highly skilled in the different legal and tax issues that cannabis businesses face. Let the cannabis tax attorneys of the Law Offices Of Jeffrey B. Kahn, P.C. located in Orange County (Irvine), the Inland Empire (Ontario and Palm Springs) and other California locations protect you and maximize your net profits.
Federal Cannabis Banking Bill Moving Through Congress – If You Can’t Beat Them, Then Join Them!
Under Federal law (Controlled Substances Act 21 U.S.C. 801) marijuana is designated as a Schedule I controlled substance due to the historical belief that it has a high potential for abuse, no currently accepted medical use in treatment, and lack of accepted safety for use under medical supervision. This status has prompted banks to prevent and block banking access to legal cannabis businesses.
Secure And Fair Enforcement (SAFE) Banking Act – HR 1595
The Secure And Fair Enforcement Banking Act (the “SAFE Banking Act”) was introduced just less than two weeks ago by Representatives Ed Perlmutter (D-CO), Denny Heck (D-WA), Steve Stivers (R-OH) and Warren Davidson (R-OH). The SAFE Banking Act would prevent federal banking regulators from punishing banks for working with cannabis related businesses that are obeying state laws or halting their services, taking action on loans made to those businesses, or limiting a depository institution’s access to the Deposit Insurance Fund. The SAFE Banking Act would also protect ancillary businesses that work with the cannabis industry from being charged with money laundering and other financial crimes, and requires the Financial Institution Examination Council to develop guidance to help credit unions and banks understand how to lawfully serve cannabis businesses.
On March 28, 2019, the House Financial Services Committee approved an updated version of the SAFE Banking Act, which would provide safe harbor and guidance to financial institutions that wish to work with legal cannabis businesses. The vote was 45-15 in support of cannabis banking which supporters included 11 Republicans. Now, the legislation will go back to the House for further consideration and should be approved for a full floor vote. It will then move on to the Senate for consideration. Stay tuned for further developments.
While this development is favorable for cannabis business, the enactment of the SAFE Banking Act into law will not solve all the problems and challenges of legal cannabis businesses.
Higher Taxes Still Remain
It still remains to be seen when favorable changes will be made to the Internal Revenue Code which treats businesses in the marijuana industry differently resulting in such business paying at least 3-times as much in taxes as ordinary businesses.
Generally, businesses can deduct ordinary and necessary business expenses under I.R.C. §162. This includes wages, rent, supplies, etc. However, in 1982 Congress added I.R.C. §280E. Under §280E, taxpayers cannot deduct any amount for a trade or business where the trade or business consists of trafficking in controlled substances…which is prohibited by Federal law. Marijuana, including medical marijuana, is a controlled substance. What this means is that dispensaries and other businesses trafficking in marijuana have to report all of their income and cannot deduct rent, wages, and other expenses, making their marginal tax rate substantially higher than most other businesses.
Reporting Of Cash Payments Still Remain
The Bank Secrecy Act of 1970 (“BSA”) requires financial institutions in the United States to assist U.S. government agencies to detect and prevent money laundering. Specifically, the act requires financial institutions to keep records of cash purchases of negotiable instruments, and file reports of cash purchases of these negotiable instruments of more than $10,000 (daily aggregate amount), and to report suspicious activity that might signify money laundering, tax evasion, or other criminal activities. The BSA requires any business receiving one or more related cash payments totaling more than $10,000 to file IRS Form 8300, Report of Cash Payments Over $10,000 Received in a Trade or Business.
The minimum penalty for failing to file EACH Form 8300 is $25,000 if the failure is due to an intentional or willful disregard of the cash reporting requirements. Penalties may also be imposed for causing, or attempting to cause, a trade or business to fail to file a required report; for causing, or attempting to cause, a trade or business to file a required report containing a material omission or misstatement of fact; or for structuring, or attempting to structure, transactions to avoid the reporting requirements. These violations may also be subject to criminal prosecution which, upon conviction, may result in imprisonment of up to 5 years or fines of up to $250,000 for individuals and $500,000 for corporations or both.
