Federal Income Tax Issues – Cannabis
The list of Federal Income Tax Issues – Cannabis shouldn’t be all that long, or should it. We are going to build out this area over time, but here are some goodies.
How is withholding calc Bonus Sup. Pay?
Bonus, Commission, Supplemental Payments – Withholding
Bonus & Commission payments are considered by the IRS as “supplemental wages”. Meaning they are supplements to an employees regular wages. The IRS says this about supplemental wages,
“They include, but are not limited to, bonuses, commissions, overtime pay, payments for accumulated sick leave, severance pay, awards, prizes, back pay, retroactive pay increases, and payments for nondeductible moving expenses. Other payments subject to the supplemental wage rules include taxable fringe benefits and expense allowances paid under a nonaccountable plan.”
How Taxes are Calculated – Bonuses or Supplemental Wages
How they are taxed largely depends on how they are paid; if you pay a bonus on a single check along with an employee’s other regular wages then you can allow the standard payroll tax tables which are driven by an employees W4 election to dictate the withholding. However, if you separate the supplemental wage payment out from the employee’s regular wages then the IRS says to withhold Federal income taxes at a rate of 25%. Therefore, if you pay someone a $5,000 bonus you would withhold $1250.00 for Federal income tax alone. In addition, you would still be required to withhold State/local income taxes (Colorado at 4.63%), Social Security at 6.2% and Medicare at 1.45% (for YTD wages below $118K annually).
Why is this? At this point, we can only theorize as I’ve never seen anything from the IRS detailing the rationale for this rate. My assumption has always been that the tax rule is designed to ensure sufficient withholding is taken out of supplemental payments so that employees don’t have a tax surprise on their hands the following April. The impact for many employees of this supplemental tax rate can be an over funding of their personal income taxes which leads to a tax refund personally. For an employer, there is zero impact from an expense standpoint. An employer should NOT deviate from the IRS tax guidance on supplemental wages and should choose one of the two common options for taxing.
Net Bonus Amounts
When an employer wishes to give an employee after-tax net bonus things get complicated. Since the IRS supplemental tax rate is 25% and can lead to an employee’s earning being over-withheld for the year; we advise employers to shy away from Net bonuses and instead settle on a gross amount for the bonus. If you wish to give an employee a $1,000 net bonus, using the supplemental rate you would need to pay a gross bonus of $1594.39 (25% fed, 4.63% state, 6.2% social security, 1.45% Medicare). That’s 37.28% you as an employer would be covering in addition to the net bonus payment and not including another 7.65% or more in employer taxes. Frustrating? Yes, in particular, if you know your employee is in a relatively low or middle-class personal tax bracket and may have various dependents and other tax breaks personally. But remember you do not want to give your employees personal tax advice. At some point you the employer must settle on a gross amount for the bonus and determine if the payment should be combined with the employee’s salary/hourly wages or tax using the flat rate percentages. Either way, the employee is being rewarded with a bonus make sure you discuss with them the gross amount as that is their true reward not the net result after taxes.
Supplemental Wages Combined with Regular Wages
If you pay supplemental wages with regular wages but do not specify the amount of each, withhold federal income tax as if the total were a single payment for a regular payroll period.
Supplemental Wages Identified Separately from Regular Wages
If you pay supplemental wages separately (or combine them in a single payment and specify the amount of each), the federal income tax withholding method depends partly on whether you withhold income tax from your employee’s regular wages
1. If you withheld income tax from an employee’s regular wages in the current or immediately preceding calendar year, you can use one of the following methods for the supplemental wages
a. Withhold a flat 25% (no other percentage allowed).
b. If the supplemental wages are paid concurrently with regular wages, add the supplemental wages to the concurrently paid regular wages. If there are no concurrently paid regular wages, add the supplemental wages to alternatively, either the regular wages paid or to be paid for the current payroll period or the regular wages paid for the preceding payroll period. Figure the income tax withholding as if the total of the regular wages and supplemental wages is a single payment. Subtract the tax withheld from the regular wages. Withhold the remaining tax from the supplemental wages. If there were other payments of supplemental wages paid during the payroll period made before the current payment of supplemental wages, aggregate all the payments of supplemental wages paid during the payroll period with the regular wages paid during the payroll period, calculate the tax on the total, subtract the tax already withheld from the regular wages and the previous supplemental wage payments, and withhold the remaining tax.
2. If you did not withhold income tax from the employee’s regular wages in the current or immediately preceding calendar year, use method 1-b. This would occur, for example, when the value of the employee’s withholding allowances claimed on Form W-4 is more than the wages.
Regardless of the method you use to withhold income tax on supplemental wages, they are subject to social security, Medicare, and FUTA taxes.”
What is the History of the CHAMPS litigation on IRC Sec. 280E ?
CHAMPS Litigation on IRC Sec. 280E (The ‘Two Business” rule)
The CHAMPS Litigation on IRC Sec. 280E use of IRC 263A alone to increase Cost Of Goods Sold may still leave the legal marijuana business with a punitive effective tax rate after application or IRC §280E. Absent any regulations to guide the practitioner, we look to relevant U.S. Tax Court cases for guidance. It is well established that a taxpayer can have more than one trade or business36. In Californians Helping to Alleviate Med. Problems, Inc. v. Commissioner (CHAMPS)37. the Tax Court expanded IRC §280E to permit the deduction of ordinary and necessary expenses to the extent two businesses are conducted at the same business location.
Some states, including California, operate using a caregiver model. It is important to understand the differences in this business model. Some dispensaries in this model offer palliative care,
which is specialized medical care for people with serious illnesses. It focuses on providing patients with relief from the systems and stress of a serious illness. The goal is improving the quality of life for both the patient and the family. CHAMPS was in the business of providing counseling and other caregiving services to its members, who were individuals with debilitating diseases.
Under the California Compassionate Use Act of 1996, the taxpayer provided marijuana to members who requested it. The business charged its members a membership fee that generally reimbursed the business for its costs of the caregiving services and its costs of the medical marijuana. This left the business substantially in compliance with California law, since in the caregiver model the caregiver is reimbursed for costs, but should not generate a profit on an ongoing basis. At audit, the Service disallowed the expenses as non-deductible under IRC §280E because they were incurred in connection with the trafficking of a controlled substance under the federal CSA.
47% of the of the CHAMPS members suffered from AIDS, while the remainder suffered from cancer, multiple sclerosis or other terminal or chronic diseases. The primary purpose the entity was to provide caregiving services to its members. The secondary purpose was to provide members with medical marijuana pursuant to the provisions of California law and instruction in the use of the marijuana to benefit their health. The most important aspect of this case is that the palliative care services provided by CHAMPS were extensive. Support group sessions were held for members including those with AIDS, addiction, and emotional development problems.
Low-income members were provided with hearty daily lunches and hygiene supplies were also available. Counseling benefits related to life-coping issues were available. In short, CHAMPS was a palliative care entity that happened to dispense marijuana, rather than simply a marijuana dispenser.
On its tax return, CHAMPS did not make any allocation subject to IRC §280E. All ordinary and necessary business expenses were deducted. At trial, CHAMPS argued they had two businesses: a primary trade or business of palliative care (caregiving) and a secondary trade or business as a marijuana dispenser. CHAMPS argued and the Court agreed, that the deductions for the non-trafficking business should not be subject to IRC §280E. The Service accepts the characterization that two or more undertakings are separate activities unless the characterization is ‘artificial or unreasonable”. Section 280E and its legislative history express a congressional intent to disallow deductions attributable to a trade or business of trafficking in controlled substances. They do not express intent to deny the deduction of all of a taxpayer’s business expenses simply because the taxpayer was involved in trafficking in a controlled substance.
We hold that section 280E does not preclude petitioner from deducting expenses attributable to a trade or business other than that of illegal trafficking in controlled substances simply because petitioner also is involved in the trafficking in a controlled substance. It is important to note that CHAMPS had contemporaneously created records which clearly showed the costs spent on each activity, including detailed time records of employees’ time spent in each of the two businesses.
Absent §280E regulations pertaining to two distinct businesses operating from the same location, we look to the guidance under IRC §183 and the supporting regulations. Reg. §1.183–1(d)(1) provides that “(t)the taxpayer’s characterization will not be accepted, however, when it appears that his characterization is artificial and cannot be reasonably supported by the facts and circumstances of the case.”
Most significant facts and circumstances in making this determination are:
- The degree of the organizational and economic interrelationship of various undertakings.
- The business purpose which is (or might be) served by carrying on the various undertakings separately or together in a trade or business or in an investment setting.
- The similarity of various undertakings.
The Tax Court later expanded facts and circumstances test in Rupp v. Commissioner, which provides nine factors for use in determining whether the two undertakings share a close relationship to one another:
- Whether the undertakings are conducted at the same place;
- Whether the undertakings were part of a taxpayer’s efforts to find sources of revenue from his or her land;
- Whether the undertakings were formed as separate activities;
- Whether one undertaking benefited from the other;
- Whether the taxpayer used one undertaking to advertise the other;
- The degree to which the undertakings shared management;
- The degree to which one caretaker oversaw the assets of both undertakings;
- Whether the taxpayers used the same accountant for the undertakings
- The degree to which the undertakings shared books and records.
The Tax Court subsequently applied the nine factors of Rupp in Olive v. Commissioner 139 T.C.No 2.. While not cannabis industry-friendly, Olive helped further frame the outer limitations of the ‘two business rule’. Olive operated “The Vapor Room”, purportedly a medical marijuana dispensary and a caregiving activity. The Court found that the taxpayer was not operating two businesses and was therefore not entitled to a portion of its IRC 61 ordinary and necessary business expenses.
Some of Olive’s patrons suffered from AIDS, HIV, cancer and other terminal diseases. Taxpayer felt CHAMP applied here. The court applied the nine factors from Rupp and found that the taxpayer operated only one business. Contrary to CHAMPS, where the Court found two businesses existed, in Olive the Court determined that there was one activity, trafficking in a controlled substance.
How Do IRC Sec. 263A UNICAP Rules Apply To CA Cannabis?
IRC Sec. 263A UNICAP Rules Apply To CA Cannabis
IRC Sec. 263A UNICAP Rules Apply To CA Cannabis. The rules require more indirect costs to be allocated to inventory than the full absorption rules under IRC §471. The UNICAP rules require a producer of inventory to include in the cost of its inventory the direct costs of such property and such property’s proper share of those indirect costs, part or all of which is allocable to such property. Under UNICAP, direct costs include direct material costs and direct labor costs. UNICAP is required for most manufacturers and resellers with the exception of businesses with less than $10 million in gross receipts on a three-year rolling average basis.
Most cannabis businesses that do not produce products will not be required to comply with UNICAP. A reseller which is not subject to the UNICAP rules is usually required to include only direct costs in the cost of its inventory.28 A marijuana business would be well advised to comply with the UNICAP rules, whether or not it is required to do so. First, this would allow it to maximize the costs allocated to cost of goods sold. Potentially, it could minimize the number of disallowed business expenses.
Nothing in the code or regulations states taxpayers cannot voluntarily follow the UNICAP rules. For growers of marijuana, not all expenses will be allowed as the cost of goods sold, but many wills. Examples include rent, electricity, water, nutrients, security, insurance, scales, grinders, packaging materials, delivery vans, labor, excise taxes, accounting software, and traceability software.
Generally speaking, a state-licensed marijuana retailer is ‘trafficking’ in the sale of marijuana in violation of the federal CSA and will NOT be allowed a deduction for ordinary and necessary business expenses. The solely written guidance from the IRS comes in the form of a Chief Counsel’s Advice (CCA). This CCA addresses two questions:
- First, how is a cost of goods sold determined for a taxpayer subject to IRC §280E? Taxpayers should calculate Cost of goods sold “using the applicable inventory-costing regulations under §471 as they existed when §280E was enacted.30 Therefore, Reg. §1.471-3(b) for resellers, and Regs. §1.471-3(c) and 1.471-11 for producers are applicable for computing COGS.
- Second, may the IRS require the taxpayer to use an inventory method for the controlled substance? “Yes, unless the taxpayer is properly using a non-inventory method to account for the…controlled substance pursuant to the Code, Regulations, or other published guidance.” It is interesting to note that the author is aware of no other circumstances where an interpretation of a law is restricted to other laws in effect at that time of passage.
What is Cost Goods Sold [“COGS”], how is it calculated?
Cannabis Cost Goods Sold Calculations
Cannabis Cost Goods Sold Calculations is not a deduction but actually, an adjustment is taken into account in arriving at gross income. Regulation §1.61-3(a) provides, “gross income” means “…the total sales, less the cost of goods sold.” Although IRC §280E disallows any deduction for a marijuana seller’s ordinary and necessary business expenses, the legislative history fails to include the cost of goods sold in this rule. The literature suggests that Constitutional concerns of the Sixteenth Amendment, which taxes ‘incomes’, are the reason for this exclusion.
In the Senate hearings prior to passing IRC §280E, discussion suggested including the cost of goods sold in the ‘disallowed’ expenses for drug traffickers. However, the feeling that this could create a constitutional issue leading to court challenges (and delays) prevailed, and cost of goods sold remained an available adjustment to drug traffickers.
