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Marijuana dispensaries face a host of tax challenges. From an accounting standpoint, the nature of operating a cash-based business with sales demands a system of detailed recordkeeping to substantiate income and cost of goods sold. For purposes of the CDTFA, sales tax obligations require monthly prepayments for many retailers with harsh penalties for late return filings and payments. With regard to the IRS, income tax audits and notices of determination assessing additional tax liability, interest, and penalties have been a mainstay of cannabis tax case law with frequent contention over cost of goods sold calculations. In short, cannabis dispensaries are well aware of the tax hurdles facing the industry, but at times even well-run operations need the assistance of a cannabis tax attorney to navigate IRS & CDTFA audits, seek penalty relief, or secure installment payment plans.
CDTFA Sales Tax Audits
The CDTFA is increasingly turning to sales tax audits to scrutinize licensed cannabis retailers, with the possibility of those audits expanding in scope and ultimately leading to IRS attention. With a host of interest and penalty assessments for various late filings and payments with enhancements for negligence or intent to evade taxes, CDTFA audits can quickly result in sizeable sales tax liabilities. For some cannabis retailers, penalty and interest relief may be an option, but for egregious cases, an installment plan may be more viable.
The IRS has scrutinized cannabis retailers operating legally under state law since the inception of the cannabis industry. Utilizing IRC 280E, the IRS seems to have replaced the Department of Justice in penalizing state-licensed cannabis retailers who by their nature violate federal law by trafficking in marijuana. Indeed, the IRS as of 2015 developed an audit technique guide for testing gross receipts of cannabis retailers which emphasized the importance of the initial unrepresented taxpayer interview. To date, the IRS continues to target cannabis retailers for income tax audits, at times following information gained from state tax agency audits.
The most effective audit technique for obtaining income information is the interview with the taxpayer… The interview will allow you to gain useful information necessary to analyze the taxpayer’s bank accounts and to reconcile their books and records to their filed return. In addition, as many taxpayers hire representation after the initial interview, it may be the only chance you have to talk directly with the taxpayer.Audit Techniques for Testing Gross Receipts – IRS Marijuana Training (2015)
Cannabis Case Law
Cannabis tax case law was mainly comprised of IRC 280E violations at the inception of the cannabis industry but has since evolved into cost of goods sold controversies. In brief, 280E has been utilized by the IRS to effectively deny cannabis retailers tax deductions for ordinary and necessary business expenses. However, cannabis retailers may still use cost of goods sold to reduce their tax liability, albeit following the COGS calculation for resellers that prohibits the inclusion of nondeductible expenses under 280E into COGS.