tax Archives - Green Market Report

Sean HockingSean HockingJanuary 16, 2019
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20min570

Authored By:  Jordan Zoot

 

We welcome Jordan to Cannabis Law Report. as well as writing detailed pieces about tax and accountancy issues relating to law in the cannabis sector Jordan has a incisive knowledge about how the cannabis sector operates and writes wickedly funny articles on his blog . We’re looking forward to publishing his work regularly.

Jordan is the principal of The Cannabis Practice Group [“CPG”] of aBIZinaBOX Inc.

The CPG has professionals in Evanston, IL, and Oakland, CA. The practice is led by Jordan S. Zoot, CPA, Managing Director – CEO, who has been in professional practice since 1982. See their capabilities reel at.

https://abizinaboxcannabis.com/abizinabox-cpas/managing/media-room/cannabis-reel/

Read his full biography below the article.

ARTICLE

On June 13, 2018, the United States Tax Court published its Opinion in Alterman & Gibson v. Commissioner, T.C. Memo 2018-83. Alterman involved income tax deficiencies and penalties asserted by the IRS for 2010 and 2011 against individual taxpayers who owned and operated a small Colorado cannabis dispensary. The individual taxpayers had filed joint returns for 2010 and 2011 in which they reported the income from their cannabis dispensary.

The amount of the income tax deficiencies and penalties asserted by the IRS against the taxpayers (2010: Tax $157,821, Penalty, $31,564; 2011: Tax $233,421, Penalty, 46,684) undoubtedly represented substantial liabilities to the individuals. These deficiencies, however, are modest for a case involving a cannabis dispensary. These deficiencies are also modest for a case that proceeds to trial before the Tax Court with such a limited likelihood of success.

The decision in Alterman was published as a memorandum decision. A Tax Court Opinion is published as a memorandum opinion when the Tax Court considers the case solely involves the application of well-established principles of federal tax law to situations that are not unusual. Anyone interested in the taxation of the cannabis industry should read the Alterman opinion for that very reason. The Alterman opinion describes how a dispensary should not be operated. The taxpayers did a poor job or maintaining financial and inventory records. Their accountant did not provide the detailed workpapers that are a requirement to support the amounts reported in the tax return. There was no evidence that the taxpayers maintained proper inventory records to support amount recorded as Cost of Goods Sold. The taxpayers in Alterman lost on every issue except for those issues the IRS conceded before the commencement of the trial.

The decision against the taxpayers in Alterman is primarily the result of failure to comply with the basic recordkeeping requirements of the Regulations and IRS guidelines. The case primarily involves recordkeeping, compliance with reporting requirements, and the maintenance of a comprehensive system of internal accounting controls. Taxpayers are expected to maintain proper records, and tax return preparers, particularly Circular 230 practitioners, are held to a higher standard than taxpayers are.

Tax professionals should be particularly careful to correct deficiencies identified as part of the annual tax return preparation process. A failure to take corrective action lays the foundation for the Internal Revenue Service to assert the existence of pattern of repeated and potentially reckless and intentional disregard of the regulations and requirements. Such a pattern can result in the assertion of the “second tier” enhanced penalty under IRC Sec. 6694(b)(2). Such a penalty assertion could result in an additional sanction through a practitioner disciplinary referral to the Office of Professional Responsibility [“OPR”].

The issues where the taxpayers did not prevail go beyond IRC 280E. The taxpayers inAlterman lost principally because they failed to create and maintain the types of books of account, records and another documentary evidence required that is required of taxpayers. The deficiencies in Alterman could have been significantly reduced if the taxpayers had prepared, maintained and presented to the Court adequate financial records and supporting documentation.

The statute, regulations and IRS policy provide basis for the abatement of all of the asserted delinquency penalties under IRC§ 6651(a) and the accuracy related substantial understatementpenalty contained in IRC Sec. 6662. The delinquency penalties for failure to file returns and failure to pay tax as well as the accuracy related penalty do not apply if the taxpayer’s failure to comply is due to reasonable cause and not to willful neglect1. Reasonable cause means that the taxpayer exercised ordinary care and prudence2. It is clear from the Opinion that the Court did not believe the taxpayers’ actions met the burden that is imposed on taxpayers to demonstrate the existence of reasonable cause at the time of the failure to file, of the failure to pay, or of the disregard of the rules which caused the accuracy related penalty to apply.

The Internal Revenue Manual defines reasonable cause as conduct which, when judged separately based on the facts and circumstances at hand, justifies the non-assertion or abatement of applicable penalties against taxpayers who have exercised ordinary business care and prudence in addressing their tax filing, payment and record keeping responsibilities3.

