Cannabis Knowledge & Insights

Cannabis Tax Audit Appeal Case

As a cannabis business owner, the incredible burden of taxes is a harsh reality.  And dispensaries are hurt the most by the restrictions of 280E.

If you need help with your cannabis business taxes or help with a cannabis tax audit, then please reach out to our team today to schedule a time to chat.

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In this video update, we review a recent cannabis tax audit appeal case that deals with METRC data and a dispensary trying to beat 280E.

We also cover four lessons from this case for ALL cannabis business operators.

Here are some helpful spots to jump to in the video:

Cannabis Tax Audit Transcript

An appeal decision came out this week, or actually last week on the 20th, we’re going to talk about, give us a moment here. We’ll let the room fill up, let people join in. And then we’re going to hop into a discussion again about cannabis business taxes and cannabis business audits. It’s a very important topic to understand right now. So we’re gonna go ahead and maybe like five, seven more seconds here. And then we’re going to hop into the presentation should be maybe 20 or 30 minutes, but it’s going to be very, very valuable for you to understand this information so that you don’t end up in the same position that this cannabis dispensary from the state of Colorado ended up in. All right. So let’s go ahead. We’ll start from the top right here. So what are we going to be talking about? Well, a new appeals court ruling came out this week regarding cannabis business taxes and audits.

Now it centers around data access and backing up tax positions by a Colorado dispensary. Now this is pretty cut and dry case, but it’s worth discussing because tax layers are out there giving dispensary’s false hope that they can beat the IRS and nullify 280e. Now this is not the case. You cannot beat the IRS very few times. You’re gonna be able to do that. That’s not the point here at any rate. If you have any questions about what we’re going to cover, today’s video, and please reach out to us via our website at GreenGrowthCPAs.com or give us a call at (800) 674-9050. All right. So before we get started, I need to let you know the information contained in this presentation is meant for guidance purposes only. And that meant is professional legal or tax advice and further it does not give any personalized legal tax investment or any business advice in general.

So with that all out of the way, let’s dive into what is the info about this case. Now with every case, there is usually something in question, that’s why we’re in the court, right? And for this case, it was to determine the IRS’s power and ability to enforce a provision in the tax code, disallowing deductions for business activities, concerning controlled substances controlled substances, which are illegal under federal law. AKA asking the court for the 20th time is 280E enforceable. Okay. Is IRC 280 enforceable. That is the main question of this court case here. Now, basically what happened is that this was a Colorado dispensary that was audited and things didn’t really end all that well for them. Okay. The IRS throughout an audit, they wanted more information to substantiate the dispensary’s financial statements. Now the IRS wanted a fair amount of data, but this also included metric data track and trace data.

It’s, you know, stuff that the state mandates of you, okay? Now they wanted this metric data to substantiate the figures on the tax returns for this cannabis dispensary. Now the dispensary did some data. They did send some data to the IRS, but they did not comply with the metric data requests. And this is where the case really goes sideways for the dispensary. Now, the timeline of this case is very, very important. Okay. This is a cannabis tax audit. Now what happened is that the tax years in question are 2013 in 2014. So six, seven years ago. Now the data was requested in 2016. Now the date of the appeal decision was October 20th, 2020. So this case has been going on for at least four to five years here. Now that means that there is four to five years, maybe even six years of interest penalties and all this stuff building up over time.

That’s what happens in an audit. When they find out you’ve underpaid, they’re going to assess penalties and interest, and it compounds sometimes monthly. Now it’s likely that once the dispenser was contacted by the IRS, either a, a legal group reached out to them or the dispensary reached out to a legal group, and this firm filed an appeal for the dispensary saying that, Hey, they didn’t miss their timelines. And that you cannot pull this data from them. It was unconstitutional or whatever they want to say. It’s not right to be pulling this data. Now from here, understand that this case now is stuck in court for lots of years, racking up those penalties and racking up those fines. And most importantly, the costs it’s never talked about is racking up all these legal fees by lawyers who are just having you on the clock, pulling and pulling and pulling this information for you and doing, doing the work eight, they deserve to get paid.

