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Dispensary Taxes – Post-Harborside – there is a silver lining for some well-advised cannabis dispensaries in the black-cloud Judge Mark V. Holmes hung out over the cannabis industry in his two 2018 Harborside opinions.
The two opinions are; 151 TC 11 and TC Memo 2018-208 . [See Harborside – Further Reflections, Harborside Redux and Harborside Beats Penalties.]
In the first opinion Judge Holmes rejected the manner in which the dispensary in the Harborside cases determined Cost of Goods Sold (“COGS”). Judge Holmes agreed with Chief Counsel Memorandum that Internal Revenue Code (“IRC”) §471 should be used by a cannabis dispensary to determine COGS.
In the second opinion, Judge Holmes determined accuracy-related penalties should not be applied to the income tax deficiencies asserted against the taxpayer. How important was the penalties decision to the taxpayer? Judge Holmes’ decision on penalties saved the taxpayer approximately $4.0M.
- What dispensaries can take advantage of the silver lining in these two decisions?
- The dispensary must have open tax years for federal income tax purposes.
- The dispensary must have operated in a manner comparable to Harborside.
- The dispensary cannot have used IRC §471 to determine COGS.
A dispensary that meets the above criteria should carefully evaluate whether it will potentially benefit from the preparation of amended federal income tax returns. If the dispensary already has one or more income tax return under examination, or if federal income tax deficiencies have already been asserted against the dispensary, the decision to evaluate the potential benefit of amended returns is a no-brainer. A dispensary that is already facing federal income tax deficiencies is being poorly advised if it does not consider the potential benefits of amended income tax returns.
For a dispensary that is not already facing a potential federal income tax deficiency, the question of whether amended income tax returns should be prepared and filed for open years is more difficult to answer. The filing of an amended federal income tax return that involves significant amounts is likely to result in an examination. In the event an examination is initiated, the entire return may be examined by the Internal Revenue Service (“IRS”).
One of the fundamental principles of the federal income tax law is that a taxpayer has no obligation to file an amended income tax return when an error in the taxpayer’s return is discovered subsequent to the filing of an income tax return that was believed to be accurate when filed. All cannabis dispensaries that filed federal income tax returns that did not utilize IRC §471 now are deemed to know that their income tax returns were erroneous. Judge Holmes’ opinion is conclusive on this issue. All cannabis dispensaries are charged with knowing this p0int of federal income tax law beginning no later than 2018. Such dispensaries, however, are not obligated to file amended returns for years prior to 2018 if the returns were believed to be proper when filed. Dispensaries can allow the statute of limitations run with respect to any such filed returns.
The flip side of this issue is that all dispensaries that do not utilize IRC §471 for 2018 and subsequent years will be subject to penalties if their returns are examined. A dispensary that files federal income tax returns for 2018 and subsequent years that fails to follow the principles outlined in Judge Holmes opinion will be deemed to have disregarded rules and regulations. Disregard of rules and regulations one of the tests for accuracy-related penalties. [Finally, See Harborside Redux Redux Redux]
Every cannabis dispensary must carefully consider its filing positions every year, although the availability of IRC §471 for California cannabis dispensaries ceased in 2018. As we have previously discussed, California cannabis dispensaries lost the benefit of IRC §471 beginning in 2018 for other reasons. [See Cannabis Inventory Costing Update – Post Harborside]
It is critical to the financial success of all California cannabis businesses, not just California dispensaries, to keep in mind the who, how and when of taxes. Governmental agencies expect to receive approximately 40% of all of the dollar collected from California cannabis consumers. California is already wondering why millions of tax dollars appear to be missing.
In 2018 the management of tax liabilities very likely became the single most important factor in the long-term financial success of every California cannabis business.