IRS Advice

Forget the old EF Hutton commercial: it’s when the Internal Revenue Service (IRS) speaks that people really listen -- especially if they work in the cannabis industry.

Veteran IRS official De Lon Harris recently took part in a webinar in which he offered valuable advice for how cannabis businesses can get and remain tax compliant.

Harris, the agency’s Commissioner of Small Business/Self-Employment (SB/SE) Examination, chatted with PBC CEO and cofounder Josh Radbod. On the agenda: how companies can color inside IRS’s carefully drawn lines even though cannabis remains illegal on a federal level.

“It’s really our mission at the IRS, not just with marijuana and cannabis industries, but with all taxpayers, to promote voluntary compliance,” Harris pointed out during the webinar. “And that can happen in different ways. When most people think of the IRS, they think of examinations or audits and they think that’s the only way that we interact or try to promote voluntary compliance with taxpayers. But we do our fair share of outreach and education, as well. Just like what we’re doing today.”

How can firms reduce audits? “Regarding the cannabis marijuana industry, we developed a strategy that we hope will increase voluntary compliance and identify and address non-compliance when it’s there,” Harris explained. “Our focus is to positively impact filing and paying and reporting compliance on the part of all cannabis businesses to keep audits to a minimum.”

Harris made his agency’s case by noting the extensive education that its examiners undergo, its strong interdepartmental communication, and the emphasis it places on helping businesses get educated.

Radbod was careful to specify that taxes need to be paid no matter cannabis’ Schedule I controlled substance status on a federal level. “As I’m sure you’re aware, and everybody listening, a business engaged in the sale or production of marijuana or cannabis is considered illegal under federal law. But nevertheless it’s a business in every sense of the word. Whether its categorized under federal statute as legal or illegal, it still remains obligated to pay federal income tax on the taxable income that it earns.”

“Income from any source is taxable and taxpayers are generally required to file a tax return to report that income to the IRS,” instructs the agency’s web site. “Many marijuana-industry businesses conduct transactions in cash, which need to be reported like any other form of payment."

‘It’s Tricky’

In a piece he authored, Harris made note of the fact that handling taxes is “tricky from a business perspective because even though states are legalizing marijuana and treating its sale as a legal business enterprise, it’s still considered a Schedule 1 controlled substance under federal law. That means a cannabis/marijuana business has additional considerations under the law, creating unique challenges for members of the industry.” Specifically, these businesses are often cash-intensive since many cannot use traditional banks to deposit their earnings. “It also creates unique challenges for the IRS on how to support these new business owners and still promote tax compliance.”

Good records-keeping -- receipts, canceled checks, other evidence of income -- is of course crucial, Harris stressed. “Well-organized records make it much easier to prepare the tax return, and to help provide answers if your return is selected by the IRS for an audit.”

Indeed, the agency tells visitors to its web site: “Good records assist in monitoring a business's progress (and) tracking deductible expenses and can substantiate items reported on tax returns. A good recordkeeping system includes a summary of all business transactions. Generally, it is best to record transactions daily.”

The Internal Revenue Code 280E “complicates matters, preventing businesses who sell cannabis from receiving tax deductions, even if those businesses operate legally in states that have legalized cannabis sales,” noted in reviewing the webinar. “However, that section does allow cannabis businesses ‘to reduce their gross receipts by properly calculating a cost of goods sold to determine its income.’ While a cannabis business can’t deduct advertising or selling expenses, it can reduce gross receipts, according to internal revenue code 471.”

For now, industry visitors to the IRS’s web site need to search the word “marijuana,” not “cannabis,” to gain the specific information they need, Harris said. “We’re making that change, but for now you would type in ‘marijuana industry,’ and it would pull up the page that we give you information about -- not only general information that would help you understand and meet tax responsibilities required by the cannabis industry, but the page which includes links to pages of more specific information.”

‘Of Course’

The IRS has also been public in explaining its position on banking vis-à-vis the cannabis businesses. Secretary of the Treasury Janet Yellen said recently that easing restrictions on banks to work with state-legal marijuana businesses would make the IRS’s tax-collecting duties easier.

“While Yellen’s response was quick, it’s yet another example of a federal official recognizing the untenability of the status quo,” commented “IRS, for its part, said in September that it expects the cannabis market to continue to grow, and it offered some tips to businesses on staying compliant with taxes while the plant remains federally prohibited.”

Until that changes, banking remains a work in progress.