Are you familiar with 280E for your dispensary business? In this episode, Tony Frischknecht goes into a deep dive on how Section 280E affects your cannabis business and a different method of accounting to work around 280E. The way the taxes are set up for a cannabis business doesn’t allow you to grow your business. Tony shares some firsthand knowledge that can help you mitigate the impact of 280E and scale your dispensary. Through the Tax Cuts and Jobs Act, learn how IRC Section 471(c) can help reduce the taxes on your business. Tune in and get to know how you can apply this workaround to your business and keep the revenue you worked hard for.
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Getting Familiar With 280E: A Different Method of Accounting
This Accounting Method Will Save You $100’s Of 1000’s In Taxes
I want to share with you some cool stuff. This is exciting for me because I wished I had the time when I was in the dispensary business to find some of this stuff out. I think this is extremely valuable for those of you who are just starting, as well as people that are in the deep part of the business now, or what I like to say the trenches. I’m going to talk to you about a couple of things. One of them is 280E. If you’re not familiar with that, get familiar with it. I’m also going to share with you what I’ve found to be a different method of accounting. It’s going to be able to help you work around 280E.
How 280E Affects Your Cannabis Business
Over the last couple of years, the media has been talking about banking like, “The industry needs banking. We’ve got to get banking.” This has been talked about since legalization happened here in Colorado. It’s not a new discussion. What I find irritating is that there are few people that are truly discussing 280E and how it affects your cannabis business, especially on the retail end. I want to start here first by saying any of this information I give you, take this to your accountant. Talk to them and see how it can possibly help you. I want you to take a look at and be careful of this information, but also remember that you are in cannabis because of the opportunity. If you’re scared, that’s a normal thing. However, the scariness of this may also be why you like the industry. It’s new and exciting but you’re going to have some ups and downs.
Ideas To Get Ahead
Please take this information and understand that you have to take other risks. What we used to say back in the day is we were distributing a federally illegal substance, which you guys still are now, but our big concern was getting arrested or sent to federal prison for trafficking. There may be a few people out there that are still concerned about that. From what I see nowadays, the regulations are starting to take place. They’re starting to take a foothold in a lot of the newer places. We’re also starting to see the federal government. These are ideas that I believe can help you get ahead because right now, the way the taxes are set up for cannabis doesn’t allow you to grow as a business.You are in cannabis because of the opportunity. If you're scared, that's normal. Click To Tweet
What can you do? I want to start by saying that I have firsthand knowledge. I’m in an audit situation dealing with 280E. I’m not telling you this because this has got to be a way around it and I’ve taken the risk. We’ve played the games with 280E and trying to move that around in several companies to take it to our advantage the most we can with the guidance of virtually nobody. That’s what we’re dealing with out there in the cannabis world. The IRS isn’t going to tell you how they’re going to audit your business. Over the last few years, they’ve been learning how to do that, taking companies like mine and saying, “We need this.” They’re doing extremely intense audits.
Tax Cut and Jobs Acts: IRS Audit
Here’s the story. I sold my business back in 2015 and then I sold another one back in 2017. Since 2015, I’ve been dealing with the same audit. To date this, I’m five years into an audit. I know some of you were like, “Are you serious?” Yes, and I’ll tell you why. We are playing the long game with this. There’s so much that’s happening with regulations and the IRS is learning and they’re coming up with new things. For the last couple of years, I’ve been hoping we could find something. I’ve come across some information and some of you may be familiar with this new accounting method. What triggered this was the Tax Cuts and Jobs Act. It was when the new administration did the overhaul of the tax program. They said it was one of the largest in decades that has taken place. There was a bunch of media around this but we hadn’t heard much more than that.
On March 30, 2020, the IRS was audited by the Department of Treasury. They were being audited on their processes and how they worked through these marijuana business audits. There was some interesting stuff that came up. Like I said, the Tax Cuts and Jobs Act triggered this audit because it’s trying to reduce tax issues throughout the business in our country. “This report represents the results of our review to evaluate the internal revenue service examination and education approach to certain cash-based industries with an emphasis on legal marijuana operations. This audit includes in our fiscal year 2020 annual audit plan and addresses the major management challenges of improving tax reporting and payment compliance.”
