May 2024 - Calyx CPA

A CASE OF STRATEGIC SILENCE: IRS GUIDANCE ON SECTION 471(C) & SECTION 280E

IRS Guidance on Section 471(c) and Section 280E: A Case of Strategic Silence

In true IRS fashion, the memorandum recently brought to our attention explicitly avoids addressing the application of Section 471(c) in mitigating the impact of Section 280E. Instead, the focus is narrowly placed on what Section 471(a) allows, which, predictably, is not much. For resellers looking for relief under Section 471(c), the IRS’s silence speaks volumes.

The Memorandum’s Take on Section 471(a)

The IRS memorandum clarifies the costs that can be capitalized under Section 471(a) for resellers. These include the invoice price of goods (minus trade discounts) and necessary transportation or other charges incurred in acquiring possession of the goods. However, it stops short of offering guidance on Section 471(c), leaving out any discussion on the broader scope of costs that might be capitalized under this section.

What the IRS’s Silence Implies

The careful wording of the memorandum implies that if a taxpayer were applying Section 471(c), a different set of rules might apply, allowing for a broader range of costs incurred in purchasing and reselling goods to be included in inventory. This tacit acknowledgment aligns with what many tax professionals have long understood: Section 471(c) can potentially offer significant relief to businesses impacted by Section 280E.

While the memorandum avoids a direct endorsement, its language suggests that those who meet the criteria for Section 471(c) could capitalize more costs, thereby reducing the taxable income affected by Section 280E. This is a crucial insight for businesses in the cannabis industry and other sectors where Section 280E poses substantial tax challenges.

The Role of Form 3115 in Changing Accounting Methods

At the end of the memorandum, the IRS mentions the necessity of filing Form 3115 to change accounting methods. This requirement has likely tripped up many taxpayers who have not filed the necessary paperwork to adopt a Section 471(c) position. Filing Form 3115 is essential for obtaining permission from the IRS to change accounting methods, and failing to do so can result in the denial of the benefits associated with Section 471(c).

For those who have successfully navigated this process, the lack of IRS audits or examinations on their Section 471(c) position may be due to the procedural hurdle of Form 3115. This reinforces the importance of adhering to proper procedures when seeking to change accounting methods and capitalize on the potential benefits of Section 471(c).

Conclusion

The IRS’s memorandum may not provide explicit guidance on Section 471(c), but its strategic silence and the careful implications within its wording reinforce what many tax professionals already believe: Section 471(c) offers a viable path to mitigate the impact of Section 280E. By ensuring compliance with the necessary procedural requirements, such as filing Form 3115, businesses can better position themselves to capitalize on the benefits of Section 471(c) and potentially reduce their taxable income under Section 280E.

Here is the referenced IRS memorandum which supports our aggressive position on a code section IRC 471(c).

PSYCON LAS VEGAS: NAVIGATING TAX CHALLENGES IN THE PSYCHEDELIC INDUSTRY

Taxation Challenges in the Psychedelic Industries

At the recent PsyCon Convention in Las Vegas, Justin Botillier of Calyx CPA based in Medford, Oregon, delivered a critical presentation addressing the intersection of taxation challenges within the cannabis and psychedelics industries. With deep expertise in cannabis taxation, Justin offered insights that are particularly relevant to both sectors, especially regarding IRS Section 280E.

Understanding IRS Section 280E and Its Broad Implications

The core of Justin’s presentation centered on IRS Section 280E. Initially implemented during the war on drugs in the early 1980s, Section 280E prohibits businesses involved with Schedule I or II controlled substances from deducting typical business expenses, except for the Cost of Goods Sold (COGS). Justin detailed how this section affects the psychedelics and cannabis businesses, creating significant financial hurdles due to the inability to deduct ordinary business expenses.

Insights for the Psychedelics Industry

While he put much focus on cannabis, Justin effectively bridged the conversation to include the psychedelics industry, which faces similar challenges and uncertainties regarding taxation and regulation. As the psychedelics sector continues to evolve, understanding the application of tax laws like 280E becomes crucial for business owners and investors within this space.

Strategic Tax Planning for Cannabis and Psychedelics

Bifurcation Strategy

Justin outlined a bifurcation strategy recommended by other professionals working in the psychedelics space to mitigate the tax burden of 280E. By splitting operations into two entities — one for plant-touching activities and another for non-plant-touching activities — businesses can optimize their tax filings.

Single Entity Strategy

For businesses that prefer a unified operational model, Justin discussed the benefits of a single-entity strategy, emphasizing rigorous accounting practices to allocate costs properly and maximize allowable deductions excluded by 280E. This approach requires a solid understanding of IRC Section 471c, which he explained in detail, demonstrating how careful inventory costing can shield a business from excessive tax liabilities.

IRC Section 471c: A Tool for Compliance and Optimization

Explaining the nuances of IRC Section 471c, Justin highlighted how this section allows for greater flexibility in accounting for inventory costs, thereby increasing deductible COGS. This is vital for both cannabis and psychedelic businesses seeking to navigate the limitations imposed by 280E effectively.