Marijuana-related businesses operate in an environment of cash transactions as many banks remain reluctant to do business with many in the marijuana industry. Like any cash-based business the IRS scrutinizes the amount of gross receipts to report and it is harder to prove to the IRS expenses paid in cash. So it is of most importance that the proper facilities and procedures be set up to maintain an adequate system of books and records.
How Do You Know Which Cannabis Tax Attorney Is Best For You?
Given that cannabis is still illegal under existing Federal law and the enactment of the SAFE Banking Act will not solve all your problems you need to protect yourself and your marijuana business from all challenges created by the U.S. government. While cannabis is legal in California, that is not enough to protect you. It’s coming down that the biggest risk is TAXES. Be proactive and engage an experienced Cannabis Tax Attorney in your area. Let the tax attorneys of the Law Offices Of Jeffrey B. Kahn, P.C. located in Orange County, Inland Empire (Ontario and Palm Springs) and other California locations protect you and maximize your net profits.
Fail To Pay In Enough Tax Withholding And Estimated Tax Payments For 2018? Relief May Be Available To You.
Fail To Pay In Enough Tax Withholding And Estimated Tax Payments For 2018? Relief May Be Available To You.
The IRS announced additional expanded penalty relief to taxpayers whose 2018 federal income tax withholding and estimated tax payments fell short of their total tax liability for the year.
At first on January 16, 2019 the IRS announced that the threshold for this relief was pre-paying and amount equal to 85% of your prior year’s tax to avoid a penalty (the law provides that you must have paid in an amount equal to 90% of your prior year’s tax). But not the IRS has lowered that threshold even further to an amount equal to 80% of your prior year’s tax to avoid a penalty.
This means that the IRS is now waiving the estimated tax penalty for any taxpayer who paid at least 80% of their total tax liability during the year through federal income tax withholding, quarterly estimated tax payments or a combination of the two.
Taxpayers who have already filed for tax year 2018 but qualify for this expanded relief may claim a refund by filing Form 843, Claim for Refund and Request for Abatement and include the statement “80% Waiver of estimated tax penalty” on Line 7. This form cannot be filed electronically.
The IRS figures that this expanded relief will help many taxpayers who owe tax when they file, including taxpayers who did not properly adjust their withholding and estimated tax payments to reflect an array of changes under the Tax Cuts and Jobs Act of 2017 (TCJA).
How Does The Penalty For Not Paying In Enough Apply?
Because the U.S. tax system is a “pay-as-you-go” system, taxpayers are required, by law, to pay most of their tax obligation during the year, rather than at the end of the year. This can be done by either having tax withheld from paychecks or pension payments, or by making estimated tax payments.
Usually, a penalty applies at tax filing if too little is paid during the year. This penalty is an interest-based amount approximately equivalent to the federal interest on the amount not paid in a timely manner.
Normally, the penalty would not apply for 2018 if tax payments during the year met one of the following tests:
- The person’s tax payments were at least 90% of the tax liability for 2018 or
- The person’s tax payments were at least 100% of the prior year’s tax liability, in this case from 2017. However, the 100% threshold is increased to 110% if a taxpayer’s adjusted gross income is more than $150,000, or $75,000 if married and filing a separate return.
For waiver purposes only, today’s relief lowers the 90% threshold to 80%. This means that a taxpayer will not owe a penalty if they paid at least 80% of their total 2018 tax liability. If the taxpayer paid less than 80%, then they are not eligible for the waiver and the penalty will be calculated as it normally would be, using the 90% threshold.
Importance To Preserve Records
Keep in mind that the IRS has up to three years to select a tax return for audit. The California Franchise Tax Board has up to four years to select a California State Income Tax Return for audit. In some cases this period is extended to six years. When a taxpayer is selected for audit, the taxpayer has the burden of proof to show that expenses claimed are properly deductible. Having the evidence handy and organized makes meeting this burden of proof much easier.