This is a 40-page document and I’ve been combing through with this and I found several things. I’m going to go over 280E. You need to take this in more in-depth and understand it. I’m going to read it. “Under the Controlled Substances Act, it is illegal to manufacture and distribute marijuana. Further Internal Revenue Code 280E prohibits the deduction of expenses incurred in trafficking-controlled substances. 280E does not apply to the cost of goods sold. Consequently, businesses that sell marijuana can reduce gross receipts by the cost of business sold but cannot deduct other business expenses.” That in a nutshell is crushing to most businesses.
For example, let’s say you had a gross income of $500,000. Your cost of goods sold is $250,000 and business expenses that cannot be deducted are $150,000. Your net income is $100,000 and then you have to add $150,000. I thought I paid that to business expenses. Technically, you did but since 280E is involved, you have to pay taxes on that $150,000 that you don’t have anymore. That’s where that tax lien comes to $250,000. You’ve got your net income plus your $150,000 is $250,000. There are graduated corporate tax depending on how you’re set up as a business will depend on how you go with your tax liabilities. You’re looking at $80,750. It seems little. However, you don’t have this money anymore. You’ve lost out on $150,000 in revenue that you don’t have anymore and you’re paying taxes on that. It’s absolutely unbelievable. I don’t want to go too far into that because it’s easy to get lost in the deep parts of 280E.
Let’s get to some of the centers of this document, the impact on taxpayers on the findings of this audit. “Marijuana is classified as a Schedule I controlled substance under the Controlled Substance Act. Businesses in this industry have limited banking access and are subject to Internal Revenue Code section 280E, which prohibits the deduction expenses incurred in trafficking Schedule I.” This all has to do with trafficking Schedule I and this goes back to the RICO Act. This was something that was used back in the ‘80s to tie conspiracies to several people for taking down large criminal organizations like the mob and different stuff like that. It became super popular. Decades later, we’re having to pay for the effect of that on the cannabis industry because we deal with a controlled substance. If you don’t know the RICO Act, you are semi in the gray area still working in the cannabis. It’s worth the read.
Why did they do the audit? “This audit was initiated to evaluate the IRS examination and education approach to certain cash-based industries with an emphasis on legal cannabis operations.” What was found? “Statistical random samples of marijuana businesses in three states and determined that 59%, 140 out of 237 of the tax filings for the tax year 2016 had likely 280E adjustments, which when projected over the population total $48.5 million in unassessed taxes for the tax year 2016.” That’s a huge amount. They’re finding that this over-taxation is happening because of 280E. What was recommended to the IRS? “It recommended that the IRS develop a comprehensive compliance approach for the marijuana industry including a method to identify businesses in the industry and track examination results. Develop and publicize guidance specific to marijuana industries such as guidance on the application of 471(c),” which is an incredible way of adjusting your accounting method.471(c) is one of the greatest tools for the tax industry right now. Click To Tweet
“In conjunction with IRC 280E, leverage publicly available information at the state level and expand the use of existing fed state agreements to identify non-filers and unreported income in the marijuana industry and increase educational outreach towards unbanked taxpayers making cash deposits regarding the unbanked relief policies available.” With all that said, the audit is requesting the IRS to start giving some guidance that they haven’t given ever.
Here’s what the IRS code 471(c) has the ability to do. “The small business self-employed division has developed an internal document participant guide that provides revenue agents with guidelines on how to audit marijuana.” This is not available to anyone. They have kept this internally. Now, we’re being audited on whatever they’ve come up with these guidelines for the IRS agents. None of us know what that is. According to the IRS internal participant guide, “Pursuant to 471-11, the cost of goods sold for producers includes direct material costs, marijuana seed or sale, direct labor cost, planting, cultivating, harvesting, sorting and indirect costs. Indirect costs may include repair expenses, maintenance, utilities, rent, indirect labor and production supervisory wages, indirect materials, tools and cost of quality control. The IRS internal participant guide noted the cost of goods sold for retailers includes the cost of marijuana purchased less trade or other discounts, plus transportation and other necessary charges in acquiring possession of marijuana. According to the marijuana industry training conduct by the IRS, large businesses and internal division inventory issues practice area, the costs of goods sold does not include,” and then it’s got a list of everything else.
