Tips For Cannabis Businesses To Prepare for the 2022 Tax Filings

On January 12, 2023, the Internal Revenue Service (IRS) announced that it will process 2022 tax returns beginning January 23, 2023.

The IRS states that with the three previous tax seasons dramatically impacted by the pandemic, the IRS has taken additional steps for 2023 to improve service for taxpayers. As part of the August 2022 passage of the Inflation Reduction Act, the IRS has hired more than 5,000 new telephone assistors and added more in-person staff to help support taxpayers.

The IRS states that the January 23^rd start date for individual tax return filers allows the IRS time to perform annual updates and readiness work that are critical to ensuring IRS systems run smoothly. This is the date IRS systems officially begin accepting tax returns. Many software providers and tax professionals are already accepting tax returns; they will transmit those returns to the IRS when the agency begins accepting tax returns on January 23.

April 18^th Filing Deadline.

The filing deadline to submit 2022 tax returns or an extension to file and pay tax owed is Monday, April 18, 2023.  By law, Washington D.C., holidays impact tax deadlines for everyone in the same way federal holidays do. The due date is April 18^th, instead of April 15^th because of the Emancipation Day holiday in the District of Columbia for everyone except taxpayers who live or have business in a California county that has been designated as a Federal Disaster Area will have until May 15, 2023 to file their returns. For more information click here.  Taxpayers requesting an extension will have until Monday, October 16, 2023, to file.

Since the IRS will begin processing tax returns on January 23^rd there is no advantage to filing tax returns on paper before then as no processing of those returns will start.  However, tax returns that are e-filed starting on January 23^rd will be processed immediately.  Nevertheless, it makes sense to start organizing your information early and so when the IRS filing systems open on January 23^rd, you are ready to submit your tax return right away.

Automatic Extension To May 15, 2023 For Certain Taxpayers

California

The IRS announced on January 10, 2023 that California storm victims now have until May 15, 2023 to file various federal individual and business tax returns and make tax payments. Subsequently on January 13, 2023 the FTB announced that California storm victims also have until May 15, 2023 to file various California individual and business tax returns and make tax payments.  Relief is available to affected taxpayers who live or have a business anywhere in Colusa, El Dorado, Glenn, Humboldt, Los Angeles, Marin, Mariposa, Mendocino, Merced, Monterey, Napa, Orange, Placer, Riverside, Sacramento, San Bernardino, San Diego, San Joaquin, San Luis Obispo, San Mateo, Santa Barbara, Santa Clara, Santa Cruz, Solano, Sonoma, Stanislaus, Sutter, Tehama, Ventura, Yolo, and Yuba counties.

Georgia and Alabama

The IRS announced on January 19, 2023 that Storm victims in parts of Georgia and Alabama now have until May 15, 2023 to file various federal individual and business tax returns and make tax payments. Relief is available to affected taxpayers who live or have a business anywhere in Butts, Henry, Jasper, Meriwether, Newton, Spalding and Troup counties in Georgia and Autauga and Dallas counties in Alabama.

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.

Additionally, while businesses can deduct ordinary and necessary business expenses under IRC Sec. 162, 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.

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 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. Under the Inflation Reduction Act the IRS is receiving $80 billion in new funding which IRS will be used to conduct far more audits, civil suits and criminal referrals.  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 2021 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 2021 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.