On September 11, 2020, the IRS released general guidance for the cannabis industry. This is likely a response to a Treasury Department internal watchdog report which was critical of the IRS’ lack of guidance towards the cannabis industry. The guidance is published on the IRS website and it addresses key issues that the cannabis industry faces such as application of Internal Revenue Code (“IRC”) 280E, cash payment options, Form 8300 filing requirements, estimated tax payments and the importance of good record keeping.
In addition, the IRS published a Frequently Asked Questions guide specific to the cannabis industry. Some of the key findings include:
- State licensed/legal cannabis operations are still subject to IRC 280E.
- Cannabis companies are eligible for payment plans or temporary delays of collections based on adverse financial circumstances.
- All penalties imposed to normal businesses may be imposed to a cannabis business including a negligence penalty if the taxpayer failed to keep adequate books and records.
- Clarifies that cannabis businesses are only entitled to the Cost of Goods Sold deduction calculated under IRC 471 and the Regulations under IRC 471.
- Refers taxpayers to the Chief Counsel Advice (CCA 201504011) for more detailed guidance on computing Cost of Goods Sold for the specific operation that the taxpayer is performing in connection with cannabis.
- Reminds taxpayers of Form 8300 filing requirements for cash receipts more than $10,000.
CHIEF COUNSEL ADVICE
In response to questions of how to compute Cost of Goods Sold for Taxpayers in the cannabis industry, the IRS published CCA 201504011 on January 23, 2015. This memorandum from 2015 clarifies how to apply IRC 280E and the regulations under IRC 471 to a cannabis operator and is still relevant today.
The CCA cited that resellers (e.g., distribution, delivery, and dispensaries) were subject to Regulation 1.471-3(b) and producers were subject to Regulation 1.471-3(c) and 1.471-11. The IRS’ position is that IRC 280E is to be applied in accordance with the regulations that existed when IRC 280E was enacted in 1982.
In 1982, the term inventoriable cost (for purposes of computing Cost of Goods Sold) was a cost that was capitalized under IRC 471. A cannabis reseller who maintains inventory would been entitled to deduct the invoice cost of the cannabis less trade or other discounts plus transportation or other necessary charges incurred in acquiring possession of cannabis. Alternatively, a manufacturer or producer who maintains inventory could capitalize direct materials, direct labor and indirect costs defined under Regulations 1.471-11(c)(2)(i) and 1.471-11(c)(2)(iii). Examples of these costs are repairs and maintenance, utilities (heating, power, lighting), rent, indirect labor and production supervisory wages (overtime, holiday, vacation and sick leave and contributions to supplemental unemployment benefit plan), indirect materials and supplies, non-capitalized tools and equipment and costs of quality control and inspection.
In the CCA report, there were other discussions in connection with the Uniform Capitalization rules, referred to as UNICAP, under IRC Section 263A. UNICAP expanded the types of costs which are inventoriable in addition to IRC 471 costs. Under IRC 263A, resellers were required to capitalize, in addition to acquisition costs, purchasing, handling and storage costs. Under IRC 263A, producers were required to capitalize a portion of their mixed service costs (e.g., Sales, General and Administrative costs that benefit both production and selling activity such as accounting, finance, legal, human resources, etc.)
The IRS was quick to point out that IRC 263A was not applicable for the cannabis industry to apply because it is considered a timing provision (i.e., IRC 263A changes the timing of the deduction but does not dictate whether a deduction is allowed or disallowed under the Internal Revenue Code). The IRS pointed out that if a taxpayer subject to IRC 280E was allowed to capitalize additional costs under IRC 263A, that would change IRC 263A from being a timing provision (which was the intent of Congress when enacting IRC 263A) to being a provision that transforms non-deductible expenses into deductible expenses.
The most recent IRS guidance reaffirms the opinions outlined in various Tax Court decisions that have come out since the 2015 CCA report. Taxpayers should be aware of how IRC 471 and the Regulations thereunder are to be applied in their cannabis businesses. In addition, maintaining adequate books and records is critical to support deductions that the taxpayer is entitled to under the Internal Revenue Code. As always, taxpayers involved in the cannabis industry should carefully review their legal entity structure with their accountants and attorneys and discuss ways to mitigate the impact of IRC 280E.
Dana R. Borys, An Accountancy Corporation is a boutique tax consulting, compliance, and representation firm working with start-up/emerging growth companies in the cannabis industry. Building connections beyond the code.