IRS Memo Could Raise Cannabis Industry’s Tax Bill by ‘Millions and Millions’ of Dollars

By John Schroyer

A new IRS memo about tax issues tied to cannabis companies could end up costing the marijuana industry millions of dollars annually, reducing already-slim profit margins for scores of businesses.

Last Friday, the IRS sent a memo to a Denver lawyer in response to an inquiry regarding 280E, a section of the U.S. tax code that prohibits deductions for any business activity that involves trafficking in controlled substances.

Tax professionals say the memo appears to close a loophole that many cannabis businesses have been using to at least partially get around 280E, whereby marijuana companies classify certain expenses as cost of goods sold, or COGS, a specific categorization for qualifying costs.

In essence, the IRS outlined its position on that strategy, providing a much narrower definition of what can be classified as COGS than many cannabis companies are currently using.

As a result, tax bills in the industry will be significantly higher – making it that much harder for cannabis companies to post a profit.

California accountant Hank Levy, who works closely with the cannabis industry, warned his clients in an email about the possible implications of the memo. Levy wrote that this is the first time the IRS has made any type of rule regarding 280E since it was first established in 1982, and the “punitive” memo has “turned logic on its head.”

The memo essentially represents an attempt to “harm the marijuana industry through broader application of Section 280E than ever before,” Levy wrote.

Section 280E essentially penalizes MMJ dispensaries and recreational retailers by banning otherwise-ordinary business tax deductions because marijuana is still illegal at the federal level.

But classifying some expenses as COGS has helped businesses lower their tax bills.

California attorney Henry Wykowski, who provides legal services to cannabis companies, offered a hypothetical as an example.

Say a recreational shop in Colorado purchases a bag of cannabis for $1,200 and sells it for $2,000; that would leave a net profit of $800.

But to prep the cannabis for sale, an employee has to trim it, weigh it, package it, and so on. Say that takes $150 worth of materials and time. The shop owner could then write off both the $1,200 and the $150 as cost of goods sold on the shop’s federal taxes, thereby getting a deduction that would typically be prohibited under 280E.

Removing that ability to classify certain costs as COGS, Wykowski said, will cost the industry “millions and millions, without a doubt.”

Under a previous precedent from 2007, the U.S. Tax Court has held that marijuana companies are entitled to COGS, but the memo from the IRS indicates that the agency is taking a stricter view.

The matter is far from settled, however.

“The Tax Court has not ruled on this. This is (the IRS’s) position, and it has yet to be reviewed,” Wykowski said. “The logic that they use is subject to challenge, and the IRS continues to treat cannabis dispensaries than every other type of retail outlet, and they’re just continuing that policy with this memo.”

Wykowski predicted that the policy espoused in the memo will “absolutely” be challenged in court, though it may take a year or more for a ruling to be handed down.

Levy also suggested that the memo could result in a backlog of federal tax audits and appeals, including at the Tax Court level, since he expects thousands of marijuana companies to be audited this year.

John Schroyer can be reached at [email protected]

15 comments on “IRS Memo Could Raise Cannabis Industry’s Tax Bill by ‘Millions and Millions’ of Dollars
  1. HigherGroundTV.com on

    This is a double-edged sword. While taxes always hurt the bottom line, recognition and approval from the IRS will help many #MJ businesses navigate their banking and financing obstacles, and it will help democratize the industry by opening opportunities to those who are not cash-rich. But higher taxes will affect market prices, and if taxes are too high, the black market will make business unviable for some legitimate shops.

    Reply
  2. James Collins on

    The companies will Gladly pay the higer rate of taxes and take the burden from the people to a degree in my opinion as these companies are pretty much operated by the People that hold the Oldest Job in the Bible, “The Gardeners” and the Gardeners will provide the world a new economy a kind economy and a caring economy, one filled with love compassion joy Health Wellness, Well being and Cures to all of Gods People. We will pay to Caesar what is owed to Caesar and we will also care for the worlds population and spread peace not war as the world and its people change. This is a tipping point and we can start to reverse the damage we have as a people caused our planet and we as a people do not need to live under the deceptions of war spread through the media owned by individuals with political interests in businesses tht enslave mankind and pollute our earth.

