MMJ Audit Advice: Avoid Responding to IRS Yourself, Handle it ‘Like Nitroglycerin’

What’s the biggest mistake a cannabis business owner can make when facing an audit? Start talking to the IRS directly.

“Never respond to an audit yourself,” said noted California marijuana attorney Henry Wykowski. “IRS agents know how to ask questions and get you talking, and before you know it, you’ve made mistakes. It’s one thing to pay a fine; it’s another to go to jail.”

Wykowski shared this advice and offered up a long list of practical legal and tax guidance for cannabis business owners in his keynote address Friday at the National Marijuana Business Conference and Expo in Auburn, Washington.

He said a marijuana business owner facing an audit should maintain a close working relationship with an attorney, not just an accountant. The main reason: Only an attorney can maintain a privacy privilege with his client, as opposed to an accountant, who can be subpoenaed in a federal court to testify against a client.

If someone arrives at your business and identifies themselves as an IRS agent, do not let them inside without talking to your attorney, Wykowski said. If they call, do not talk to them; instead, forward them to your lawyer. Make sure your lease is not in violation of any municipal or state rules against cannabis businesses, he added. And do not try to file a tax return as an agricultural business, because the IRS will not be tricked.

“Treat this like nitroglycerin,” he said.

Wykowski said a good marijuana professional should consult an attorney and an accountant familiar with the cannabis industry during the setup stage of a business to learn exactly what deductions one can make on a tax return. Because of the 2007 CHAMP victory over the IRS, cannabis businesses can deduct the cost of caregiver services and cost of goods sold from their tax burden. But understanding which services fall under this umbrella requires someone with experience in navigating the law.

“The goal is to establish yourself in a way so you can defend your position if you’re audited, so the IRS will not risk challenging CHAMP,” he said. “You need a defensible 280E formula, and you should do it before you open.”

Wynkowski said lawyers are currently fighting a handful of regulations that hurt cannabis businesses. He said attorneys are currently challenging the government’s strategy of pressuring armored car companies not to do businesses with the cannabis industry.  There is no precedent that protects the government when it sends threatening letters to mortgage owners of cannabis businesses, he added.

Wykowski said attitudes are also changing within the DEA and IRS, which could spell a brighter future for the industry. He believes most DEA agents understand that attitudes toward cannabis are shifting, and their efforts are better director toward other crimes.

“We expect that most U.S. attorneys will honor of the intent of the Cole Memorandum and proceed in good faith,” he said. “We will have rogue prosecutors and DEA agents who will cause trouble for you.”

2 comments on “MMJ Audit Advice: Avoid Responding to IRS Yourself, Handle it ‘Like Nitroglycerin’
  1. Luigi Zamarra, CPA on

    For a more complete discussion of this issue and the ramifications of a Kovel letter, please see: http://www.forbes.com/sites/robertwood/2012/10/28/neat-trick-attorney-client-privilege-from-an-accountant/

    Extending this privilege to CPA work via having the attorney hire the CPA is of limited value to businesses that do not commit crimes. There are some provisions that extend privilege to tax preparation services. Although I agree that if an IRS audit exam is likely this may be a useful tool; that said, it is not usual business practice – only rarely are CPAs hired by tax attorneys. One thing is certain, your costs for the (typically more expensive)tax attorney will increase as he will need to incur addtional time to oversee the CPA than would otherwise be required.

    Reply
  2. Margaret Gedde on

    Thanks for putting IRS challenges to cannabis businesses into perspective.

    I have wondered how sellers of medical marijuana could function at all, if all federal tax deductions are denied as I had heard. However, the article says “Because of the 2007 CHAMP victory over the IRS, cannabis businesses can deduct the cost of caregiver services and cost of goods sold from their tax burden.”

    Would you link to articles about this 2007 CHAMP victory?

    Not all readers are familiar with it. Thanks –

    Reply

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