Just because California suspended the cultivation tax on cannabis, don’t think that as an unlicensed grower you have nothing to worry about.

Legal California cannabis businesses have been complaining about taxes, which in parts of the state are among the highest in the nation. This is one of the reasons why the black market continues to operate in California.  But with the State stepping up its enforcement efforts to uncover and prosecute illegal cannabis operators, the State is hoping to help legal operators by eradicating non-compliant operators.

Suspension Of Cannabis Cultivation Tax

To help licensed cultivators, the State Of California enacted Assembly Bill 195 (Stats. 2022, ch. 56) into law which revised the Cannabis Tax Law.  Starting July 1, 2022 the cultivation tax no longer applies to cannabis or cannabis products entering the commercial market. Cannabis enters the commercial market when the cannabis or cannabis products pass the required testing and quality assurance review.

• Distributors and manufacturers (including microbusinesses authorized to distribute or manufacture) are no longer required to collect the cultivation tax from cultivators.
• Cultivators (including microbusinesses authorized to cultivate) are no longer responsible for paying the cultivation tax to manufacturers or distributors when cultivators sell or transfer cannabis to another licensee.
• Cultivation tax is not due on cannabis or cannabis products entering the commercial market on or after July 1, 2022, even if you received cannabis from a cultivator prior to July 1, 2022.
• Any cultivation tax collected on cannabis that enters the commercial market on or after July 1, 2022, must be returned to the cultivator that originally paid the cultivation tax.

But this suspension only applies to licensed growers.

Cultivation Tax On Unlicensed Growers

To penalize unlicensed cultivators, the State Of California revised the Cannabis Tax Law so that unlicensed cultivators would have to face hefty tax bills despite the tax relief afforded to licensed cultivators.  Cannabis Tax Section 34015.1(a)(1) imposes a tax liability on the unlicensed person required to be licensed with DCC who possesses, keeps, stores, or retains for the purpose of sale, or sells or offers to sell any cannabis or cannabis products.  Section 34015.1(a)(2)(A) requires the department to ascertain “as best it may” the category and amount of the harvested cannabis deemed as having entered the commercial market, and the average market price or gross receipts, based on any information within the department’s possession or that may come into its possession, of the retail sale of the cannabis or cannabis product deemed as purchased from a cannabis retailer.

Section 34015.1(a)(2)(A) provides that if a penalty is to be imposed, the  penalty shall be 25% of the amount of tax or $500.00, whichever is greater.

Illustration Of How The State Calculates Liability

Let’s assume that you operated an unlicensed cannabis cultivation activity and you were raided by the authorities.  The authorities will take a count of the plants seized (assume 100), assume 16 ounces of cannabis per plant and apply a current market value (assume $160.00) to the calculated ounces to arrive in arriving at a Gross Receipt Value Of Seized Cannabis of $256,000.  Applying the 25% penalty rate, under this illustration, the liability to the State is $64,000.

What Should You Do?

Not only is the State’s calculation of liability arbitrary but also under the law, the liability could be abated due to “reasonable cause”.  If you thought as an unlicensed grower you had no liability and now you find yourself under investigation, protect yourself by engaging the cannabis tax attorneys at the Law Offices Of Jeffrey B. Kahn, P.C. located in Orange County (Irvine), Los Angeles County and other California locations. Let us work out the best possible result.  Also, if you are involved in crypto currency, check out what a bitcoin tax attorney can do for you.

If You Can’t Beat Them, Join Them! US Virgin Islands Passes Cannabis Legalization Bill

On January 18, 2023 the U.S. Virgin Islands legislation to legalize cannabis for adult, medicinal and sacramental use (Virgin Islands Cannabis Use Act “Act 8680”) was signed into law by Governor Albert Bryan Jr.  The governor of the Caribbean island territory also issued a proclamation that allows persons convicted of simple possession of marijuana to apply for a pardon through the Virgin Islands Department of Justice.

The Growing Trend In Legalizing Cannabis – Current Standings:

Medical marijuana is legal in 37 states.

The medical use of cannabis is legal (with a doctor’s recommendation) in 37 states and Washington DC. Those 37 states being Alabama, Alaska, Arizona, Arkansas, California, Colorado, Connecticut, Delaware, Florida, Hawaii, Illinois, Louisiana, Maine, Maryland, Massachusetts, Michigan, Minnesota, Mississippi, Missouri, Montana, Nevada, New Hampshire, New Jersey, New Mexico, New York, North Dakota, Ohio, Oklahoma, Oregon, Pennsylvania, Rhode Island, South Dakota, Utah, Vermont, Virginia, Washington and West Virginia. The medical use of cannabis is also legal in the territories of the Northern Mariana Islands, Guam, Puerto Rico and the U.S. Virgin Islands.

Recreational marijuana is legal in 21 states.