Let’s go to 471(c). I want to start off by saying that this applies to only businesses making under $25 million. This hasn’t been tested at any courts right now, but I know some large accounting companies that are using this formation. How do I know? It’s because I’m involved in it. What I want to say here is that this is something that you, the new business owner, can start with or if you’re willing to change your accounting methods, you can start using this process. Case A, the tax year 2017, I’m going to give you an example. You’ve got gross sales of $1 million, the cost of goods sold $500,000, minus that so your gross income is $500,000. Then you’ve got advertising, repairs, maintenance, salaries and wages, and total business expenses. Here’s where we go into your 280E adjustments, $250,000. Net business expenses, zero. We’ve got a taxable income of $500,000.
Case B, changing in the accounting method. Here’s when you use 471(c). You’ve got $1 million in gross sales, cost of goods is $750,000. On that case A, we had $500,000. Now we’ve reduced our gross income by $250,000. We’ve used this new accounting method, took it out of 280E and put it in our cost of goods. In our advertising, we have in this accounting method, zero. In our repairs and maintenance, we have zero. In our salaries and rages, we have zero. Our total business expenses, we have zero. IRS 280E adjustment is zero and that business expense is zero. The taxable income is $250,000. We cut our taxable income in half. This is one of the greatest tools I’ve seen for the tax industry.
I’m sitting here thinking to myself, “What about people? How can we trust this?” That’s what you have to talk to your tax advisor as to what are the pros and cons of working this method. It hasn’t been tested but you are in this industry because it’s thriving and it’s growing. You’re taking chances. This is how you can grow your business. People are going to probably throw their arms up and be like, “Tony, you don’t know what the hell you’re talking about.” I do. I’ve taken risks to be here in front of you. These are the things that the real entrepreneur, which I know there are tons of you guys out there right now, you’re looking for these key things. This is survival. This is growing your business. It’s a huge advantage to you to look at this. If you have a tax advisor who knows nothing about this, you need to run, especially if they don’t know anything about 280E.
Choices To Make
I’m going to bring some different accounts because there are cons to this. There are several different choices you can take out there, but I’m going to provide you with some stuff that I don’t see anybody has given you out there. I wish somebody would have been like, “This is something I need to talk to my tax guy.” At the end of the day, what you take home, that’s how you can judge your success if your success is judging on how much cash you make. Everybody has got their own judgment of success. Please look into this because it’s huge. Come check me out on PlantProblem.com. It’s free to read.
I’ve got a lot of people I’m talking with about this 471(c). Take some time, talk to some people and talk to people that advise you. Talk to them about this memorandum. Give it to them and say, “Read this.” There are some people backing this up that they’re prominent attorneys that are testing this. It’s happening now. If you want to save some money on taxes, grow your business and make some money, look into this system. It’s always a pleasure being with you here. I’m trying my best to find anything I can to help the small business owner and even the large business if they haven’t heard of this.
Some of these things, when you get in these large accounting companies it’s, “Steady go, we’ve been doing this for years.” You can’t take the cannabis business or the cannabis industry. It’s a different animal when it comes to moving and adjusting through the weeks and months. We’ve had some hard times, but what I’m excited about is there’s a ton of cannabis companies that are taken advantage of this right now because they’ve been deemed essential in a lot of states. There’s some super big growth happening, so don’t lose that revenue that you’ve worked your tail off for the last couple of months. You guys have been crushing it lately. Please look into this. Also, stay connected with me so you can see when I’m going to talk to some accounting specialists about this.
We’re going to tear this apart and decide what are pros and cons. We’ll figure out how this looks and then you can make a decision from there as to whether you want to take this further and potentially use this in your company. Thank you so much for joining me. I want to be able to provide you with some great information. I’m trying to be as creative as possible so you are able to either spin this into a new idea or spin this off into another opportunity for yourself. I love you guys out there. I respect you. I know you are fighting the fight. Keep going and come back to join me when I have a new episode. I look forward to being here.