I’m not saying that lawyers don’t deserve to get paid, but this is a very expensive process. If a lawyer is going to fight the IRS for you now, the cannabis dispensary, his lawyer, they had made arguments for again, are my asking for this additional data…was unnecessary. Essentially. Now those arguments were number one, the IRS has investigation is quasi criminal. Yes. The lawyer said this about the IRS and exceeds the agency’s authority and is being conducted in an illegitimate purpose. Okay, well, how it came back, the court said, Hey, the IRS was conducting this investigation in good faith and followed all their protocols. So this argument is gone and off the table. Now the second argument the lawyers tried to stand on and a dispensary tried to stand on because they did sign off on this is that even if the investigation was a legitimate investigation, it had a legitimate purpose.

The information sought is irrelevant. Well, in general, what you need to understand is that the IRS has what we call broad latitude issue. Summons is for the purpose of ascertaining the correctness of any return, making a return where none has been made or determining the liability of a person for internal revenue tax or collecting any such liability. So pretty much the IRS can ask for whatever they want to substantiate your return. So this argument is gone and off the table. Now the third arts or the third argument here that we have is that the lawyer said the investigation is in bad faith and constitutes an abuse of process because a, the IRS may share the information collected with federal law enforcement agents. Well guess what? The dispense, they wanted us to not do this because they didn’t want to get a, you know, anything with the DOJ department of justice, you know, DEA coming up at them now, guess what?

The dispensary is blatantly selling cannabis in. Anyone in the general area could tell that. And so any enforcement agent could have, you know, just walked into the area and learn this on their own. So this argument off the table, now B why this constitutes an abuse of process. What the lawyer said is that the IRS summons was overly broad and rich require the creation of new reports. Guess what? Doesn’t matter. This has no bearing you the taxpayer and not the IRS needs to provide data to back up your tax position. If you’ve created a tax position with no backup data, this is now your big, big, big problem. It doesn’t matter if you have to unearth a hard drive from the landfill to backup your tax position, you better find that hard drive. Okay? So this point is off the, you know, off the table.

And then there’s two more here to base it. This was an abuse of power by the IRS. What the lawyer said was that the dispensary’s have a reasonable expectation of privacy in data. They tender to a state regulatory authority pretty much from another cannabis tax case. The precedent was already said that the taxpayers have no reasonable expectation of privacy in the metric data collected on their business. Essentially, a person has no legitimate expectation of privacy in information that they voluntarily turn over to third parties, okay? That is verbatim from previous case. So that point is off the table. Now the last one here, why this case could have been potentially an abuse of power by the IRS. The lawyer said is that those state authorities cannot provide this requested information without violating Colorado law, save you the explanation. Guess what? It came right off the table.

They looked at other precedents. And it said that the court therefore concluded that med employees, which is the marijuana enforcement division in Colorado, their employees compliance with a summons seeking metric information would not constitute a crime. So pretty much all the arguments for the dispensary were easily thrown out by anyone that has half a brain and can retaught precedents. Okay. Now let’s keep walking through this year and we’ll talk about the result results of this cannabis tax court case. Okay. As you may understand, or may guessed by now, the dispensary lost their appeal and the IRS will get the requested data, the metric data themselves from metric or from the med, which is the marijuana enforcement division in Colorado. But now the cannabis company is going to cost them a lot, a lot more money compared to if they just shared the data four or five years ago with the IRS.

Now here’s the court’s verbatim response. And I need you to pay attention to this. This is incredibly important. They say about the arguments. We just talked about that these argument starts start the court right here. These arguments are familiar to us over the last several years, multiple Colorado marijuana dispensaries have challenged the IRS, his ability to investigate and impose tax consequences. Upon those dispensary’s understand that those dispensaries have been represented by the same attorneys that are representing the dispensary’s fighting the summonses. In this case, those dispensaries have lost every time. And it ends here saying the same result is warranted here. And then they then list off all the cases where these same exact lawyers loss on those same arguments. It’s essentially the same case. And these lawyers are just cutting and pasting and repeating of course changed a little bit of specific information, but they use the same arguments and they last for their client.