Essential Records to Have for a Tax Audit
If you are getting ready for a tax audit, one of the most important things to do is gather and organize your tax records and receipts. There’s a good chance that you have a large amount of documents and receipts in your possession. No matter how organized you are, it can be a daunting task to collect the right pieces and make sure that you have them organized and handy for the audit conference.
We have seen many tax audits that hinge on whether or not the taxpayer can provide proper documentation for their previous tax filings. A tax lawyer in Orange County or elsewhere can make sure that the documentation is complete and proper. By submitting this to your tax attorney in advance of the audit, your tax attorney can review your documentation and determine if there are any gaps that need to be addressed before starting the dialogue with the IRS agent.
So what are the most essential tax records to have ahead of your audit? Here are a few must-have items:
- Any W-2 forms from the previous year. This can include documents from full-time and part-time work, large casino and lottery winnings and more.
- Form 1098 records from your bank or lender on mortgage interest paid from the previous year.
- Records of any miscellaneous money you earned and reported to the IRS including work done as an independent contractor or freelancer, interest from savings accounts and stock dividends.
- Written letters from charities confirming your monetary donations from the previous year.
- Receipts for business expenses you claimed.
- Mileage Logs for business use of vehicle.
- Entertainment and Travel Logs for business activities.
What Should You Do?
You know that at the Law Offices Of Jeffrey B. Kahn, P.C. we are always thinking of ways that our clients can save on taxes. If you are selected for an audit, stand up to the IRS by getting representation. Tax problems are usually a serious matter and must be handled appropriately so it’s important to that you’ve hired the best lawyer for your particular situation. The tax attorneys at the Law Offices Of Jeffrey B. Kahn, P.C. located in Orange County (Irvine), San Diego County (Carlsbad) and elsewhere in California are highly skilled in handling tax matters and can effectively represent at all levels with the IRS and State Tax Agencies including criminal tax investigations and attempted prosecutions, undisclosed foreign bank accounts and other foreign assets, and unreported foreign income. If you are involved in cannabis, check out what our cannabis tax attorney can do for you.
Why Is Taxation Related To Cannabis Businesses So Complicated?
Beware 2019 Could Be A Banner Year For IRS Audits Of Cannabis Businesses.
We previously reported in our blog that the Trump Administration organized a committee of federal agencies from across the government to combat public support for marijuana and cast state legalization measures in a negative light while attempting to portray the drug as a national threat. The IRS appears to be following the agenda of the Trump Administration when it comes to Cannabis and has formed special audit groups that are tasked with conducting cannabis tax audits on medical and recreational cannabis businesses.
I.R.C. § 280E
The Federal Controlled Substances Act (“CSA”) 21 U.S.C. § 812 classifies marijuana as a Schedule 1 substance with a high potential for abuse, no currently accepted medical use in treatment, and lack of accepted safety for use under medical supervision.
Generally, businesses can deduct ordinary and necessary business expenses under I.R.C. §162. This includes wages, rent, supplies, etc. However, in 1982 Congress added I.R.C. §280E. Under I.R.C. §280E, taxpayers cannot deduct any amount for a trade or business where the trade or business consists of trafficking in controlled substances…which is prohibited by Federal law. Cannabis, including medical marijuana, is a controlled substance. What this means is that dispensaries and other businesses trafficking in cannabis have to report all of their income and cannot deduct rent, wages, and other expenses, making their marginal tax rate substantially higher than most other businesses.
IRS Guidance On Cannabis.
The IRS issued a memo to provide guidance to its agents on conducting audits of cannabis businesses addressing whether an IRS agent can require a taxpayer trafficking in a Schedule 1 controlled substance to change its tax accounting to conform to I.R.C. §280E.
Not surprisingly that the IRS ruled that IRS agents have the authority to change a cannabis business’ method of accounting so that pursuant to I.R.C. §280E costs which should not be included in inventory are not included in Costs Of Goods Sold (“COGS”) and remain non-deductible for income tax purposes.
Cannabis Tax Audits & Litigation.