    Lets Grow Hemp and save our Trees starting right through the Amazon because they are killing it so lets act fast and save our planet. Blessings upon you all amd lets support these brave new ventures such as ERBB HEMP PMCB and so Many more as we all find our individual PromisedLand. Blessings and Cures World Blessings and Cures

    JC

    Reply
  3. James Collins on

    Peace

    :o)

    Lets have a brave Green New World and Start Here Guys, because it takes us all to change..

    https://www.youtube.com/watch?v=6FMNFvKEy4c

    Nd you have to hear a Man Name Murph From London Mix this one in all, you can find him at Keffufle in Brixton mixing in this tune :o)

    Blessings Upon You all Whatever Your Creed Coulour Race or Religion. Blessings and Peace Upon You All!!! Hurra!!

    JC
    London

    Reply
  4. Luigi Zamarra, CPA on

    Although not stated above, the inference appears to be that Hank Levy feels that the $150 in the example above would not be allowed to be an inventoriable item under IRC Section 471. This is not correct and this is not what GCM 20150411 concluded. Anyone wishing a different reading of this GCM should contact me directly. I am comfortable that this GCM does not change anything: it only clarifies that taxpayers need to chose a method of accounting for inventory that does not expense all costs as COGS and it makes it clear that the $150 costs are indeed inventoriable costs.
    See this direct quote from this GCM: “Similarly, a marijuana producer using an inventory method would have capitalized direct material costs (marijuana seeds or plants), direct labor costs (e.g., planting; cultivating; harvesting; sorting), Category 1 indirect costs (§1.471-11(c)(2)(i)), and possibly Category 3 indirect costs (§1.471-11(c)(2)(iii)).” Sorry, Hank, but I think you might have mis-read this GCM.

    Reply
  5. Jeff Cohen on

    Thank you Luigi.. Not sure where all the panic is.. I’ve studied IRC sections 471 & 263A.. I agree with you.. 471 still allows for the additional costs – anything “incidental to and necessary for” the production of said product.. 263A might have given some additional latitude, but not much when it comes to 280E.. So nice to see your comment..

    Reply
  6. LLoyd Santiago Covens on

    The tax issues will kill off 2/3rd of the uncoupled(those no longer growing for their stores) MJ businesses. We need to push the new
    AG 24/7 to get cannabis off DEA schedule 1 & 2.
    It is absurd to be lumping MJ with killer drugs.

    Reply
  7. HigherGroundTV.com on

    “We need to push the new AG 24/7 to get cannabis off DEA schedule 1 & 2. It is absurd to be lumping MJ with killer drugs.”

    Good point, Lloyd. But it looks like the new AG isn’t friendly to the #mj cause: tinyurl.com/qz9ea63

    Reply
  8. Scott Giannotti on

    I’d like to remind everyone that it was taxes that caused the colonies to go Independent. Taxes are for nations that seek to take away freedom. They are and will forever be UnAmerican.

    Cannabisandhemp.org

    Reply
  9. Scott Murphy on

    Can we get a reply from Henry Wykowski as he was called out for being incorrect in his reading?

    The reply by Zammarra without a rebuttal will leave many confused as to the true interpretation.

    Reply
  10. Hank Levy on

    All tax professionals who work in the cannabis industry should be studying this memo as well as the Code and Regs Under Section 471. I think it will be possible to use Sec. 471 to allow us room to take back what the IRS has tried to take away. Don’t forget that the real name for Sec. 263A is “Uniform Capitalization Rules,” and therefore we can assume that all other rules will be “non-uniform” rules. So, yes, I think that we all need to be creative and use the “non-uniform” rules to help us here. However, the context here is that the IRS will fight against capitalizing as many “indirect” costs as possible. This is already what they are doing in current audits that some of us are involved in. Creative use of indirect costs under Section 471 will now become the new battleground.

    Reply
  11. Jerry Chin on

    Professionals can always disagree as to the meaning of any guidance. But what we can all agree on is that the IRS, through this memo, continues its adversarial stance towards our industry. Hank Levy is correct that this is the first time the IRS office of chief counsel has issued a memo directly addressing our tax issues. Heretofore they have only fought us on a case by case basis. I’m still reading through the memo and so am unprepared to provide my opinion, but suffice it to say, that the mere fact that the office of chief counsel is issuing a memo directed specifically at us, does not bode well for our clients.

    Reply
  12. Abraham Finberg CPA on

    I think the discussions with IRS Auditors will remain over indirect costs. I’ve had some success regarding COGS as 75.16% of sales as the standard based on Olive vs. Commissioner.

    I wonder if we can argue the tax court implicitly accepts indirect costs by accepting Hank’s (Levy) rate of 75.16?

    Reply

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