Although the Service has not issued regulations related to IRC §280E, the Service allows the adjustment for Cost of Goods Sold (COGS) on the tax returns of businesses engaged in drug trafficking. On November 24, 2010, U.S. Representatives Fortney Pete Stark, Barney Frank, Jared Polis, Linda Sanchez, Raul Grijalva, and Sam Farr wrote to the office of the Chief Counsel of the IRS, asking the service to create guidance for regulations related to deductions for state-licensed marijuana businesses.
The Chief Counsel’s Office replied to the Congressman on December 16, 2010, stating that the IRS is unable to issue regulations for IRC §280E since neither the Controlled Substances Act nor IRC §280E makes the exception for medical marijuana. Further, the Chief Counsel places blame on Congress to change either IRC §280E or the Controlled Substances Act.
Cost Method for Cost of Goods Sold
A business must use an inventory method of accounting whenever “the production, purchase or sale of goods is an income-producing factor. Under an inventory method, costs related to producing, acquiring, storing, and handling goods are not currently deductible. These costs must be included in the costs of inventory and deducted when inventory is sold. In the typical business, tax professionals look to minimize current income by taking deductions during the current period. IRC §263A does not magically transform otherwise disallowed costs under IRC §280E into allowed capitalized costs, although the tax professional should look to maximize the number of deductions which can be justifiably capitalized. Much billable work exists for tax and accounting professionals who possess the skills to wade through client inventory records and classify expenses to maximize the cost of goods sold deduction and support the conclusions at an examination.
Generally, the current year inventory costs are added to the beginning of the year inventory amount and reduced by the costs of inventory on hand at the end of the year to calculate costs of goods sold for the year.
Section 471 and methods required by Section 263A provide that marketing, advertising and selling expenses are “not required” to be treated as inventory costs. Under Reg. §1.471–11, 6(a), taxpayers must include as inventoriable costs all direct (e.g., the cost of inventory and delivery, and the cost of materials and labor for manufactured inventory) and indirect production costs (e.g., rent and utilities related to inventory).
How report cash pmt > $10,000 to IRS?
Report cash payment over $10,000 to IRS
Form 8300 – Is Your Business Filing the Proper Cash Transaction Forms?
Has your business ever received a large cash payment, and you were not quite sure what your reporting obligations were regarding that large payment? The general rule is that you must file Form 8300, Report of Cash Payments Over $10,000 Received in a Trade or Business, if your business receives more than $10,000 in cash from one buyer as a result of a single transaction or two or more related transactions.
The Form 8300 provides valuable information to the Internal Revenue Service and the Financial Crimes Enforcement Network (FinCEN)
in their efforts to combat money laundering. This is an important effort, since money laundering is a tool used to facilitate various criminal activities, ranging from tax evasion to terrorist financing to drug dealing, to hide the proceeds from their illegal activities.
Filing Form 8300
Generally, any person in a trade or business who receives more than $10,000 in cash in a single transaction or in related transactions must file a Form 8300. Persons includes an individual, a company, a corporation, a partnership, an association, a trust, or an estate. Persons must file a Forms 8300 with the IRS if any part of the transaction occurs within any of the 50 states, the District of Columbia, or a U.S. possession or territory (American Samoa, The Commonwealth of the Northern Mariana Islands, Guam, Puerto Rico and the U.S. Virgin Islands).
If you are required to file Form 8300, you must do so by the 15th day after the date the cash transaction occurred. A person can file Forms 8300 electronically or by mailing the form to the IRS at: Detroit Computing Center, P.O. Box 32621, Detroit, Michigan 48232.
In addition to filing Forms 8300 with the IRS, companies need to furnish a written statement to each person whose name is required to be included in the Form 8300 by January 31 of the year following the transaction. This statement must include the name, address, contact person, and telephone number of the business filing Form 8300, the aggregate amount of reportable cash the business was required to report to the IRS from the person receiving the statement, and that the business provided this information to the IRS.
Meeting the proper filing requirement and the requirement to furnish a written statement to each person named on the Form 8300 is very important, because there are potential civil and criminal penalties for failure to file Form 8300. Penalties for violation of the Form 8300 filing and furnishing requirements have been increased by the Trade Preferences Extension Act of 2015. Increased penalties apply to Forms 8300 and related notices requiring filing or furnishing after December 31, 2015. In addition, penalty amounts are now adjusted annually for inflation.
Electronic Filing of Form 8300
On Sept 19, 2012, FinCEN announced that businesses may electronically file their Forms 8300 using the Bank Secrecy Act (BSA) Electronic Filing (E-Filing) System. E-filing is free, and is a quick and secure way for persons to file Forms 8300. Filers will receive an electronic acknowledgment of each submission. For more information about Form 8300 e-filing, see the FinCEN news release.
How file a complaint about a tax pro or return preparer?
File Complaint – Tax Pro Return
If you need to File Complaint – Tax Pro Return
- IRS OPR Circular 230 Tax Professional Complaint – is submitted in a letter to OPR.
Internal Revenue Service
Office of Professional Responsibility
SE:OPR – Room 7238/IR
1111 Constitution Avenue NW
Washington, DC 20224
- IRS Return Preparer Complaint
- IRS Return Preparer – FRAUD or CRIMINAL CONDUCT
- IRS Identity Theft Affidavit
- IRS CPE Provider Complaint
- IRS Impersonation Scam Reporting
- IRS Waste and Abuse Reporting
- Whistleblower Retaliation Reporting
- Government Contractor Fraud Reporting
The Internal Revenue Service’s [“IRS’s”] Office of Professional Responsibility [“OPR”] is the point of contact for Circular 230 tax practitioner professional discipline and regulation.
OPR’s organizational structure includes three major segments: Office of the Director, Legal Analysis Branch, and Operations and Management Branch.
OPR is committed to:
- Independent, fair and equitable treatment of all tax practitioners consistent with our Title 31 authority and principles of due process.
- Rendering fair and independent determinations regarding alleged misconduct in violation of Circular 230, Regulations Governing Practice before the Internal Revenue Service.
- Educating/maintaining tax professionals’ knowledge of relevant Circular 230 provisions.
- Providing guidance and feedback to field/agency sources regarding essential referral criteria for each relevant Circular 230 provision.
- Strengthening partnerships with other parts of the IRS and with external practitioner organizations.
- Developing procedures that ensure timely case resolution.
- Developing policies and regulations that ensure fair and equitable disposition of Circular 230 cases.
- Developing and implementing proactive strategies for identifying violations of Circular 230.
OPR maintains a FAQ for Circular 230 Tax Professionals that can be found here.
Treasury Inspector General for Tax Administration [“TIGTA”]
audits, investigations, and inspections and evaluations protect and promote the fair administration of the Federal tax system and work to ensure that the Internal Revenue Service (IRS) is properly doing its job.
TIGTA reports directly to the Secretary of the Treasury and has oversight and review responsibility that extends to the IRS Office of Chief Counsel, the IRS Oversight Board, and the Taxpayer Advocate Service.
A maintains a highly skilled, proactive, and diverse Inspector General organization dedicated to working in a collaborative environment with key stakeholders to foster and promote fair tax administration.
How much can I contrib. to my SEP plan?
Calculating SEP Contribution Limits
There are rules to consider in calculating SEP contribution limits. The contributions you make to each employee’s SEP-IRA each year cannot exceed the lesser of:
- 25% of compensation, or
- $55,000 for 2018 ($54,000 for 2017 and subject to annual cost-of-living adjustments for later years).
These limits apply to contributions you make for your employees to all defined contribution plans, which includes SEPs. Compensation up to $275,000 in 2018 ($270,000 in 2017 and subject to cost-of-living adjustments for later years) of an employee’s compensation may be considered. If you’re self-employed, use a special calculation to determine contributions for yourself.
Contributions must be made in cash; you cannot contribute property.
If you’ve contributed more than the annual limits to your SEP plan, find out how to correct this mistake.
How much can I contribute if I’m self-employed?
The same limits on contributions made to employees’ SEP-IRAs also apply to contributions if you are self-employed. However, special rules apply when figuring the maximum deductible contribution. See Publication 560 for details on determining the contribution amount.
Must I contribute the same percentage of salary for all participants?
Most SEPs, including the IRS model Form 5305-SEP, require you to make allocations proportional to your employees’ salary/wages. This means that everyone’s contribution is the same percentage of salary.
If you haven’t made contributions to participants’ SEP-IRAs equal to the same percentage of each participant’s compensation, find out how you can correct this mistake.
If you are self-employed, base your contribution on net profit – minus one-half of the self-employment tax – minus your SEP contribution. See IRS Publication 560 on determining the contribution amount.
If I participate in a SEP plan, can I also make tax-deductible traditional IRA contributions to my SEP-IRA?
If the SEP-IRA permits non-SEP contributions, you can make regular IRA contributions (including IRA catch-up contributions if you are age 50 and older) to your SEP-IRA, up to the maximum annual limit. However, the amount of the regular IRA contribution that you can deduct on your income tax return may be reduced or eliminated due to your participation in the SEP plan.