It is no surprise that cannabis businesses are proliferating as more States legalize cannabis and make available licenses to grow, manufacture, distribute and sell cannabis. The IRS recognizes this and it is making these cannabis businesses face Federal income tax audits. IRC §280E is at the forefront of all IRS cannabis tax audits and enforcement of §280E could result in unbearable tax liabilities.
Proving deductions to the IRS is a two-step process:
• First, you must substantiate that you actually paid the expense you are claiming.
• Second, you must prove that an expense is actually tax deductible.
Step One: Incurred And Paid The Expense.
For example, if you claim a $5,000 purchase expense from a cannabis distributor, offering a copy of a bill or an invoice from the distributor (if one is even provided) is not enough. It only proves that you owe the money, not that you actually made good on paying the bill. The IRS accepts canceled checks, bank statements and credit card statements as proof of payment. But when such bills are paid in cash as it typical in a cannabis business, you would not have any of these supporting documents but the IRS may accept the equivalent in electronic form.
Step Two: Deductibility Of The Expense.
Next you must prove that an expense is actually tax deductible. For cannabis businesses this is challenging because of the I.R.C. §280E limitation. Recall that under I.R.C. §280E, taxpayers cannot deduct any amount for a trade or business where the trade or business consists of trafficking in controlled substances…which is prohibited by Federal law. What this means is that dispensaries and other businesses trafficking in cannabis have to report all of their income and cannot deduct rent, wages, and other expenses, making their marginal tax rate substantially higher than most other businesses.
A cannabis business can still deduct its Cost Of Goods Sold (“COGS”). Cost of goods sold are the direct costs attributable to the production of goods. For a cannabis reseller this includes the cost of cannabis itself and transportation used in acquiring cannabis. To the extent greater costs of doing business can be legitimately included in COGS that will that result in lower taxable income. You can be sure the IRS agents in audits will be looking closely at what is included in COGS. Working with a cannabis tax attorney can ensure that you receive the proper treatment of COGS versus ordinary and necessary expenses resulting in the lowest possible income tax liability.
In addition to IRS audits, state cannabis audits are also complex and thorough and generally include all taxes specific and nonspecific to the cannabis business. Potentially at risk is the cannabis license that enables the business to operate. State audits will focus on records regarding sales and use tax, excise taxes, and seed-to-sale tracking records.
Now if your cannabis IRS tax audit is not resolved, the results may be challenged and litigated in the U.S. Tax Court or Federal District Court. The U.S. Tax Court has jurisdiction to hear disputes over federal income taxes before final assessment and collections while the Federal District Court generally requires taxpayers to first pay the liability then seek repayment through a refund request.
What Should You Do?
Ultimately it is the tax risk with IRS that could put any cannabis business “out of business” so you need to protect yourself and your investment. Level the playing field and gain the upper hand by engaging the cannabis tax attorneys at the Law Offices Of Jeffrey B. Kahn, P.C. located in Orange County (Irvine), the Inland Empire (Ontario and Palm Springs) and other California locations. We can come up with tax solutions and strategies and protect you and your business and to maximize your net profits.
Evolution Of California Cannabis Law – Pending Bills Considered By The Legislature: Senate Bill 34 and Senate Bill 67.
Two bills currently being considered by the California State legislature that would authorize legal cannabis businesses to provide free cannabis or cannabis products to a medicinal cannabis patient and would allow temporary licenses to be re-validated if an annual license application has been submitted. These measures if enacted into law could help legal cannabis businesses to thrive and level the playing field with cannabis businesses that continue to operate in the grey and black markets.
Senate Bill 34 (The Compassionate Care Bill, formerly SB 829)
The proposed legislation, which is sponsored by state Senator Scott Weiner, was introduced in the current session on December 3, 2018 would allow licensed cannabis businesses to provide free cannabis or cannabis products to a medicinal cannabis patient if specified requirements are met. This is more liberal that existing administrative law which prohibits a retailer licensee from providing free cannabis goods to any person or allowing individuals who are not employed by the retailer to provide free cannabis goods to any person on the licensed premises. The bill also provides relief from the imposition of state taxes on the donated cannabis and cannabis products. The full text of the Bill can be viewed here.
