Internal Revenue Code Section 6662(b)(1) & (2) imposes a 20 percent penalty if (1) the taxpayer’s negligence or disregard of the rules or regulations caused an underpayment of tax, or (2) the underpayment is “substantial.” For cannabis corporations, an underpayment in tax is “substantial” if it exceeds the lesser of (1) $10,000,000 or (2) the greater of 10% of the tax owed or $10,000. However, taxpayers are not liable for the 20% accuracy-related penalty if they can show that they had “reasonable cause” for the underpayment and acted in “good faith.”
Reasonable Cause & Good Faith
In determining reasonable cause, the court will consider all the pertinent facts and circumstances. In general, the most critical factor is the effort taken by the taxpayer to determine the proper tax liability. For cannabis businesses, efforts to determine the proper tax liability often boil down to records to substantiate income, deductions, and credits. For instance, in Olive v. Commissioner, the marijuana dispensary failed to keep adequate books and records to substantiate costs of goods sold and the Court imposed accuracy-related penalties on the portion of the understatement attributable to unsubstantiated deductions.