Anticipating Future Legal and Regulatory Shifts

Justin speculated on potential shifts in drug policy and legal frameworks that could impact the application of 280E to both cannabis and psychedelic businesses. He discussed possible rescheduling efforts and new regulatory developments, suggesting that changes in the legal landscape could mitigate some of the current challenges faced under 280E, beyond just rescheduling cannabis.

Expert Guidance for Navigating Complex Tax Landscapes

Concluding his presentation at PsyCon, Justin Botillier emphasized the importance of engaging with tax professionals who specialize in cannabis and, increasingly, in psychedelics. As the regulatory environments evolve, his insights into effective tax planning provide a roadmap for businesses to navigate these complex fields while maintaining compliance and optimizing financial outcomes.

Justin warns that beyond concerns about the ramifications of IRS audits, companies operating in “trafficking” businesses need to be extremely careful about whom they choose to file tax returns. More often than not, it is the accountant who will mire their clients in tax debt rather than the IRS.

Simply fill out the form and we will be in touch to answer any of your queries,

And feel free to check out our blog & video Section for more info.

“IS THE DEA’S RESPONSE TO RESCHEDULING CANNABIS OVERLY HYPED?” CALYX RESPONDS……

Cannabis Rescheduling and the IRS’s Response to Business Deductions

The recent decision by the Drug Enforcement Administration (DEA) to consider rescheduling marijuana under the Controlled Substances Act (CSA) marks a watershed moment in the history of American drug policy. Initially classified as a Schedule I drug, marijuana was deemed to have no medical value and a high potential for abuse, placing it alongside substances like heroin and LSD. This strict classification has governed its legal status, restricting not only its use but also research into its potential benefits.

The push for rescheduling comes on the heels of a comprehensive review by the U.S. Department of Health and Human Services (HHS), which highlighted marijuana’s accepted medical use and lower abuse potential relative to other Schedule I drugs. The proposal to shift marijuana to Schedule III, which includes drugs like ketamine and some anabolic steroids, suggests a significant change in federal perspective, recognizing both medical value and a lower risk of dependency.

For businesses in the cannabis industry, this reclassification could open up several financial opportunities, particularly regarding taxation. Currently, under IRS code 280E, cannabis businesses are unable to deduct ordinary business expenses because marijuana is classified as a Schedule I substance. The move to Schedule III would alleviate this issue, allowing these businesses to claim deductions that were previously disallowed. This could significantly reduce their tax burden, making operations potentially more profitable and sustainable.

The process of rescheduling marijuana from Schedule I to Schedule III may take longer than the media portrays. Initially, the proposal must pass through the scrutiny of the White House Office of Management and Budget (OMB), a step that ensures all legal and policy implications are thoroughly evaluated. This review can vary in length but is critical in shaping the framework under which marijuana would be regulated going forward.

Following the OMB review, the proposal enters a public comment period, where stakeholders from various sectors—medical, legal, business, and the general public—can provide feedback. This stage is vital for incorporating community and expert opinions and typically lasts several months, further extending the timeline.

Once the public comment period concludes, the DEA reviews the feedback and makes any necessary adjustments to the proposal. This step can also be time-consuming, as it may require additional rounds of revision and approval to address complex issues raised during the public comments.

The final rule is then published in the Federal Register, formalizing the rescheduling of marijuana. This publication is the trigger for the IRS to begin adjusting its policies, including the re-evaluation of tax codes such as 280E, which currently prevents cannabis businesses from deducting typical business expenses.

The IRS will likely respond by issuing new guidelines and possibly updating forms and instructions to accommodate the changes in marijuana’s scheduling. However, these adjustments won’t be instantaneous and will require time to implement. The IRS must ensure that their systems, procedures, and publications reflect these changes accurately, a process that could extend over several months post-rescheduling.

Throughout this period, businesses must stay informed and prepared for changes in compliance requirements, both from a scheduling and taxation perspective. It’s important to note that while the IRS adjustments will provide future relief, they will not apply retroactively to previous tax years before the reclassification is officially in effect.

It is vital that you act now. As cannabis businesses anticipate the shift from Schedule I to Schedule III, it goes without saying that good advice is essential to effectively navigate the new regulatory landscape, while poor advice can result in permanent harm to your business.

Recognizing that the IRS will not allow retroactive application of tax deductions, minimally businesses should consider filing protective claims for refund to preserve the right to amend past returns based on the outcome of future legal changes. Additionally, firms like Calyx CPA are confident that the CSA’s application to states with cannabis programs will eventually be overturned. Following the example of companies like Trulieve, which received $113 million in refunds from amending their tax returns, they encourage cannabis businesses to maintain meticulous records and consider filing amended returns where feasible. They advocate for a proactive approach in managing audits and potential disputes with the IRS, emphasizing the necessity of sound legal arguments and rigorous compliance with emerging regulations.

Secure Your Refund Form

Calyx CPA

Monthly Archives: May 2024