Cannabis Businesses Income Tax Refusal

Advertisements

IMPORTANT RECOMMENDATIONS:

  • A pending U.S. Tax Court case offers an interesting theory that prevents all deductions from a marijuana business from being allowed to tax federal income.

  • The theory is based on a provision in the Tax Cuts and Jobs Act 2017 that allows small taxpayers to use a simplified method of inventory accounting for tax purposes.

  • Legislation pending in Congress would remove marijuana from the list of substances in the Controlled Substances Act, resulting in no income tax deductions for marijuana businesses.

For the past 40 years, cannabis businesses have been barred from deducting operating expenses on their federal income tax returns. Jeffrey Edmondson v. After a brief victory in the Tax Court in the Commissioner’s case,[1] Allowing business cuts for an illegal drug dealer to pay for office rent, weighing, packaging, and automobile expenses, Congress amended the Internal Revenue Act in 1982 to deny all business cuts and loans to illegal drug dealers. The amendment does not allow taxpayers operating a controlled substance smuggling business, which is prohibited by federal or state law, to deduct costs to calculate their taxable income or to claim credits against their tax liabilities.[2] Controlled substances include marijuana.

Since 1982, many states have legalized medical and recreational marijuana, but federal laws have not been affected by the legislation in those states. Federal income tax deductions are not allowed for marijuana producers and distributors. However, one taxpayer has now come up with an interesting new theory to avoid the effects of the deduction benefit.

Currently pending in Tax Court, Alternative Therapies Group, Inc. v. Commissioner.[3] The taxpayer, a marijuana business, claims that a provision in the 2017 Tax Cuts and Jobs Act that simplifies the tax accounting method for inventories authorizes them to account for expenses recorded as “cost of goods sold” in their books. not accepting “cuts”.

The simplified inventory accounting method on which the taxpayer is based, [ ] The accounting method of that taxpayer reflected in a valid financial statement for that taxable year, or, if the taxpayer does not have a valid financial statement for that taxable year, the taxpayer’s books and records relating to that taxable year. with the taxpayer’s accounting transactions.”[4]

The taxpayer used the second alternative – taxpayer books and records prepared according to the taxpayer’s accounting procedures. The simplified method of inventory accounting applies to a “small” business. A business is small if it has gross revenues that do not exceed $25 million adjusted for annual inflation for the previous three years.[5] A small taxpayer may also use the cash accounting method (income items are included in gross income when received and expenses are deducted when paid), which is a departure from the general rule that taxpayers with inventory should use the accrual accounting method..[6]

In Alternative Therapies, the taxpayer grew and harvested marijuana and produced marijuana products. It paid direct and indirect expenses for its growth and cultivation activities. The Tax Court petition alleges that, like other small businesses, it has the right to use the new simplified book and record inventory method and the cash accounting method of its inventory. The taxpayer’s books and records and tax return included $2 million for the cost of goods sold, which the IRS did not allow. This amount is at issue in the pending case.

Cost of goods sold reduces gross revenue. The resulting amount is gross income (gross profit). Allowed deductions are deducted from gross income. Tax law makes a distinction between cost of goods sold and deductions because federal tax law cannot allow cost of goods sold. The United States Constitution allows “taxation of income”.[7] A tax that does not allow for an “above the line” reduction (balancing) in gross revenues on the cost of goods sold would be an unconstitutional gross income tax. As a result, federal tax law does not allow only “below the line” deductions from the “gross profit” of a cannabis business.

The taxpayer’s petition alleges that the accounting procedures properly balance the cost of goods with the gross revenues from sales. The taxpayers’ books and records kept an inventory account capitalizing on the direct and indirect costs they paid to produce and distribute cannabis products. When the taxpayer sells his products, he enters his books and records as the gross receipt and deducts the gross receipt amount against the cost of the inventory he sells.

Clearly, Congress can change tax law to move an expense from an permissible below-the-line deduction to an allowable above-the-line cost of goods sold. According to the taxpayer, the change that provides this transformation in Alternative Treatments is the simplified inventory accounting method.