Further, courts have held that “reasonable cause exists where:

  • A taxpayer relies on the advice of counsel that a tax return is not required to be filed4.

  • A taxpayer’s good faith belief that no return is due may constitute reasonable cause for late filing5.

  • A taxpayer’s reliance upon on the advice of a competent tax advisor6. The taxpayer must have received incorrect advice after contacting a tax advisor who is competent on the specific tax matter and who is furnished all necessary and relevant information.

  • In addition, the taxpayer must have exercised ordinary business care and prudence in determining whether to obtain additional advice based on the taxpayer’s own information and knowledge.

The “reasonable care” requirement in connection with the execution of recordkeeping and maintenance of records relating to the operation of a business can provide a foundation for a waiver by the IRS of the assertion of the twenty percent substantial understatement penalty.

1 IRC §6651(a)(1)

2 Rags. §301.6651-1(c); U.S. v. Boyle, 469 U.S. 241 (1985)

3 IRM 20.1.1.3.1 (8-20-98)

4 See U.S. v. Boyle, 469 U.S. 241 (1985); Paxton Est. v. Comr., 86 T.C. 785 (1986).

5 See, e.g., LFAM Corp. v. U.S., 99-1 USTC ¶50,223 (Fed. Cl. 1999); Diaz v. U.S., 90-1 USTC ¶50,209 (C.D. Cal. 1990) (Good faith belief that employees were independent contractors is reasonable cause for failure to file employment tax returns).

6 U.S. v. Boyle, 469 U.S. 241 (1985). See also Henry v. Comr., 170 F.3d 1217 (9th Cir. 1999) (Reliance on accountant in treating option sale as capital gain instead of ordinary income held reasonable); IRM 20.1.1.3.2.4.3 (8-20-98).

 

The bulk of the issues in the Alterman case involved IRC §280E either directly or indirectly.

We have previously written extensively on this topic.1 Alterman should be read by anyone contemplating engaging in commercial business within the cannabis industry.Alterman is a “poster child” example of what not to do. Alterman provides a punch list of actions to avoid. Diligence is required of a cannabis industry business in vetting professionals [e.g. attorneys, certified public accountants] as well as in securing appropriate advice relating to compliance, security, and inventory control. The selection of an advisor lacking in competence will exacerbate the problems for a cannabis business.

Alterman is likely significant for the cannabis industry for another reason. A dispensary case is pending before the Tax Court – Patients Mutual Assistance Collective Corporation d.b.a. Harborside Health Center v. Commissioner (Docket Nos. 29212-11, 30851-12 and 14776-14) – that involves much larger income tax deficiencies than the deficiencies inAlterman.

Harborside had been fully briefed and pending decision for over a year when the Opinion in Alterman was filed. A decision in the consolidated Harborside cases appeared imminent. However, the IRS filed a motion to reopen the record in the Harborside cases on June 14, 2018 – the day after the Opinion in Alterman was filed. The IRS undoubtedly moved to reopen the record to address an over-sight relating to the IRS’ penalty assertions. A motion to reopen the record is required in some Tax Court cases as a consequence of the decision of the Tax Court in Graev v Commissioner, 149 T.C. No. 23 (December 20, 2017). The reopening of the record in the Harborside cases will delay for at least a couple of months the issuance of a decision.

The Opinion in Alterman is significant for the cannabis industry for another reason. Judge Richard T. Morrison’s analysis in Alterman is likely to portend the analysis the Tax Court will apply in the consolidated Harborside cases. We are hopeful the accounting and inventory records in the Harborside cases will create a substantially stronger evidentiary record. Strong internal accounting controls, proper recordkeeping and diligence are critical create a foundation to minimize the impact of IRC §280E on a cannabis dispensary.

Taxpayers will continue to lose in proceedings in the Tax Court unless they have prepared and maintained complete and accurate financial records. The creation and maintenance of complete and accurate financial records for a cannabis dispensary requires the guidance of qualified professionals as well as adherence to the recordkeeping guidance they provide.

1 A Methodology for Cost and Expense Allocations for IRC Sec. 280E – in particular, Footnotes 9, 10, 11 and 12 contain an extensive elucidation of IRS requirements with respect to internal accounting controls over cash, IRS requirements for reporting certain cash transactions, the purpose, use, and type of accounting records which must be maintained, and record retention requirements.

 

FULL BIOGRAPHY & CONTACT DETAILS

The Cannabis Practice Group [“CPG”] of aBIZinaBOX Inc.

