Alterman TC Memo 2018-83 Alternative View

Alterman TC Memo 2018-83 Alternative View

Alterman TC Memo 2018-83 Alternative View presents an angle on the decision that is substantially different from what appears to be the majority view of the case…there may be a surprise here.

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 Alterman TC Memo 2018-83 Alternative Viewdeficiencies 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 a 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 in Alterman 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.

Alterman TC Memo 2018-83 Alternative View

The statute, regulations and IRS policy provide a basis for the abatement of all of the asserted delinquency penalties under IRC§ 6651(a) and the accuracy-related substantial understatement penalty 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 neglect[1]. Reasonable cause means that the taxpayer exercised ordinary care and prudence[2]. 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 responsibilities[3].

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 filed[4].
  • A taxpayer’s good faith belief that no return is due may constitute reasonable cause for late filing[5].
  • A taxpayer’s reliance upon on the advice of a competent tax advisor[6]. 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.

The bulk of the issues in the Alterman case involved IRC §280E either directly or indirectly.  We have previously written extensively on this topic.[7] 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 TC Memo 2018-83 Alternative View

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 in Alterman.

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 oversight 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 require the guidance of qualified professionals as well as adherence to the recordkeeping guidance they provide.

Alterman TC Memo 2018-83 Alternative View

[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).

[7] 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.

Alterman TC Memo 2018-83 Alternative View

Alterman TC Memo 2018-83 Alternative View

Author: abizcannabis

Managing Director & CEO of integrated transactional financial advisory, tax, and technology consulting firm - aBIZinaBOX Inc New York, Chicago, and OaklandCPA.CITP.CISM.CGEIT.CGMAExpertise with: Alt. Investments/Private Equity, Real Estate, Professional Services, CA Cannabis, Tech Start-Ups and Distressed Assets/DebtTechnology Certifications including:Advanced & High Complexity Cloud Integrator AICPA PCPS, CAQ,, IMTA, CITP ISACA CGEIT, CISMState CPA Societies in California, Florida, Illinois, New York and TexasExpertise with Regulatory Compliance - US - HIPAA, FINRA, SEC Rule 17(a)(3)/(4), eDiscovery, FINCEN - EU- EBA, ESMA, EIOPA UK - BoE, PRA, FCA