TIGTA issued a report on March 30, 2020 that indicates that the IRS may have missed out on $242.6 million in unassessed taxes against marijuana businesses in three states that likely claimed prohibited business expense deductions.
Highlights of Reference Number: 2020-30-017 to the Commissioner of Internal Revenue.
IMPACT ON TAXPAYERS
Marijuana is classified as a Schedule I controlled substance under the Controlled Substances Act. Businesses in this industry have limited banking access and are subject to Internal Revenue Code (I.R.C.) Section (§) 280E, which prohibits the deduction of expenses incurred in trafficking Schedule I controlled substances. The IRS risks diminished taxpayer compliance when marijuana businesses fail to report all income as required under I.R.C § 61, regardless of source, and deduct expenses not allowed under I.R.C. § 280E.
WHY TIGTA DID THE AUDIT
This audit was initiated to evaluate the IRS’s examination and education approach to certain cash-based industries with an emphasis on legal marijuana operations.
WHAT TIGTA FOUND
TIGTA reviewed statistical random samples of marijuana businesses in three States and determined that 59 percent (140 out of 237) of the tax return filings for Tax Year 2016 had likely I.R.C. § 280E adjustments, which when projected over the population totaled $48.5 million in unassessed taxes for Tax Year 2016 or $242.6 million when the results are forecasted over five years.
TIGTA also estimated the tax impact to comply with I.R.C. § 280E for the same sampled marijuana business taxpayers. When projected to the population, TIGTA estimated a $95 million Federal income tax impact to these taxpayers from the application of I.R.C. § 280E on their Tax Year 2016, or $475.1 million when forecasted over five years.
In addition, TIGTA selected a statistically random sample of 90 marijuana businesses that filed State returns for Tax Year 2016 in the State of Washington to determine whether these taxpayers were reporting all of their income in compliance with I.R.C. § 61. TIGTA found that 23 (26 percent) of 90 returns likely have I.R.C. § 61 adjustments involving either underreported income or nonfiling of tax returns. When projected over the population for Washington, the IRS missed the opportunity to address $3.9 million of potential assessments for Tax Year 2016, or $19.3 million when forecasted over five years.
Also, the IRS lacks guidance to taxpayers and tax professionals in the marijuana industry. Such guidance would improve awareness of tax filing requirements for taxpayers in this industry, such as the correct application of I.R.C. §§ 280E and 471(c), which would reduce the burden of tracking inventory for certain small businesses.
WHAT TIGTA RECOMMENDED
TIGTA recommended that the IRS develop a comprehensive compliance approach for the marijuana industry, including a method to identify businesses in this industry and track examination results; develop and publicize guidance specific to the marijuana industry, such as guidance on the application of I.R.C. § 471(c) in conjunction with I.R.C. § 280E; leverage publically available information at the State level and expand the use of existing Fed/State agreements to identify nonfilers and unreported income in the marijuana industry; and increase educational outreach towards unbanked taxpayers making cash deposits regarding the unbanked relief policies available.
The IRS agreed with five of the six recommendations. The IRS did not agree with the recommendation to develop and provide guidance on I.R.C. § 471(c) citing other priorities. However, the IRS added that once the 2019-2020 Priority Guidance Plan is resolved, developing guidance to ensure coordination between I.R.C. §§ 280E and 471(c) will be considered.
To view the report, including the scope, methodology, and full IRS response, go to:
