The IRS plans on ramping up audits for cannabis businesses this year — and many might not survive the cost
“In their minds, it’s all just low-hanging fruit.”
An IRS audit is not something any business wants to undergo. It’s expensive and time consuming; it requires financial legal representation, a Certified Public Accountant, spotless books, receipts and proofs of purchase for everything, and if the Feds find even a hint of mis-management you might be subject to huge fines and potentially even jailtime.
Generally, it’s just a major pain in the ass. And particularly for those in the cannabis industry. Because, not only do they function in a legal grey area, selling a product that’s federally illegal; but they’re also subject to an insane Reagan-era tax law that was designed to foil drug dealer kingpins like Tony Montana and Walter White.
Today, that law, known affectionately as 280E, puts cannabis companies in an extremely vulnerable and delicate position. Making them easy (and profitable) targets for the IRS. Which is exactly why, this year, the IRS is planning on increasing the amount of cannabis companies they audit.
“20 percent of the industry has historically been audited every year,” explains Keegan Peterson, the founder and CEO of WURK, a payroll, HR, scheduling and time-keeping software company for Cannabis businesses. But this year, that number is going to increase, says Peterson.
“We're already dealing with a pretty challenging market environment. And now the IRS is going to be looking for ways to find more tax revenue.”
Making an already difficult year for business owners, even more challenging.
Peterson started Wurk when a friend of his in the cannabis industry explained that he was paying his taxes in cash, doing them on Excel, and delivering the money to the government in a duffel bag. Today, WURK is the largest money-mover in the US for the still-largely cash-based cannabis industry, operating in 33 states nation-wide.
Meaning that, Peterson and his team at Wurk are no strangers to the 280E tax provision. They are almost constantly helping cannabis businesses deal with it.
Peterson explains that back in the 80s, there was a drug trafficker who the IRS caught evading taxes. The feds discovered that this kingpin was writing off his houses, his boats, his cars and his lavish lifestyle, and getting tax refunds for all of it. Needless-to-say, that didn’t make the IRS very happy.
So, they created the 280E tax provision, which stipulates that no expenses related to drug trafficking can be written off as legitimate “business expenses.”
On its face, that law makes sense. But now, almost forty years later, it’s being used unfairly against the cannabis industry. No cannabis business is allowed to write off business expenses on their taxes because, weed is technically still a schedule I substance. According to the feds, cannabis businesses in Colorado (and anywhere in the US) are dealing hard drugs and therefore are ineligible for almost any business-related tax expenses.
“That is what's creating these 90-percent tax rates for these companies,” Peterson says. They don't get to deduct labor expenses, benefit expenses, building costs, insurance lines or even office supplies, he says.
“They're paying 100 percent tax on all of that.”
As Ryan Buffkin, the part-owner and master grower for Denver Recreation (DenRec), put it, if they make a million dollars of profit for the year, they only get to walk away with around $50,000 of that.
“Any ‘normal’ company with a million dollars being brought in, would walk with closer to $250,000 to $300,000,” Buffkin says. “So, if we're a million dollars successful, we're still far less successful than those ‘normal’ companies.”
There’s nothing fair about that. And, it forces many of these businesses onto very tight margins — thin ice, existing one month to the next, as the IRS bleeds them like a stuck pig.
And now, this year, as a global pandemic rages all around us, and as the world scrambles to stay on its feet, the IRS has announced that they are going to be increasing the number of cannabis businesses that they audit this year.
“Obviously it’s in the IRS’ best interest to audit these cannabis companies,” says Peterson. “I'm sure in their minds, it’s all just low-hanging fruit.”
Easy pickings, in other words. And, besides, who cares if these businesses are already off kilter and unstable? Who cares that this year has already been a gauntlet for those in the cannabis industry? Who cares if they go under because they can’t afford an audit, or because the IRS finds out they tried to write off printer paper and ballpoint pens?
Attempts to reach the IRS for comment on this story, naturally, were never responded to.
The IRS has got a golden goose in the cannabis industry right now, and it seems like they are preparing to squeeze it dry. The only thing at this point that’s going to change this situation would be federal decriminalization or outright legalization of cannabis — because then, and only then, would all of these banking and taxation issues be resolved.
And despite the current administration, according to Peterson, there might actually be some hope in that regard.
“There is light at the end of the tunnel,” Peterson says. He refers back to the Great Depression of 1928, when alcohol prohibition was at its height. The government eventually realized in 1933 that legalizing alcohol would be an easy tax-cash-grab. Which at the time, the feds desperately needed (not so unlike our current situation, during the COVID-19 pandemic, and subsequent recession).
“This might be a similar opportunity for big progress in cannabis,” Peterson says. “If [cannabis] were legalized, that would solve a lot of these problems.”
And it would put money directly into Federal coffers, so they don’t have to send the IRS in to hound these small businesses and rob them of their legitimately earned profits.