Hope for Colorado Marijuana Businesses
With banks wary of dabbling in an industry that is still at odds with federal law, and with looming threats of IRS audits, Colorado Marijuana companies are forced to reconcile tax best-practices in a cash-dominant industry.
Since becoming legal in Colorado, recreational marijuana businesses are facing increasingly common, yet “random” IRS audits. The instigator of IRS audits is tax-law culprit 280E, which prohibits businesses from claiming normal operating expenses on their tax returns. Because businesses cannot claim these expenses, they end up paying ludicrous tax amounts – so much so, the volume of incoming cash has prompted the IRS to augment its cash counting capacities in both its Denver and Seattle offices (locations where recreational marijuana is legal). Due to seemingly punitive federal tactics against legal state practices, more and more businesses are fighting 280E by taking the IRS to court. With each new cannabis litigation case, federal law seems to constantly shift– causing cannabis business’ wondering how best to stay compliant, while also trying to save money.
To cure those tax-season headaches, Colorado cannabis businesses need to educate themselves on the evolution of 280E. This article highlights some important case laws that may have a direct impact on your business, which might save you money come tax season and offer reassurance of compliance should you be audited.
History of 280E
The 1981 Edmondson tax court case was the catalyst to the IRS adding 280E to its tax code. In the Edmundson v. Comm’r, T.C. Memo 1981-623 an illegal drug trafficker was permitted tax deductions for telephone, auto and rental expenses incurred by an illegal drug business. Prompting public policy outcry, the IRS swiftly reacted creating 280E – a tax law which disallows “drug dealers the benefit of business expenditure deductions”. As such, traditional deductions like rent, employee salaries, utilities, traveling and rental expenses are not allowed. Going even further, 280E discourages marijuana companies from marketing their products by making advertising expenses nondeductible. Because Colorado marijuana businesses cannot claim the same hefty expenses that other businesses can, the IRS is collecting vast sums of money. One company reported owing $275,000 for one year of taxes.
Case Law Impacts
However, there is hope for the marijuana industry in Colorado as the state has excluded 280E in calculating state income tax, somewhat lessening the tax burden that businesses face. Additionally, in 2007 the CHAMP (Californians helping to elevate medical problems) case won the ability to deduct some of its expenses from its tax liabilities. As a nonprofit entity, the CHAMP organization offers medical services for those suffering from long-term diseases, including medical marijuana. This case sets a precedent for Colorado companies who can show that if they are involved in additional legal business dealings, that those dealings can be tax deductible. However, companies still dealing in cash may face continued problems with validating these business costs without a proper paper trail.
How You Can Save Money
In 2015, the IRS issued Chief Council Advice (CCA) 201504011 to clarify issues surrounding trafficking costs vs. production costs in 280E. The memo stated that 280E only specifically dealt with business expenses related to trafficking and not production. Hence, all production related expenses which are associated with the cost of goods sold can be deducted. For marijuana businesses who maintain grow houses, below are items that may deducted when filing annual tax returns:
- Raw materials such as seeds, soil and fertilizer
- Utilities related to production, such as water and electricity
- Maintenance costs associated with production and storage
- Rent of grow houses
- Materials and supplies related to grow and packaging activities
- Wages paid for indirect (supervisors) and direct labor (trimmers and packers)
- Quality control costs
Additionally, if a business can provide supplementary services unrelated to marijuana, then they can also claim the business expenses related to that activity. Remember to keep accurate and separate records of these additional services as proof for your tax return and in the event of an audit.
As the industry continues to evolve and new case laws influence legal precedence, businesses will continue to face uncertainty in determining costs of goods sold and the confusion surrounding tax returns. To avoid these risks amidst IRS audits and potentially save money, cannabis businesses would be smart to consult with a tax attorney. Please call (303) 688-0944 to schedule your consultation with one of our attorneys.