300 Frank Ogawa Plaza, Suite 370

Oakland, CA 94612

Phone: 1-510-761-9977

Website: https://abizinaboxcannabis.com

Jordan Zoot is licensed as a CPA in CA, FL, IL, NY, and TX. He has a national reputation of technical and transactional taxation of pass-thru entities [Partnerships, LLC’s and S Corporations], private equity and alternative asset funds primarily in distressed mortgages and assets, professional services, real estate, venture-funded tech start-ups, and the commercial cannabis industry in California.

Mr. Zoot has extensive experience in taxpayer and practitioner representation with the Examination, Appeals and Collection functions with IRS, including Special Procedures – Bankruptcy, Insolvency, Offer in Compromise, and Circular 230 Practitioner Representation with the Office of Professional Responsibility [“OPR”]

Mr. Zoot has a member of the AICPA, and state societies [CalCPA, FICPA, ICPAS, NYSSCPA, and TSCPA] for over thirty years. He has served an appointed member of AICPA’s Responsibilities in Tax Practice, Practice Management, and Subchapter K Technical Committees and as the CITP Champion for Illinois. He has had extensive involvement in the regulation commenting process with the US Treasury.

Mr. Zoot is engaged at numerous points of contact in a lead role with AICPA senior executives in the process of developing policy, advocacy and education for CPA’s serving the legal cannabis industry. He has been involved with OPR in connection with the cannabis industry, Title 31 [FinCEN] matters and the IRS’s OVDP Amnesty Program.

Mr. Zoot is engaged with CalCPA’s Government Liaison Office in connection with SWOT analysis, talking points for engagement with the legislature, the cannabis regulatory agencies, Bureau of Cannabis Control “BCC” [Retail, Retail-Delivery, Distribution – Packaging], California Dept. of Public Health “CDPH” [Manufacturing, Processing, Extraction], California Dept. of Food and Agriculture “CDFA” [Cultivation] and the California Dept. of Tax and Fee Administration [“CDTFA”] in connection with urgently need regulatory guidance for Cannabis Cultivation, Excise and Sales Taxes.

The firm is skilled in dealing with:

• The unique financial record-keeping needs of cultivators, distributors, processors, and extractors.

• The selection of optimal operating structures for each participant in the California cannabis industry.

• Adjusting structures and modifying financial record-keeping to comply with a rapidly evolving regulated California marketplace.

• Understanding of the challenges presented by a long history in this industry of “doing business in cash” and the associated problems.

• The practical needs related to banking, card processing, and anti-money laundering issues applicable to this industry.

• The complex processes relating to permitting, licensing as well as reporting and paying cannabis excise tax and gross receipts tax at the municipal and county level.

• Implementing effective strategies for addressing the onerous impact of the limitation on the deduction of ordinary and necessary business expenses imposed by Internal Revenue Code §280E on businesses engaged in “trafficking”.

A Leader in California’s Cannabis Practice, the CPG will retain its position as a leader in financial record-keeping and be reporting for California’s medical and recreational cannabis industry by constantly adjusting to the demands of this evolving industry.

The CPG moderates a California Cannabis Regulation subreddit athttps://www.reddit.com/r/cacannabisregulation/


Sean HockingSean HockingJanuary 14, 2019
IRS.jpg

11min1090

Authored By:  Jordan S. Zoot, CPA, aBIZinaBOX Inc – CPG

This the second of our 2019 gifts to California’s cannabis industry.

As we noted in an earlier Post, we have not yet seen a copy of a receipt issued by a California cannabis dispensary to a cannabis consumer in which it appeared to us that the dispensary “Got it Right” in connection with the collection of taxes.  The failure of a dispensary to issue receipts to retail purchasers of cannabis that establish the dispensary properly collected and accounted for taxes will ultimately prove to be a fatal error for many, if not most, California dispensaries.

Dispensaries are on the front-line with respect to the collection, reporting, and remittance of taxes.  Dispensaries collect all of the taxes that are imposed on the cannabis industry.  The bulk of the taxes a cannabis dispensary collects from a consumer are the direct taxes on cannabis that are imposed at the time of the sale transaction.  For a California dispensary, 20%-35% of the total amount a dispensary collects[1] from a cannabis consumer will be direct taxes imposed at the time of the sale of the cannabis product – Sales Tax, Cannabis Excise Tax (“CET”), and local excise, nuisance, and gross receipts taxes.  Cannabis Cultivation Tax (“CCT”) and other taxes imposed on commercial cannabis are included in COGS and indirectly collected from the consumer.  However, a dispensary is solely responsible for collecting, reporting, and remitting the taxes imposed at the time of the sale transaction.