And I’m sure they knew they were going to lose. They’re just trying to get those fees and shoot their shot. See what happens. So here’s what happened to the dispensary, right? They got audited. They didn’t like the outcome. And they engage in expensive legal group who used unoriginal arguments that always lose to give false hope to the dispensary owners, the dispensary lost. And now they’re out a lot more money compared to if they had just simply number one, filed their taxes properly in 2013, in 2014 and kept accurate records to substantiate their tax return position. Number two, if they had complied with the auditors, when they requested more documentation, if you just play by play ball with the IRS, you’re going to probably end up in a better spot, unless you just go ahead and say, all right, let’s go do legal stuff on them and see if we can push them.

Then you will, you will not win. Okay. And number three, they had just at the end of the audit, worked with the IRS to set up a payment plan and then just start paying down that debt. Maybe they didn’t have the money at the time. And someone said, Hey, fight it, kick the can down the road. And maybe you can win a judgment later or, you know, whatever’s going to happen. But again, putting these things in the court for multiple years, your penalties, your interest in your fines are going to rise, rise, rise, and you’re going to be caught holding the bag. And the lawyer is going to say, well, sorry, we tried. Can’t help you out. Okay. So this is not what you want to do. You do not want to go against the IRS.

So lessons

And what this means for the cannabis industry. Okay. I want to start this off before we go into the four lessons that I want to cover. I want to talk about audits in general, just real quick. We’ve talked about this at length. In many other videos, you may have not seen them, but you will likely get audited as a cannabis business. Okay? One in five cannabis businesses in the state of Colorado is being audited at some level of the government. Now, why Colorado would I bring that stat up? That stat that we have from boots on the ground from tax lawyers and CPAs on the ground, but also because it’s the first recreational legitimate market. So they’ve got a little bit of headway. If you look at these timelines, we’re talking about tax returns from 13 and 14, this is not when it was recreational, but at any rate, you’re going to start seeing audits from those first few years of the recreational market, because they need to wait a little bit of time so they can go back and actually do that.

And process takes a long time. So what should you do when you get audited as a cannabis company, number one, you need to contact your CPA immediately and let them know the state of your situation. Now, from there, you’re going to take specific advice from them. But generally what you’re going to do is respond back to that data request from the IRS with complete information. And you’re going to be courteous throughout the entire process as well. Even if you have to be the bigger person, be that bigger person, you don’t want to piss off an auditor. And lastly, if you do get a judgment, consider what they call an offer in compromise, which has been, Hey, say they levee a penalty of, you know, 700,000. What if you could offer them 500,000 and just call it a day. See if they’re able to do that with you, if not, then get on a payment plan that works for you and your financial situation, do not try to be a Renegade and try to challenge the IRS on their practices that are well-established with court precedents in you.

It just will not end well. So those are the steps to take for a cannabis tax audit. Now let’s hop into four lessons here that I want to kind of extrapolate from this…this court case here. Okay. So number one, the first lesson is that organizational entity structures are incredibly important for cannabis-based businesses. Now, some of the entities that were involved in this tax court case were LLCs, and these are called. These are called pass through entities, essentially all the financials flow the business through the business, pass through onto the member of the LLC, which could be multiple or single members. Now, what this means is that if you’re being audited and you have, you know, an LLC is one of your entities, they can now dig into your personal 1040, your personal tax returns and look into those things. Now, if you’re married, they can start to pull apart all your spouse’s stuff.

And I’m sure you don’t want that. Okay. Now they’re gonna also be able to look into your personal bank account information. Now, maybe they look and they see a $12,000 deposit for cash. Okay? You better have a receipt to substantiate what that was from and that it wasn’t diversion of cash from your cannabis business, out of the business and into your personal pocket. Okay. Now, another reason why it’s important to have proper proper entity structure is that when they audit you as an LLC, you’re going to get, well, how is he going to get taxed at your personal tax rate, which could be 30, 40, even 50%, depending on your tax bracket. Now at a corporate tax rate, it’s capped at 21% as a C Corp. So it’s very important to work with a CPA and a lawyer to decide on the right entity structure for your cannabis business, from the get-go having a balance of risk and of the economics of the business and the deals that you are creating with your business.

