A primer on marijuana-related IRS terminology

Logo art for "The Tax Man's Marijuana Secrets" terms primer

The marijuana-related IRS documents that serve as the basis for this series can be accessed here.

Section 280E of the Internal Revenue Code: Prohibits any company that traffics in Schedule 1 or Schedule 2 controlled substances from taking standard business deductions on their federal taxes.

The practical result for state-legal marijuana companies: They often pay up to an 80%-90% tax rate to the IRS, a situation that has led many cannabis businesses to try to find workarounds for 280E over the past two decades.

Participant Guide/Audit Technique Guide: These are written and published internally by the IRS to help agents when they audit businesses.

The only difference between an Audit Technique Guide and a Participant Guide is the former is made public for businesses to use to help them pay federal taxes, while the latter is for internal IRS use only and remains confidential.

The IRS has issued a wide range of Audit Technique Guides for mainstream industries. But the IRS has kept the marijuana industry Participant Guide under wraps. A copy of the marijuana industry Participant Guide is being published as part of this series.

Authorization form: Used by IRS agents to request a targeted series of audits known as a Compliance Initiative Project (see below).

The form must be filled out by agents and signed by their superiors. It includes a description of the audit, its aims and its scope.

CHAMP: Shorthand reference to Californians Helping to Alleviate Medical Problems v. Commissioner, one of the first major legal cases that centered on 280E and its application to state-legal marijuana businesses.

The ruling, issued in 2007, held that while the medical marijuana dispensary that brought the case could not deduct most of its business expenses – due to 280E – the dispensary could deduct its cost of goods sold (see below) and expenses related to its separate caregiving service for medical patients. The court found the caregiving service was distinct from the dispensary.

CIP: Abbreviation for Compliance Initiative Project. Formal title for targeted audit programs of noncompliant taxpayer groups and industries.

CIPs typically are used to target tax returns in certain sectors. The goal is to dig up returns where taxpayers might have underpaid their federal taxes.

The IRS has launched at least five CIPs targeting marijuana companies since 2010.

COGS: Abbreviation for Cost of Goods Sold. This is the only deduction open to cannabis companies on their federal tax returns.

COGS refers to the cost of producing or purchasing the goods being sold. It could be the wholesale price of marijuana paid by a retailer that is selling MJ to consumers. In the case of a grower, it could be the cost of growing the marijuana sold by the cultivator.

It does not include expenses involved with selling a product or service, such as wages or rent.

DIF: Abbreviation for Discriminant Function System.

An internal IRS computer program that helps the agency identify tax returns that might be good targets for audits to collect unpaid federal taxes. The higher the DIF score, the more likely a tax return will yield unpaid taxes.

In the internal documents published in this series, the DIF results from mainstream companies considered ripe for audits are often compared – and contrasted – with marijuana audit results.

FOIA: Abbreviation for Freedom of Information Act, a federal law enacted in 1967 to ensure government transparency.

The FOIA allows U.S. citizens to request documents from any government agency. There are exemptions to the rule that allow agencies to withhold or redact certain documents.

The documents published in this series were all obtained by MJBizDaily under a FOIA request to the IRS, but many were heavily redacted.

Olive: Shorthand reference for another seminal 280E legal case, Olive v. Commissioner, decided in 2012.

A judge ruled that the medical marijuana dispensary in question was not entitled to deduct expenses from a separate caregiving business for patients because there was too much overlap between the dispensary and the caregiving operation.

Olive and CHAMP are considered key legal precedents for how the IRS applies 280E to marijuana businesses.

Tax Deficiency: Unpaid federal taxes identified by the IRS during audits. A tax deficiency is essentially the difference between what a taxpayer reports on a return and what the IRS has determined is owed based on its records.

TIGTA: Abbreviation for Treasury Inspector General for Tax Administration.

While technically an arm of the U.S. Department of the Treasury, TIGTA is a semi-autonomous watchdog agency that has oversight for the IRS and other Treasury agencies.

TIGTA issued a report in March 2020 that was critical of the IRS’ handling of 280E. The report also proposed a national audit program to root out noncompliance with 280E in the marijuana industry.

TP: Abbreviation for Taxpayer.

TP is found in many of the IRS PowerPoint training presentations published in this series. It refers to marijuana businesses, the primary taxpayers in question in the training materials.

Has your cannabis company been audited by the IRS? If so, we’d like to hear about it. Contact John Schroyer at [email protected].