With cannabis being a federally illegal substance, managing money in businesses can be tricky, especially with a wave of IRS audits suspected to be around the corner.
Having a nationwide client base, we at GreenGrowth CPAs were wondering when we would get confirmation of some rumors we were hearing.
On Oct. 16, Marijuana Business Daily confirm the planned “tsunami of 280E audits” the Internal Revenue Service (IRS) is preparing for our industry.
We highly encourage everyone to read that, but here, we will help you to understand the implications, including some “reading of the tea leaves” about what we will be advising clients.
What the IRS calls (CIP), or the Compliance Initiative Project, could affect ancillary cannabis entities, mainly what are considered “management companies” in Oklahoma. Less publicized, it seems they are taking a deeper dive into audits and list a few tools they can use against you if you are not properly prepared. Missing 8300 forms, missing tax forms or poor cash-handling procedures might provide big teeth to their bite in the way of large fines for you or your business.
To understand the shift in the IRS to pursue nontraditional 280E companies, we must understand the underlying court cases they are basing this strategy upon: a Los Angeles dispensary called Alternative Health Care and Harborside Health Center in Oakland, California.
For brevity, the Harborside decision is used to show precedent that even though cannabis is legal in California, 280E still applies to anything that is Schedule I federally. A recent bill states that California will allow state tax deductions for cannabis businesses.
The more interesting case is about Alternative Health Care (AHC). AHC tried to circumvent the entire purpose of 280E by hiring a management company to run the dispensary storefront. Court rulings generally tend to apply 280E to both entities, to deter further people from utilizing this “tax strategy.” Now it seems the IRS is using this as a way to investigate if they can also apply 280E to other entities that are close to touching cannabis plants.
The Marijuana Business Daily article contains a section titled, “All MMJ Companies at Risk.” Although this sounds dire and people should absolutely pay attention to this section, we are not as fearful as some.
It is correct in that there is no clear guidance and it appears to be a gray area, but where does or where should the IRS draw the line? With cannabis law firms? Cannabis grow supply companies? What about payroll companies?
After speaking with different operators and experts in the field, here is where we differ slightly philosophically in what we think they will pursue. We think they continue to go after the nontraditional 280E companies that are acting in a capacity to bypass, almost in bad faith, the purpose of 280E — in other words, “management companies.”
In hindsight, this was a large ship bound to hit an iceberg eventually with basic fundamentals not in place. For example:
- AHC’s QuickBooks practices were done very poorly, to the point of almost becoming evidence against themselves.
- We would have advised differently on its square footage of THC versus non-THC products in its store.
- We would have advised differently on its use of employees’ time, more specifically its employee time tracking.
- The “management company” had 95 percent of the same ownership as the dispensary.
- Most importantly, the “management company” had no other clients besides its own dispensary.
Instead of worrying excessively about where the IRS will draw the line, we still anticipate it will initially pursue the bad faith actors and the unproven schemes certain law firms put into place. It is still the IRS, so it will go after what it considers to be the low-hanging fruit.
I mention this in contrast, as there are United States Tax Court-approved strategies that we use every day to minimize the impact of 280E. These strategies have nothing to do with a management company, and the proof is in the results.
Our last three projections for year-round dispensary clients are for them to save only 9 percent of net sales (not including applicable sales tax or medical cannabis tax) for their federal tax bill. Projections are an internal document that quantifies how much we save clients annually, along with how much they need to save per month. These strategies are taken from U.S. Tax Court cases on how to legally move indirect operating costs over to cost of goods sold.
No matter how your attorney’s or certified personal account’s firm structures your business, it is possible that the IRS can use two other aspects against you: cash-intensive operations and Form 8300. Understand that the IRS will be diving further into audits than before and, if warranted, could use cash-handling procedures to expose you to further fines.
Let us face the facts, my fellow business owners. You are not looking over your shoulder for the Drug Enforcement Administration (DEA) anymore. Cash crimes are now the drug charges of old, and the powers that be will try to use what you provide them against you if not handled properly.
All of GreenGrowth CPAs’ processes with clients are predicated on proper cash handling techniques, including obtaining a cannabis bank account, when feasible. Cannabis bank accounts open up easier payroll processing and merchant services for dispensaries (for example, the ability to take a card, not just cash).
These are the positive consequences of our main concern, like financial transparency. The more items that are electronic, the less transactions are scrutinized. Plus, the less cash-intensive your operation is, the more efficient retail or wholesale operator you will become.
Cash costs you money, not only in loss of productivity, but it also potentially becomes an unforeseen liability. With cash-only operations and improper standard operating procedures, you might lose the ability to prove where your money came from and where it went. We provide every client with approximately 25 pages of SOPs to help mitigate this exact situation. Being able to properly prove and trace what you have done from day one is paramount to keeping what you have earned and protecting yourself during an audit.
We work with national banks and even have a few in Oklahoma. Regent Bank in Oklahoma has been the most customer-friendly, responsive, forward-thinking in helping this industry move out of the Stone Age. It has been integral in helping dispensaries accept new payment methods, such as debit cards instead of just cash.
If the IRS was to look into your cash-handling SOPs, it will probably notice at least one infraction: not properly utilizing Form 8300. If you have not been properly advised by your accounting firm about what Form 8300 is, why it exists and when it is triggered, an example of using Form 8300 would be when a transaction to a vendor is greater than $10,000 at one time. How many dispensaries have purchased over $10,000 in one transaction from a vendor this year? Growers and processors, do you file a Form 8300 with your clients when they buy more than $10,000 of product at a time? We know this answer for our clients, and we would encourage everyone to review their transactions and find out how many potential $25,000 fines are sitting on their books at this moment.
For some, this might be scary, but we believe it is a healthy dose of reality. We at GreenGrowth CPAs are happy to see our philosophy being upheld again by the courts. We are, at times, unpopular for not blindly agreeing to the “newest fad in hiding money” from the IRS. We will always focus on the fundamentals and follow tax court rulings as they arise. In subsequent columns, we will shed some light on what we see in Oklahoma with management companies and where we see the industry going in the next 12 to 24 months.
Lawrence M. Cagigal
Lawrence M. Cagigal is the southwest territory sales manager for GreenGrowth CPAs, a boutique certified public accounting firm based in Los Angeles that specializes in cannabis entities. Cagigal, who is from Oklahoma City, returned to run operations for their eastern expansion after spending 13 years advising and selling in the financial services industry in Texas.