A 280E Audit Could Be Coming For You
You’re operating in a relatively new industry, and so, you’ve likely learned how to roll with the punches. As precedents are established and boundaries are determined, you have to keep on your toes so you can continue to succeed as a business while avoiding any pitfalls.
The question is – are you ready for a 280E audit?
Do you even know what a 280E audit is?
What Is A 280E Audit And Why Does It Apply To You?
Cannabis retailers are becoming aware of 280E audits mainly thanks to IRS trial lawyer Nick Richards, who raised the alarm about an incoming influx in the cannabis industry. In Richards’ expert opinion, recent modifications to IRS policy will allow the agency to audit, possibly fine, and collect taxes from cannabis businesses amounting to millions.
How did this happen?
To start, 26 U.S. Code Section 280E is the federal statute that states that a business engaging in the trafficking of a Schedule I or II controlled substance, such as cannabis, is barred from taking tax deductions or credits.
In English, this means that cannabis entrepreneurs are required to pay taxes on all of their revenue without the benefit of being able to use business expenses to reduce their taxable income.
Should Section 280E Apply To Marijuana Retailers?
Some say no – and they’ve argued as much in court, and lost. The Tax Court rules against two different companies that argued cannabis businesses shouldn’t be subject to 280E:
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Harborside (Oakland, California) argued that 280E shouldn’t apply, but lost when the Tax Court ruled that it applies to any Schedule 1 narcotics, even those legalized by state governments (such as cannabis).
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It doesn’t stop with the specific cannabis business in question. In fact, the change in policy will also allow for 280E audits of ancillary management companies, such as those that lease property to cannabis companies (i.e. landlords), and anyone else that directly profits from cannabis sales.
How Does The Audit Process Work?
Audits will be carried out as a part of the “Compliance Initiative Project”. This initiative was originally meant to only examine businesses in Colorado, but as legalization has expanded to other states across the country, the scope of the Compliance Initiative Project has been expanded with it.
The Compliance Initiative Project uses an audit technique guide based on the Colorado cannabis industry, which will help auditors to consider what could be years of missing tax forms that are required for cash payments of more than $10,000, which could mean penalties amounting to millions of dollars.
How Should You Prepare For 280E Audit?
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Incorporate Your Small Business: Any small business that wants to limit potentials tax burdens should consider becoming a Corporation or Limited Liability Corporation – cannabis retailers included. In the case of 280E, the former is the smarter choice. 280E disallows deductions and creates “phantom income” that flows through to owners and creates personal income tax, meaning owners of LLCs gett taxed on income they never received.
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Comprehensive Documentation: Make sure to track every single expense in detailed documentation. In the process of an audit, you’ll need to show a paper trail to support the cost of goods sold, and if you can’t prove what you claim, you’ll be at risk of fines.
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Select Categories For Your Employees: Specifically assigning roles to each employee allows for more accurate reporting on wages, and lower risk of fines.
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Get Expert Assistance: In addition to consulting a tax attorney like Richards, make sure every aspect of your business is supported by an expert in their field. This means your IT as well, especially given how crucial it is to your documentation and compliance. Partner with DeVeera to have your compliance practices double-checked and supported by the right technology.
DeVeera is an IT Support and Computer Services company serving Monterey, California. Businesses like yours need technology support to run highly effective organizations. DeVeera offers software support services for companies in Monterey, California. Contact us at (831) 200-1434 or inquiries@deveera.com.
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