The IRS appears to be harshing the mellow of some 30 cannabis companies in Colorado.
That’s according to tax lawyers, accountants. and business owners in the state, who say the federal agency is auditing the cannabis entrepreneurs for tax years 2014 and 2015, possibly because they failed to fill out form 8300—a document that businesses file when they make cash deposits over $10,000. Some companies are also having issues with tax code 280e, which was created for drug traffickers and does not allow for normal business deductions.
Whether the audits are civil or criminal is unclear, according to tax attorney James Thorburn of Thorburn Walker LLC, who is representing some of the business owners. One audit letter obtained by Inc. was sent from the IRS’s fraud group. “When you see something about criminal investigations and fraud, it typically is not a civil audit,” he says.
However, Thorburn says that when he questioned an IRS agent about the specific department, the agent said he used “inappropriate letterhead” and is no longer part of the fraud group. Still, “I am telling my clients that there is potential for criminal charges,” Thorburn says.
The IRS says it cannot comment on specific taxpayers, but a representative did say that the agency follows federal law, which considers marijuana a Schedule I drug under the Controlled Substances Act. Inc. confirmed the audits by speaking with business owners who are being audited and seeing the audit letters. The news about the Colorado audits was first reported by Marijuana Business Daily.
There is a big difference between civil and criminal audits. A civil audit can result in fines, while a criminal audit could result in a prison sentence and steeper fines.
The audits come as marijuana cultivation and sales are now legal in some form in 25 states. But new laws—passed by state legislatures—conflict with federal law. The IRS, in fact, has a cut-and-dry stance on marijuana: It’s an illegal substance, according to federal law, and entrepreneurs running state-legal marijuana businesses are considered drug traffickers.
Since the IRS must adhere to federal law, “these new state statutes do not have any impact on federal tax law when determining allowable expenses for income tax purposes,” according to a memo written by Kristen E. Bailey, the director of collection policy at the IRS.
The IRS wouldn’t say it is targeting marijuana companies for audits.
In Colorado, Thorburn says the conflict between the federal government and state has caused a great deal of friction. He believes that the Department of Treasury is not making concessions for the industry as laws are slowly reforming. In 2013, Deputy Attorney General James Cole released guidance for federal agencies, noting that authorities should focus limited resources on marijuana companies that sell to minors, serve as fronts for drug cartels, use violence and firearms to distribute, or cause other harm.
In December 2015, Congress extended a rider in the 2016 spending bill that banned the Department of Justice from preventing states from creating their own marijuana laws. All of these reforms gave the cannabis industry confidence that federal legalization was on its way, Thorburn says, but tax code 280e and the recent audits have deflated some of that confidence.
“The IRS is taking a strong position that what the industry is doing in Colorado is a criminal violation of federal law,” says Thorburn. “It’s not a huge step to say that the federal government could prosecute the violators of the federal crime.”
Hank Levy, a CPA who handles taxes for marijuana companies, has his own theory: He believes the IRS is taking the opportunity to collect while marijuana is federally illegal.
“I would not be surprised if they are combing through cannabis companies,” says Levy. “The IRS perceives there is big, easy money by auditing these companies.” It’s easy to pick up a retail dispensary’s tax return and see if they’ve done their forms correctly—and it’s easy for the IRS to win at the tax court level, he adds.
A co-founder of one of Colorado’s largest cultivators and retailers, who requested to be anonymous, says his company is being audited for failing to fill out form 8300 in about 20 instances.
“Our accountant did not tell us we needed to fill out form 8300 for single cash deposits over $10,000,” he says. “It’s our fault; we should've known.”
Still, the entrepreneur believes the IRS is targeting marijuana businesses on a moral level. He is afraid of criminal prosecution and is working with his lawyers during the audit process.
“We are very sensitive as an industry, but the IRS has been aggressively going after us,” he says. “They are acting as the judge, jury, and executioner and assigning punishment without due process.”