The percentage of the total amount paid to a dispensary by a consumer for a cannabis product that consists of direct taxes imposed at the time of the sale transaction will depend on the transaction and the jurisdiction in which the sale occurs.  We have included at the end of this Post an example of the receipt we believe should be issued by a San Diego dispensary in connection with an adult-use sale in order to create the best possible record for the dispensary.

A dispensary is a fiduciary to some degree with respect to 20%-35% of the total amount it collects from a cannabis consumer.  The money a dispensary collects for taxes is not the dispensary’s money.  This money belongs to the taxing agencies that imposed the taxes.  In the instance of Sales Tax, a responsible person may be held personally liable for a failure to collect and pay-over taxes [the CCT and CET statute does not have a comparable provision][2].  A dispensary that does not consider and treat tax money that the dispensary has collected as property that belongs to a governmental agency makes a grievous error.  This is just one of many errors a dispensary can make in connection with its collection, reporting, and remittance of taxes.

The most common group of errors made by dispensaries flow from the inadequacies of the point of sale [“POS”] software dispensaries used in front end retail operations. A dispensary operator would do well to compare the tax rate and calculations in the POS software with the software it uses to maintain its back-end records and prepare and to file its quarterly Sales and Cannabis tax returns.  If the POS system does not generate accurate tax calculation and generate proper receipts, difficulties are inevitable.

A dispensary is responsible for properly computing and collecting the taxes imposed at the time of the sale of a cannabis product. A dispensary must not only prove it collected the correct amount of tax, but a dispensary must also be able to establish it paid over the correct amount to, or for the benefit of, each the taxing agencies for which it has a tax collection obligation.  Reliance on a POS system that improperly computes will not provide a dispensary with a defense.  In fact, the information from the system will be used against the dispensary to prove the dispensary collected the wrong amount.  Further, the utilization of a system that does not collect the proper amount of tax will work against the dispensary whether the dispensary collects too little or too much tax.  If a dispensary collects more tax from a consumer than the dispensary was supposed to collect, the dispensary in most instances is required to pay over the excess amount it collected to the taxing agency.

The most egregious error most California dispensaries make is unthinkingly complying with the California requirement that the receipt issued by a dispensary to a consumer include a statement that the CET is included in the purchase price of a cannabis product.  If such a statement is included without more, the CET becomes part of the dispensary’s gross revenue.  If taxes are included in a dispensary’s gross revenue, these taxes will be included in the dispensary’s gross income.  If cannabis taxes that are collected and paid over are included in gross income, the dispensary will have to pay income tax on the amount of such taxes pursuant to IRC §280E.

It is far better for a dispensary to separately itemize all of the taxes it collects from a consumer, and include a statement in the receipt that each of these taxes is being collected by the dispensary solely as the agent for the taxing agency that has imposed this tax.

With such an itemization and such a statement, a dispensary will be able to exclude these funds from revenue.  The dispensary will not be taxed on these funds; provided that the dispensary also has records that establish it paid over these funds to the proper taxing agency or other collectors of these taxes.  A dispensary, of course, is required by law to not only collect the proper amount of tax but also to be able to prove it paid over the amount it collected to the agency to which the tax is owed[3].  This last point is likely to prove the biggest downfall in the future for dispensaries.  Dispensaries are notoriously lax in record-keeping relating to their payments to suppliers.

CET will invariably be the largest amount of a single tax that a dispensary will collect from consumers.  Dispensaries are required to pay over these taxes to distributors.  A dispensary will have to maintain the CET that it collects from consumers in a separate account from which all payments of CET are made in order to be completely confident it will be able to prove its CET payments to distributors.  Such a dispensary will also have to secure and maintain invoice records of its payments to distributors that correspond to the disbursements from the CET account.

 

[1] See our prior post – Cannabis Tax Calculation Example

 

[2] See our prior post CCT-CET Responsible Person

[3] Our prior post, CCT-CCT Responsible Persons contains an extended discussion and suggestions for a procedure that would facilitate a dispensary’s ability to prove the amounts of tax that was paid over to a specific distributor.


William SumnerWilliam SumnerMay 16, 2018
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5min4670

As the debate to legalize cannabis in the state of New York rages on, one report offers to shed some light on the financial incentives that come with legalization. On May 15, 2018, New York City Comptroller Scott Stringer published a report estimating the potential size of the state’s legal cannabis market and how much tax revenue it would generate for both the city and the state.

According to the report, the New York state cannabis market could see up to $3.1 billion in annual sales, with up to $1.1 billion being generated in New York City alone. In terms of tax revenue, legal cannabis could generate up to $436 million for New York state and $336 for New York City.

In order to estimate both market size and potential tax revenue, Stringer used several different data points. First Stringer used data from a 2012 survey conducted by the New York City Comptroller’s Office, which estimated the size of New York City’s cannabis market to be approximately $1.65 billion.