Senate Bill 67
The proposed legislation, which is sponsored by state Senator Mike McGuire, was introduced in the current session on January 8, 2019 would revalidate an expired temporary license if the licensee submitted an application for an annual state license before the licensee’s temporary license expiration date, and would require the extended temporary license to expire on December 31, 2019, unless otherwise revoked. This legislation has serious ramifications for the legal cannabis industry in California as many businesses are operating under temporary licenses and there are delays and other challenges poised at the local level that could result in temporary licenses expiring before final annual licenses are issued. If this legislation is not enacted into law, current temporary license holders will not be able to operate after their temp licenses expire, leaving the state with a major supply crisis and discouraging future investment into legal cannabis. The full text of the Bill can be viewed here.
Even though 33 states have legalized cannabis for medical or adult use, banks and financial institutions are hesitant to provide services to cannabis businesses because federal law still classifies cannabis as an illegal Schedule 1 drug under the Controlled Substances Act.
Higher Federal Taxes Still Remain
While the developments listed above are favorable for California cannabis business, it still remains to be seen when favorable changes will be made to the Internal Revenue Code which treats businesses in the marijuana industry differently resulting in such business paying at least 3-times as much in taxes as ordinary businesses.
Generally, businesses can deduct ordinary and necessary business expenses under I.R.C. §162. This includes wages, rent, supplies, etc. However, in 1982 Congress added I.R.C. §280E. Under §280E, taxpayers cannot deduct any amount for a trade or business where the trade or business consists of trafficking in controlled substances…which is prohibited by Federal law. Marijuana, including medical marijuana, is a controlled substance. What this means is that dispensaries and other businesses trafficking in marijuana have to report all of their income and cannot deduct rent, wages, and other expenses, making their marginal tax rate substantially higher than most other businesses.
Federal Reporting Of Cash Payments Still Remain
The Bank Secrecy Act of 1970 (“BSA”) requires financial institutions in the United States to assist U.S. government agencies to detect and prevent money laundering. Specifically, the act requires financial institutions to keep records of cash purchases of negotiable instruments, and file reports of cash purchases of these negotiable instruments of more than $10,000 (daily aggregate amount), and to report suspicious activity that might signify money laundering, tax evasion, or other criminal activities. The BSA requires any business receiving one or more related cash payments totaling more than $10,000 to file IRS Form 8300, Report of Cash Payments Over $10,000 Received in a Trade or Business.
The minimum penalty for failing to file EACH Form 8300 is $25,000 if the failure is due to an intentional or willful disregard of the cash reporting requirements. Penalties may also be imposed for causing, or attempting to cause, a trade or business to fail to file a required report; for causing, or attempting to cause, a trade or business to file a required report containing a material omission or misstatement of fact; or for structuring, or attempting to structure, transactions to avoid the reporting requirements. These violations may also be subject to criminal prosecution which, upon conviction, may result in imprisonment of up to 5 years or fines of up to $250,000 for individuals and $500,000 for corporations or both.
Marijuana-related businesses operate in an environment of cash transactions as many banks remain reluctant to do business with many in the marijuana industry. Like any cash-based business the IRS scrutinizes the amount of gross receipts to report and it is harder to prove to the IRS expenses paid in cash. So it is of most importance that the proper facilities and procedures be set up to maintain an adequate system of books and records.
How Do You Know Which Cannabis Tax Attorney Is Best For You?
Given that cannabis is still illegal under existing Federal law you need to protect yourself and your marijuana business from all challenges created by the U.S. government. While cannabis is legal in California, that is not enough to protect you. It’s coming down that the biggest risk is TAXES. Be proactive and engage an experienced Cannabis Tax Attorney in your area. Let the tax attorneys of the Law Offices Of Jeffrey B. Kahn, P.C. located in Orange County, Inland Empire (Ontario and Palm Springs) and other California locations protect you and maximize your net profits.
Are You Effected By The Alabama Tornadoes And Severe Storms? IRS Is Providing You With Tax Relief And Extending Upcoming Tax Deadlines.