The IRS disallowing theory is undoubtedly that the 2017 enactment of the simplified method of inventory accounting did not tacitly repeal the 1982 law that prohibited cannabis businesses from deducting operating expenses. The Treasury Department publicly expressed this theory in a regulation it published in 2020 to explain the simplified inventory accounting method.[8] IRS theory would be based on the rule that implied statutory revocations by later legislation are not preferred unless the intent of Congress is clear and unambiguous.[9] The regulation appears to be based on a non-existent statutory provision, making its validity problematic.

The question in Alternative Treatments may turn to whether the simplified method of inventory accounting allows the taxpayer to define cost of goods sold in accounting procedures. The petition does not disclose the specific costs in the taxpayer’s cost of goods sold, which was denied by the IRS, only alleging that the taxpayer pays the direct and indirect costs as a producer to grow and produce marijuana. If this can be proven, the taxpayer has a substantial argument that the costs can be included in the cost of goods sold under the simplified method of inventory accounting and cannot be deducted as a deduction due to constitutional constraints.

The most recent marijuana deduction denial case was Lord v. It’s a commissioner’s case.[10] In this case, the taxpayer, a grower, processor, and distributor of marijuana, unsuccessfully argued that deductions should be made for accelerated depreciation.[11] and bonus depreciation[12] argued that for a tax year prior to the introduction of the simplified method of inventory accounting, it should be included in the cost of goods sold. These depreciation deductions are capitalized into inventory under uniform capitalization rules.[13] The rules state that even if a taxpayer’s books and records treat these depreciation costs as current expenses, they still cannot currently be deducted for tax purposes but must instead be added to inventory and released when the related goods are sold. Uniform capitalization rules clearly state that a non-deductible cost for any taxable year is not converted into a cost that can be included in the cost of goods sold. For this and other reasons, the taxpayer in Lord lost the case.

The Administrative Procedure Act: Tax Court on Alternative Treatments petition also alleges that the IRS has an administrative practice that denies marijuana growers the ability to report cost of goods sold under the simplified inventory accounting method, and the practice is invalid because of the IRS. It did not report on implementation as required by the Administrative Procedure Act and did not give an opportunity to comment. This IRS guide is apparently included in an unpublished IRS audit guide for the cannabis industry. Taxpayers have recently prevailed in cases where the IRS has proven to have issued an administrative rule that was not first made public and submitted to taxpayer opinion.[14]

Pending Legislation: The penultimate paragraph of the Lord’s opinion announces that in the absence of legislation, the Tax Court will strictly enforce the 1982 cannabis prohibition act. A bill currently pending in Congress will remove marijuana from the list of substances under the Controlled Substances Act, resulting in disallowing income tax deductions and credits for marijuana businesses.[15] The bill also includes imposing a federal excise tax on marijuana. The bill passed the House on April 1, 2022, but the Senate is working on its own bill. As a result, enactment is controversial as passage may require 60 Senate votes, and meanwhile, the Tax Court will continue to take the position that it is not responsible for resolving the technical tax issues presented by the deduction allowance.

FINAL NOTES

[1] TC Note. 1981-623.

[2] IRC §280E.

[3] 2022-8668 (January 7, 2022).

[4] IRC §471(c)(1)(B)(ii).

[5] IRC §448(c)(1).

[6] IRC §448(b)(3).

[7] USA Ins. 16. Amendment.

[8] Treasures. Registration §1.471-1(b)(6)(i).

[9] National Ass’n. of HomeBuilders v. Defenders of Wildlife, 551 US 644, 662 (US, 2007).

[10] TC Note. 2022-14 (March 1, 2022).

[11] IRC §168(a).

[12] IRC §168(k).

[13] IRC §263A.

[14] Mann Construction, Inc., / United States, 2022WL 619822 (6th Cir. 3 March 2022) (IRS Notice void); Liberty Global, Inc. / United States, No.1:20-cv-03501-RBJ (Fed. Dist. Ct. Col. 4 April 2022) (interim regulation under IRC §245A void).

[15] Marijuana Opportunity Reinvestment and Expungement (MORE) Act (117. Cong., HR 3617).

© 2022 Miller, Canfield, Paddock and Stone PLC National Law Review, Volume XII, Issue 109

Leave a Comment

Your email address will not be published.