So that’s lesson number one. Now, lesson number two is that you want to make sure that you work with experienced professionals to file and prepare your cannabis business tax returns, investing in a CPA that can give you the proper guidance on IRC. 280e can be an incredible investment that can serve you big time and save you big money on your cannabis business tax returns. And if you get audited, you already have someone in your corner who can help you work with the IRS to reaffirm your tax position, because any credible CPA is not going to create a tax return and prepare a tax return for a cannabis business without having any substantiating information behind the numbers that create that return. If you’re working with someone that’s not you having backup data for your tax return to substantiate those claims, you better want to, you may want to look for somebody else to work with.

Hey, hit us up, hit our website. GreenGrowthCPAs.com or call us at (800) 674-9050. We’ll always be here, but really work with somebody experience. Don’t just try to save 500 or a thousand dollars in your tax prep fees. Only to later be given, you know, a huge punch in the mouth by the IRS, because you just wanted to save a thousand bucks. And now you’re holding the bag for a hundred grand in taxes. That is not a smart choice on saving money. Don’t cut corners on CPAs and don’t cut corners on your lawyers. Now, the third lesson I want to talk about here is that if you are being audited by the IRS or any level of the government and a tax agency, then you should consider engaging a CPA. First, before you engage your lawyer, understand that you’re not in any legal

Trouble here. You don’t need a lawyer right now.

You need a CPA who can interface with you and the IRS to make sure that your tax position is sustained substantiated. Now, there are many amazing lawyers out there, and I’m not trying to say don’t work with lawyers and I’m not anti lawyer. I think lawyers are essential to everything to protect you, to make sure you’re doing things right. So please do work with lawyers. You will need lawyers in the cannabis industry. There’s I don’t think anybody that can make it through two or three years without having to contact a lawyer, at least one time. Now, having a CPA can help put you at ease and help you actually remedy the situation instead of getting hostile and being Sue crazy and posturing up to the IRS and saying, bring it, bro, because look, they will bring it, bro. And they will smash you. Okay? Now again, you’re not in any legal trouble.

They just want clarification. So, you know, don’t start seeking your lawyers on the IRS right away, work with your CPA. First. If they can’t remedy it, then seek the help of a lawyer. Now the IRS, they want to see it. You’re probably going to have to show it, especially if you’re a cannabis business. So don’t think that you have some type of power where you don’t have to show things off to the IRS. They will find a way to get around it. Trust me, they have all the time. It’s not time. It’s not in your favor because interest and penalties are racking up every month. They’ll take five, six years to do what they want to do because they know that it will make them more money. Now here’s a point to the dispensary, but I’m going to take it away from them immediately. I think I covered this a little bit at the beginning.

What the dispenser was afraid of is essentially that the IRS is going to hand that metric data over to the DOJ. The department of justice would then kick off an investigation for criminal drug trafficking. Well guess what? That’s as well, setback, the dispensary wanted immunity from the DOJ. If they were going to hand this information over and look, I totally get it. It’s pre recreational. They probably, and it is federally illegal. So they were a little bit nervous handing this data over, but, but is where the point gets taken away from the dispensary. Look, they’re advertising that they are the number one dispensary in Colorado and anyone with a medical card could just walk in there and see that they were breaking federal laws. It doesn’t take, you know, undercover investigation to unearth this or a fishing expedition by the IRS to show that you’re trafficking cannabis.

It’s very obvious. We can just see it from the street. We can probably smell it from the street. So again, all of these things that the dispensary used as, how do you say…defenses and arguments were already set a precedent that they were, you know, no and void, you were never, never gonna win. Once its brief was filed by an appeal was filed by the lawyers. It was lost. It was already dead on arrival. So look, the only people that made out in this are the IRS and the lawyers and lawyers. They said, Hey, we’ll help this cannabis business, but they can’t make any guarantees. And no one would ask for guarantees. You can’t guarantee these types of things, but they should have known anyone with half a brain would have known that they were going to lose this battle. Now the fourth lesson, we’ll round it out here.