Are You Effected By The Alabama Tornadoes And Severe Storms? IRS Is Providing You With Tax Relief And Extending Upcoming Tax Deadlines.
The IRS announced on March 7, 2019 that victims of the tornadoes and severe storms that took place March 3, 2019 in Alabama may qualify for tax relief. Individuals who reside or have a business in Lee County have until July 31, 2019, to file certain individual and business tax returns and make certain tax payments.
IRS Tax Relief Details
The IRS is offering this relief to any area designated by the Federal Emergency Management Agency (FEMA), as qualifying for individual assistance. The current list of eligible localities is always available on the disaster relief page on IRS.gov.
The declaration permits the IRS to postpone certain deadlines for taxpayers who reside or have a business in the disaster area. As a result, affected individuals and businesses will have until July 31, 2019, to file returns and pay any taxes that were originally due during this period. This includes individual income tax returns and payments normally due April 15, 2019. Eligible taxpayers will also have until July 31, 2019 to make 2018 IRA contributions.
The July 31, 2019, deadline also applies to quarterly estimated income tax payments due on April 15, 2019 and June 17, 2019 and the quarterly payroll and excise tax returns normally due on April 30, 2019. It also applies to tax-exempt organizations, operating on a calendar-year basis, that have a Form 990 information return due on May 15, 2019. Businesses, including corporations, S corporations and partnerships, that have a 2018 return due during this period also have the extra time.
In addition, penalties on payroll and excise tax deposits due on or after March 3, 2019, and before March 18, 2019, will be abated as long as the deposits are made by March 18, 2019.
Importance To Preserve Records
Keep in mind that the IRS has up to three years to select a tax return for audit. The FTB has up to four years to select a tax return for audit. In some cases this period is extended to six years. When a taxpayer is selected for audit, the taxpayer has the burden of proof to show that expenses claimed are properly deductible. Having the evidence handy and organized makes meeting this burden of proof much easier.
Essential Records to Have for a Tax Audit
If you are getting ready for a tax audit, one of the most important things to do is gather and organize your tax records and receipts. There’s a good chance that you have a large amount of documents and receipts in your possession. No matter how organized you are, it can be a daunting task to collect the right pieces and make sure that you have them organized and handy for the audit conference.
We have seen many tax audits that hinge on whether or not the taxpayer can provide proper documentation for their previous tax filings. A tax lawyer in Orange County or elsewhere can make sure that the documentation is complete and proper. By submitting this to your tax attorney in advance of the audit, your tax attorney can review your documentation and determine if there are any gaps that need to be addressed before starting the dialogue with the IRS agent.
So what are the most essential tax records to have ahead of your audit? Here are a few must-have items:
- Any W-2 forms from the previous year. This can include documents from full-time and part-time work, large casino and lottery winnings and more.
- Form 1098 records from your bank or lender on mortgage interest paid from the previous year.
- Records of any miscellaneous money you earned and reported to the IRS including work done as an independent contractor or freelancer, interest from savings accounts and stock dividends.
- Written letters from charities confirming your monetary donations from the previous year.
- Receipts for business expenses you claimed.
- Mileage Logs for business use of vehicle.
- Entertainment and Travel Logs for business activities.
Develop And Implement Your Backup Plan
Do not wait for the next disaster to come for then it may be too late to retrieve your important records for a tax audit or for that matter any legal or business matter. And if you do get selected for audit and do not have all the records to support what was claimed on your tax returns, you should contact an experienced tax attorney who can argue the application of your facts and circumstances to pursue the least possible changes in an audit.
The tax attorneys at the Law Offices Of Jeffrey B. Kahn, P.C. located in Orange County (Irvine), San Diego County (Carlsbad) and elsewhere in California are highly skilled in handling tax matters and can effectively represent at all levels with the IRS and State Tax Agencies including criminal tax investigations and attempted prosecutions, undisclosed foreign bank accounts and other foreign assets, and unreported foreign income. And if you are involved in cannabis, check out what our cannabis tax attorneys can do for you.
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