- Five cannabis industry lawyers and accountants told Business Insider they’re bracing their clients for an uptick in audits and investigations.
- The audits stem from a section of the tax code called 280E, which prohibits companies that sell illegal drugs — like marijuana — from deducting regular business expenses, like office supplies or health insurance premiums.
- 280E is “probably one of the worst things that’s forced onto this industry,” KushCo CEO Nich Kovacevich said.
- For more stories like this, subscribe to Insider Cannabis, Business Insider’s weekly cannabis newsletter.
US cannabis businesses are facing rising numbers of audits and investigations, according to cannabis lawyers, related to a section of the federal tax code that cannabis executives say unfairly targets their companies.
The probes stem from the fact that cannabis is illegal in the eyes of the US federal government, though it’s legal for at least some uses in 33 states. The audits are centered on a section of the federal tax code known as 280E that was passed to aid former US President Ronald Reagan’s war on drugs, and the uptick is a reminder of the industry’s continued precarity, even as there is growing support for legalizing marijuana.
Five lawyers and accountants told Business Insider their clients have been seeing an uptick in audits and investigations in recent months. Most traced the uptick to March, while one said the increased scrutiny of the US cannabis industry began late last year.
‘They’re coming after everything’
“It really is a lesson that they’re coming after everything,” Eric Berlin, the co-head of the law firm Dentons’ Cannabis Group, said in a webinar on investigations related to 280E last month. “I don’t mean that in a mean way, but anything is fair game, so it’s a lesson and a reminder to get one’s compliance house in order.”
280E prohibits companies that illegally sell drugs from deducting regular business expenses, like office supplies or health insurance premiums. It applies to cannabis companies because marijuana is federally illegal, and the companies say it forces them to pay unfairly high taxes compared to other industries.
The Internal Revenue Service wouldn’t say whether it has ramped up cannabis industry audits in recent months. There’s no public data to indicate whether investigations have increased, but lawyers say the uptick has been substantial enough to prompt them to ready their clients for the surge.
The consequences of the audits can include paying back taxes and fines. According to a report from Viridian Capital Advisors, getting rid of 280E would save the top 10 publicly traded US cannabis companies an estimated $279 million each year.
Legalization is on the ballot in five states, but there’s no end in sight for 280E
Cannabis is legal for medical use in 33 states and for recreational use in 11. It’s on the ballot in 5 states next Tuesday. But those votes, as well as Democratic presidential candidate Joe Biden’s cannabis plan, wouldn’t change cannabis firms’ vulnerabilities to audits related to 280E.
President Donald Trump hasn’t outlined a specific approach to cannabis policy. In early 2018, then-Attorney General Jeff Sessions rescinded guidance that directed the federal government to refrain from interfering with state-legal marijuana, though a crackdown some in the industry feared did not materialize.
Some cannabis lawyers said the uptick in audits came after the Treasury Inspector General for Tax Administration (TIGTA) published a report in late March recommending that the IRS “develop a comprehensive compliance approach for the marijuana industry.”
Read more: Law firm giants like Dorsey & Whitney, Locke Lord, and Dentons are forming special teams in an attempt to win over clients in the $56 billion cannabis industry
Business Insider reached out to both TIGTA and the IRS for comment on whether more audits and investigations into the cannabis industry have occurred in recent months. TIGTA did not respond.
The IRS referred Business Insider back to the report, and highlighted its recommendation to increase scrutiny of the cannabis industry. The report estimates that 59% of cannabis companies underpaid their taxes by not complying with 280E, based on a sample of 237 marijuana businesses.
Industry insiders say the IRS is focusing on cannabis
Matt Sapowith, a partner at cannabis advisory firm MGO, said the IRS started focusing more on cannabis businesses even before the report came out. He said audits were already ticking up in March, and that the scrutiny dates to the end of 2019.
Sapowith says it’s hard to quantify exactly how big the increase is, but he estimates that the number of audits he’s seen in recent months is 20-40% higher than what he’s seen previously. MGO has over 500 cannabis clients across the US, according to Sapowith.
The investigations range from a focus on compliance with 280E to more general investigations that look at overall accounting records, he said.
Multi-state operators and other bigger cannabis companies with larger revenue streams have particularly been targeted, he said.
Jennifer Fisher, a partner in the law firm Goodwin’s Cannabis and White Collar practice, told Business Insider she’s seen a number of signs that the IRS is increasing its focus on the cannabis industry. The agency put out a FAQ page on its website geared toward cannabis businesses. This coupled with the recent TIGTA report point her toward the idea that the agency is signaling a closer look at businesses operating in the cannabis space.
“A focus of a lot of audits I’ve seen in the space is taking a closer look at what the companies are deducting,” she said. Since cannabis companies, in accordance to 280E, are only allowed to deduct the cost of goods sold, it makes it difficult for operators to be profitable.
“This gives the IRS a lot to dig into when doing these audits, to uncover a lot of compliance issues on that front which has resulted in them issuing fines and collecting back taxes,” she said.
Daniel Lauer, director of Small Business/Self-Employed (SB/SE) field examination for the IRS, said the agency is putting together teams to focus on the cannabis industry, as previous reported by Cannabis Wire.
“What we’re striving for there is consistency of application of the tax law within the spokes of the cannabis industry,” he said during an online event.
280E is ‘one of the worst things’ forced on the cannabis industry, executives say
To cannabis executives, the challenges with 280E go beyond audits. The law increases the amount of taxes the companies pay, effectively driving up the price of their products and making it harder for them to turn a profit.
280E is “probably one of the worst things that’s forced onto this industry,” KushCo CEO Nich Kovacevich said during a panel organized by Reed Smith, another law firm with a wide-ranging cannabis industry practice. Kovacevich said he and others in the industry have seen a big increase in 280E audits in California.
For other executives, eliminating 280E is the first piece on a long wish list for cannabis businesses to be treated like any other legal business.
Read more: The top 7 law firms in cannabis, according to investors, startups and major companies in the booming industry
280E is “such a drain on cash flow,” Jason Wild, the chairman of TerrAscend, a Canadian-listed cannabis company that’s rapidly expanding in New Jersey, told Business Insider. “That’s especially true if you’re a dispensary-oriented business.”
The 280E tax code is also one of the primary obstacles for public cannabis companies aiming to achieve positive earnings per share, according to Cowen analyst Vivien Azer. The 280E code “subjects cannabis companies to paying taxes on their gross profit, regardless of their business operating expenses,” Azer wrote in a September note.
Azer says the most likely way of getting rid of 280E is by tying its removal to broader federal cannabis legalization. She says a standalone bill to remove 280E from the IRS code is a nonstarter.