10 recommendations on learn how to assist your marijuana enterprise survive an IRS audit

(Editor’s Note: This story is part of a recurring series of comments from professionals in the cannabis industry. Michael Sampson is a partner at Leech Tishman Fuscaldo & Lampl in Pittsburgh, where he chairs the law firm’s Cannabis Group. Alexander Gase is an associate of the Corporate Practice Group of the company.)

Make no mistake, the US Internal Revenue Service is playing for victory. And cannabis companies must prepare accordingly if they are to survive federal tax scrutiny.

According to MJBizDaily, the IRS “has been training its agents in the details of auditing marijuana companies for … years.”

Recently released IRS documents received from MJBizDaily indicate that “the IRS has researched and refined its methods of auditing tax returns for the marijuana industry …”.

These documents include a “participant’s guide” from the cannabis industry, which at least one other tax attorney has called the IRS “playbook”.

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In the participant guide, for example, the IRS emphasizes the importance of initial interviews, since “since many taxpayers hire a representative after the initial interview, this may be the only way (agents) to speak directly to the taxpayer.”

Therefore, cannabis-related companies should proactively develop their own tax / legal game plans.

As it is often said, “The best defense is a good insult.”

While relevant tax considerations may vary depending on the structure of a particular company, a company’s “sweepstakes” should incorporate “best practices” including, but not necessarily limited to, the following:

1. Understand the applicable law.

For example, under Section 162 (a) of the Internal Revenue Code, a company may generally deduct expenses that are “normal and necessary” to carry out its trade or business.

While such deductions are generally not industry specific, they are generally not available to the cannabis industry due to Section 280E of the Code.

2. Review the cost of doing business to ensure that the cost that might qualify as the “cost of goods sold” under Section 471 (a) of the Code is correctly characterized.

For example, for a retailer the “cost of goods sold”, which should constitute a valid exclusion, could include the purchase price of cannabis, but not certain indirect costs such as repair and maintenance costs.

The US 9th Circuit Court of Appeals recently underscored this point in the Mutual Assistance Collective Corp. v Commissioner of Internal Revenue (Harborside) case, underlining some of the amounts in question. Section 280E does not purport to deny those taxpayers within its scope the ability to apply for exclusions available to other businesses. “

3. Keep all tax records for seven years.

While the statute of limitations for an audit is usually three to six years (depending on the tax return date), cannabis-related companies should consider keeping tax documents for a longer period of time as a precaution.

Tax documentation may include, but is not limited to, tax returns, receipts, correspondence with tax authorities, and supporting working papers.

4. Retain and organize documentation on personal cost of living and business owners’ net worth as the IRS has identified this information as potentially relevant in determining business revenue.

Because a particular audit technique – the “Net Worth Method” – instructs the IRS to consider a further increase in a taxpayer’s net worth during a particular tax year, adjusted for Section 280E non-admissions, it is important to remain relevant Documentation, among other things, to refute such treatment.

5. Carefully follow US Treasury and other federal court rulings, US Treasury Department guidelines, and IRS bulletins and publications.

The constitutional and other challenges to Section 280E continue. Recently, in the Harborside case, the 9th Circuit declined to determine that Section 280E violated the 16th Amendment to the US Constitution.

These challenges are unlikely to end anytime soon and formal legal / tax guidance will continue to inform and control industry behavior.

6. Use IRS prepaid credit cards to pay estimated taxes online.

The IRS has created easier ways for cash-intensive taxpayers to pay their taxes, including the IRS2Go mobile app, which allows taxpayers to deposit money on prepaid cards (virtual via the mobile app or via a physical card) at one of the agency’s retail partners .

7. Work with IRS agents.

A fine can be imposed if agents refuse entry to a place of business.

However, be sure to protect all legal rights, including the right to invoke the fifth amendment if necessary and appropriate. Consult an experienced legal advisor if necessary.

8. Prepare for the on-site shop tours and initial interviews that are common with audits in this industry.

In coordination with legal counsel and in accordance with all applicable laws, it is important to adequately prepare employees for the collaboration and to be able to assist the IRS in its review.

Involving a legal advisor in this process can not only contribute to complete preparation, but – at least under certain circumstances – also hold discussions with employees who are subject to legal and client law.

9. Make sure that all correspondence with the IRS is in writing.

Not only does this provide a “paper path” and a solid organizational framework, but it can also give the taxpayer additional time to gather information and consult with legal counsel.

10. Contact an experienced tax attorney, preferably one with knowledge of the cannabis industry, and / or a qualified accountant once the company has been identified for the audit.

Having a quarterback to lead your team over the goal line during an audit can be invaluable. For example, lawyers and / or accountants can explain relevant laws, hold direct discussions, identify applicable privileges, and define strategies.

While an IRS audit can be intimidating, it doesn’t have to be one-sided competition.

By proactively creating a game book and then putting together a strong team to execute the game plan, cannabis companies can level the playing field and best protect themselves in the event of an audit.

Michael Sampson is a partner at Leech Tishman Fuscaldo & Lampl in Pittsburgh, where he chairs the law firm’s cannabis group. Alexander Gase is an associate in the company’s Corporate Practice Group. They can be reached at 412-261-1600 or [email protected] and [email protected].

The previous edition of this series can be found here.

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