Stringer then used aggregate data on marijuana sales in both Washington and Colorado to help improve estimates. Although both New York City and state have larger populations that Washington and Colorado, Stringer estimates that a smaller segment of the New York population uses cannabis.

It is estimated that only 8-10% of New Yorkers use cannabis on a monthly basis; compared to the 17% of Colorado adults and 11% of Washington adults. With the estimated rates, Stringer was able to determine that approximately 1.5 million New York residents use cannabis, of which an estimated 550,000 live in New York City. These estimates do not include the nearly 1 million individuals that work in New York City but commute from out of state, nor does it account for out of state and international tourists.

To estimate tax revenue, Stringer devised a tax structure based off of what other states with legal adult cannabis sales have. Under this theoretical tax structure, state-wide cannabis sales would carry a 10% excise tax on top of the normal 4% state sales tax. Like many other states, cities and municipalities would be free to levy local cannabis taxes up to a certain percent; in this case 25% would be the ceiling.

Assuming both New York City and state were to implement this tax structure, legal adult cannabis sales would generate $336 million and $436 million in tax revenue, respectively. In a statement, Stringer said that aside from the tax revenue generated by cannabis, legalization would also go a long way towards reducing public safety costs and reducing “a source of harm that has afflicted communities of color for so long.”

“This is not just about dollars – it’s about justice. Not only is marijuana an untapped revenue source for the City and the State, but the prosecution of marijuana-related crimes has had a devastating and disproportionate impact on Black and Hispanic communities for far too long,” said New York City Comptroller Scott M. Stringer. “There is simply no reason for New York to be stuck in the dark ages. This new analysis shows just how much New York City and State stand to benefit by moving toward legalization.”

Stringer went on to note that a legalization bill has already been submitted to the state legislature by Sen. Liz Krueger and Assemblywoman Crystal D. Peoples-Stokes, which is called the Marijuana Regulation and Taxation Act.

Separately, New York City’s Mayor Bill DeBasio called for the New York Police Department to overhaul its marijuana enforcement policies within the next 30 days. The New York Times recently published a story about racial disparity and marijuana arrests. It turns out that 86 percent of those arrested for low-level marijuana possession were either black or Hispanic.


Debra BorchardtDebra BorchardtDecember 13, 2017
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4min7670

The state of Colorado is now releasing sales data on marijuana transactions. Previously, the state only posted tax revenues, leaving researchers and journalists with guesswork as to how that translated into sales. So far, total sales through October have increased 42% year-over-year and tax revenues through November have increased 16%.

On Wednesday, the state released medical and retail sales data going back to January 2014, even though sales began prior to this date. Going forward, monthly reports will be published on the seventh business day of each month. The data is self-reported by the businesses and aren’t audited or use the Metrc tracking system.

“We know this information is highly desired by the general public, media, and researchers,” said Mike Hartman, executive director of the Colorado Department of Revenue (CDOR). “To that end, in our efforts to be as transparent as possible, we will now provide aggregate sales data. That, coupled with state tax revenue data already provided, will give an accurate picture of the financial footprint of this burgeoning industry.”

Marijuana Sales Reports

Calendar Year Total Marijuana Sales Total to Date
2014 $683,523,739 $683,523,739
2015 $995,591,255 $1,679,114,994
2016 $1,307,203,473 $2,986,318,467
2017 (Jan – Oct) $1,259,861,988 $4,246,180,455

Updated December 2017

Calendar year is defined as January 1 – December 31

 

The Department of Revenue also stated that the Office of Research and Analysis would produce monthly reports that would show the total sales for retail and medical marijuana by county. Plus, the ORA will calculate a cumulative total of actual sales figures from year-to-date and total sales per year. The sales reports will be posted on the same day as the tax reports.

Colorado changed its marijuana sales tax on July 1, 2017. Retail sales taxes rose from 10% to 15%. Retail products were exempt from sales tax on personal property. So far in 2017, the state has collected $226 million in total marijuana tax, license and fee revenues.

Marijuana Taxes, License, and Fee Revenue

Calendar Year Total Revenue
2014 $67,594,323
2015 $130,411,173
2016 $193,604,810
2017 (Jan-Nov) $226,157,028

Updated December 2017

Calendar year is defined as January 1 – December 31

 



About Us

The Green Market Report focuses on the financial news of the rapidly growing cannabis industry. Our target approach filters out the daily noise and does a deep dive into the financial, business and economic side of the cannabis industry. Our team is cultivating the industry’s critical news into one source and providing open source insights and data analysis


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