Twenty-one states and Washington DC, have legalized marijuana for recreational use — no doctor’s letter required — for adults over the age of 21. Those 21 states being Alaska, Arizona, California, Colorado, Connecticut, Illinois, Maine, Maryland, Massachusetts, Michigan, Missouri, Montana, Nevada, New Jersey, New Mexico, New York, Oregon, Rhode Island, Vermont, Virginia and Washington and the territories of the Northern Mariana Islands, Guam and the U.S. Virgin Islands.

Recreational marijuana is legal in 6 tribal nations.

Six Tribal nations have legalized marijuana for recreational use.  Those 6 tribes being the Flandreau Santee Sioux Tribe (South Dakota), Oglala Lakota Sioux Tribe (South Dakota), Suquamish Tribe (Washington state), Squaxin Island Tribe (Washington State), Eastern Band of Cherokee Indians (North Carolina) and St. Regis Mohawk Tribe (New York).

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.  And if you are involved in crypto currency, check out what a bitcoin tax attorney can do for you.

The Biden Administration Continues Its Stance Against Cannabis In A Section 280E Legal Battle

On May 21, 2021, acting Solicitor General Elizabeth Prelogar filed an Opposition Brief on behalf of the United States in its opposition to a Petition For A Writ Of Certiorari To The United States Court Of Appeals For The Tenth Circuit in the case of Eric D. Speidell et al vs. United States Of America (U.S. Supreme Court No. 20-1332).

Eric Speidell of Colorado-based The Green Solution who is included in the petitioners owns and operates marijuana dispensaries in Colorado, which has decriminalized marijuana in some respects under state law.  The tax returns filed by the cannabis businesses were selected for examination.  Unlike non-cannabis businesses which can deduct all expenses incurred in carrying on a trade or business under IRC Sec. 162, cannabis businesses are subject to IRC Sec. 280E.

Under IRC Sec. 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.

The question as presented to the U.S. Supreme Court is: Whether the court of appeals correctly affirmed the district court’s decision to enforce several third-party summonses issued by the Internal Revenue Service as part of investigations into the accuracy of petitioners’ federal income tax returns.

If the Supreme Court grants the Writ Of Certiorari, the Court would eventually hear this appeal and issue a ruling which could have huge implications for the cannabis industry given that prior challenges in the lower courts by cannabis businesses have been unsuccessful.

Yes – Cannabis Businesses Have to Report Income To IRS And Pay Taxes!

While the sale of cannabis is legal in California as well as in a growing number of states, cannabis remains a Schedule 1 narcotic under Federal law, the Controlled Substances Act. As such businesses in the cannabis industry are not treated like ordinary businesses. Despite state laws allowing cannabis, it remains illegal on a federal level but cannabis businesses are obligated to pay federal income tax on income because I.R.C. §61(a) does not differentiate between income derived from legal sources and income derived from illegal sources.

While most expenses cannot be deducted under IRC Sec. 280E, IRC Sec. 280E does allow a cannabis business to deduct its Cost Of Goods Sold (“COGS”). Cost of goods sold are the direct costs attributable to the production of goods. For a marijuana 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.

I.R.C. Section 280E IRS Tax Audits

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 Sec. 280E is at the forefront of all IRS cannabis tax audits and enforcement of Sec. 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 a cannabis businesses this is challenging because of the I.R.C. §280E limitation; however 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.

Tips For Cannabis Tax Return Preparation

Here are some tips for cannabis businesses to follow in the preparation of their 2019 tax returns.

• Reconcile Your Books Before Closing Your Books. Incomplete books can cause delays and add unnecessary complexities.
• Utilize A Cannabis Tax Professional. Engage a tax professional who has experience in the cannabis industry. Such a professional would be familiar with the intricacies of IRC Sec. 280E and relevant cases to make the proper presentation on the tax return in a manner that would support the smaller tax liability possible.
• Justify Your Numbers As If An IRS Audit Is A Certainty. Don’t wait to receive a notice from IRS that the tax return is selected for examination.  That can be one or two years away.  Instead make it a point to put together the backup to you numbers now while everything is fresh.

Time Limits For Keeping Your Tax Records

Even though your 2020 income tax return is processed by the IRS and a refund is issued, that does not mean the IRS can later question or audit the tax return,  In fact the Statute Of Limitations allows the IRS three years to go back and audit your tax return.  That is why it’s a good idea to keep copies of your prior-year tax returns and supporting backup documentation for at least three years.

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 cannabis clients can save on taxes, minimize the impact of IRC Sec. 280E and limit audit risk. The cannabis tax attorneys and professionals at the Law Offices Of Jeffrey B. Kahn, P.C. located in Orange County (Irvine), Northern California (including San Francisco and Sacramento) and elsewhere in California are highly skilled in handling cannabis tax matters and can effectively represent at all levels with the IRS and State Tax Agencies. Also if you are involved in crypto-currency, check out what a Bitcoin tax attorney can do for you.