280e is going nowhere. It is here to stay in less cannabis is rescheduled out of schedule one and schedule two of the controlled substances act. Now don’t let any lawyers or any inexperienced tax professionals tell you that you can beat the IRS when it comes to 280e look, several high profile cases in many more, not so high-profile cases have shown time and time again that the us government will not back down from enforcing IRC 280e. So what you can do is prepare your taxes in accordance with tax laws and precedent set forth. Okay, don’t use any new tax loopholes. Don’t look read some stupid blog by some CPA saying, Oh, you can try this thing out. Don’t be a Renegade and try some crazy new thing out. Do things that are proven and tested by the tax courts and reform reaffirmed by the IRS.

That, yes, this is the way that you file your taxes as a cannabis business. And look, don’t do any funny business with your cogs. Don’t try any of that funny stuff. Okay. You have to have a reasonable methodology. Don’t just start stuffing things into your cogs and think you’re going to get away with it because you’re going to have to back up every one of those things that you said you would do. Okay. And conversely, from that position, you know, if you want to be a Renegade or you don’t want to do, and you want to go ahead and you know…do all this stuff and that’s your own prerogative, right? Some people say, Hey, this is a negative mindset. Jim. Don’t put yourself in that mindset and we should fight the tax man and fight the pressure of the IRS. Hey, your position is your choice.

And if you want to be a champion for the industry and fight the fight, Hey, that’s your choice. I wish you much success. Our company wishes you much success, but you knew the tax issues that were in this industry. If you did even one day of due diligence when researching the cannabis industry. So don’t come out here and say, you didn’t know, this was the way it was. You have to do your due diligence. Okay? And conversely, from that position, if you want to fight the fight great. But again, conversely, there are plenty and most, I would say an overwhelming majority of cannabis business operators are out there now building their business, paying their taxes, potentially even paying too much tax. They should reach out to us. We can help them with that. And then making the best of this current scenario. They’re not sitting there griping about how unfair it is.

They knew coming in that it was going to be relatively unfair compared to other ordinary businesses in the tax realm. But they’re going to do what they have to do to sustain over a few periods a few year period, or maybe Hey, Amy’s eight years until it gets rescheduled, who knows at any rate, they know that they’re coming into a tough situation. They’re going to make the best of it. And they’re going to hopefully be successful for the longterm now. So this video has brought you some value and helped you to better understand how fighting the IRS on. Well, a SAB established precedents around IRC 280e will only result in you paying higher taxes and incredibly unnecessary legal fees. Now, if you need help with cannabis, business taxes, cannabis, accounting, or help with your cannabis business tax audit, then please reach out to us via our website at GreenGrowthCPAs.com or give us a call at (800) 674-9050.

All right. So let’s hop in here. Let’s answer some questions. If there’s any more questions here. The goat tree said, Hey, guilty until proven innocent. Welcome to dealing with the IRS essentially. Yeah, it’s going to be guilty until proven innocent. That’s not really how it is, but it looks like that you have to substantiate your tax return. It’s not the, they call it. The burden of proof is not on the IRS to say that you’re wrong. It’s the burden of proof on you to say that you’re right and hear all the reasons why you’re right. So look, it may seem unfair, but you should know this stuff going into the cannabis industry. If you don’t know this, you’ve obviously not done enough research on the legitimate legal cannabis industry. If you’re operating in the gray market or the illicit market or the illegal market, and you know, you get into the legit market and you want to gripe about it, Hey, you should have looked at this, but also understand if you are in the gray market, illegal market, the illicit market, you still have to pay taxes on illegal money.

It doesn’t matter how you make this money. You still have to pay the IRS. So it doesn’t matter really if you’re licensed or not, you still have to pay taxes and you still have to do all of your accounting, like a regular cannabis business. And you know, if you don’t right, look at people like the Al Capone’s of the world, they don’t go down for killing people or selling drugs or doing really bad things. They go down for tax evasion. So make sure that you’re paying your taxes on all of your income, legal or illegal. All right. Let’s see any more questions in here? I don’t see any other questions. So we’re going to sign off on this again. If you have any questions about cannabis tax audits, or if you need help with your cannabis business taxes, then please reach out to us via our website at GreenGrowthCPAs.com or give us a call at 800-674-9050. Have a great day. And we’ll talk to you soon.

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