Does a Tax Cut Jobs Act Provision Decrease Income Taxes on Marijuana Businesses?

KEY TAKEAWAYS:

  • A pending U.S. Tax Courtroom case presents an fascinating concept to preclude the federal earnings tax disallowance of all deductions of a marijuana enterprise.

  • The speculation rests on a provision within the 2017 Tax Cuts and Jobs Act that allows small taxpayers to make use of a simplified stock accounting methodology for tax functions.

  • Laws pending in Congress would take away marijuana from the checklist of drugs within the Managed Substances Act, leading to repeal of the earnings tax disallowance of deductions for marijuana companies.

For the final 40 years, marijuana companies had been prohibited from deducting enterprise bills of their federal earnings tax returns. After a temporary victory within the Tax Courtroom in Jeffrey Edmondson v. Commissioner,[1] permitting an unlawful drug seller’s enterprise deductions for workplace hire, a weight scale, packaging, and vehicle bills, Congress amended the Inner Income Code in 1982 to disclaim unlawful drug sellers all enterprise deductions and credit. The modification supplies that taxpayers carrying on a enterprise of trafficking in managed substances prohibited by federal or state regulation are usually not allowed to deduct prices to compute their taxable earnings or declare credit towards their tax legal responsibility.[2] Included in managed substances is marijuana. 

Since 1982, many states have legalized medical and leisure marijuana, however federal regulation is unaffected by laws in these states. Federal earnings tax deductions for marijuana producers and distributors stay disallowed. Nonetheless, a taxpayer now has expressed a new and fascinating concept to keep away from the consequences of the deduction disallowance.          

At present pending within the Tax Courtroom is Different Therapies Group, Inc. v. Commissioner.[3] The taxpayer, a marijuana enterprise, alleges that a provision within the 2017 Tax Cuts and Jobs Act that simplifies the tax accounting methodology for inventories authorizes it to keep in mind expenditures recorded in its books as “cost-of-goods sold,” which bypasses the disallowance of “deductions.”  

The simplified stock accounting methodology on which the taxpayer depends should “conform [ ] to such taxpayer’s method of accounting reflected in an applicable financial statement of the taxpayer with respect to such taxable year or, if the taxpayer does not have any applicable financial statement with respect to such taxable year, the books and records of the taxpayer prepared in accordance with the taxpayer’s accounting procedures.”[4]  

The taxpayer used the second various—the books and information of the taxpayer ready in accordance with the taxpayer’s accounting procedures. The simplified stock accounting methodology is offered to a “small” enterprise. A enterprise is small if has gross receipts that don’t exceed $25 million, adjusted yearly for inflation, for the previous three years.[5] A small taxpayer additionally could use the money methodology of accounting (earnings gadgets are included in gross earnings when obtained and expenditures are deducted when paid), which is a departure from the final rule that taxpayers with inventories should use the accrual methodology of accounting.[6] 

The taxpayer in Different Therapies grew and harvested marijuana and manufactured marijuana merchandise. It paid direct and oblique bills for the expansion and cultivation actions. Its Tax Courtroom petition alleges that similar to another small enterprise, it’s entitled to make use of the brand new simplified books and information stock methodology and the money methodology of accounting for its stock. The taxpayer’s books and information and its tax return included $2 million for cost-of-goods offered, which the IRS disallowed. This quantity is in difficulty within the pending case.

Value-of-goods offered decreases gross receipts. The ensuing quantity is gross earnings (gross revenue). Allowable deductions are subtracted from gross earnings. The tax regulation distinguishes between cost-of-goods offered and deductions as a result of federal tax regulation can’t disallow cost-of-goods offered. America Structure authorizes a “tax on incomes.”[7] A tax that doesn’t permit an “above-the-line” lower (offset) in gross receipts for cost-of-goods offered can be an unconstitutional gross receipts tax. As a end result, federal tax regulation disallows solely “below-the-line” deductions from the “gross profits” of a marijuana enterprise.

The taxpayer’s petition alleges that its accounting procedures correctly offset gross receipts from gross sales with cost-of-goods. The taxpayer’s books and information apparently maintained a listing account that capitalized the direct and oblique prices that it paid to provide and distribute marijuana merchandise. When the taxpayer offered its merchandise, its books and information entered the quantity of the gross sales as gross receipts and offset the quantity of gross receipts with the price of the stock that it offered. 

Clearly, Congress can amend the tax regulation to maneuver an expenditure from a disallowed below-the-line deduction to an allowable above-the-line cost-of-goods offered offset. The modification that achieved this transformation, in accordance with the taxpayer in Different Therapies, is the simplified stock accounting methodology.

The IRS concept of disallowance undoubtedly is that the 2017 enactment of the simplified stock accounting methodology didn’t implicitly repeal the 1982 enactment prohibiting marijuana companies from deducting enterprise bills. The Treasury Division usually expressed this concept in a regulation revealed in 2020 to clarify the simplified stock accounting methodology.[8] The IRS concept would rely on the rule that implicit statutory repeals by later enactments are usually not favored except the intention of Congress is obvious and manifest.[9] The regulation seems to relaxation on a nonexistent statutory provision, which makes its validity problematic.

The problem in Different Therapies could devolve as to if the simplified stock accounting methodology permits the taxpayer to outline its cost-of-good offered in its accounting procedures. The petition doesn’t disclose the particular prices within the taxpayer’s cost-of-goods offered the IRS rejected, asserting solely that the taxpayer paid direct and oblique prices as a producer to domesticate and produce marijuana. If that may be proved, the taxpayer has a substantial argument that the prices had been includable in costs-of-goods offered below the simplified stock accounting methodology and couldn’t, due to constitutional constraints, be topic to disallowance as deductions.    

The newest marijuana deduction disallowance case is Lord v. Commissioner.[10] In that case, the taxpayer, a marijuana cultivator, processor, and distributor, unsuccessfully argued that deductions for accelerated depreciation[11] and bonus depreciation[12] that it claimed for a tax yr predating enactment of the simplified stock accounting methodology ought to be included in its cost-of-goods offered. These depreciation deductions had been capitalized to stock below the uniform capitalization guidelines.[13] The principles present that even when a taxpayer’s books and information deal with these depreciation prices as present bills, they nonetheless are usually not presently deductible for tax functions, should as an alternative be added to stock, and have to be launched when the products to which they relate are offered. The uniform capitalization guidelines expressly state that a price that was not deductible for any taxable yr just isn’t reworked into a price that may be included in cost-of-goods offered. For that and different causes, the taxpayer in Lord misplaced the case. 

Administrative Process Act: The Tax Courtroom petition in Different Therapies additionally alleges that the IRS has an administrative observe of denying marijuana growers the power to report cost-of- items offered below the simplified stock accounting methodology, and that the observe is invalid as a result of the IRS didn’t present discover and a possibility to remark on the observe as required by the Administrative Process Act. This IRS steering apparently is included in an unpublished IRS audit information for the marijuana business. Taxpayers have prevailed lately in instances during which they proved that the IRS revealed an administrative rule with the pressure and impact of regulation that was not first submitted for public discover and taxpayer remark.[14] 

Pending Laws: The penultimate paragraph within the Lord opinion broadcasts that within the absence of laws, the Tax Courtroom will strictly implement the 1982 marijuana disallowance statute. Now pending in Congress is a invoice that might take away marijuana from the checklist of drugs below the Managed Substances Act, leading to repeal of the earnings tax disallowance of deductions and credit for marijuana companies.[15] Additionally within the invoice is imposition of a federal excise tax on marijuana. The invoice handed within the Home on April 1, 2022, however the Senate is working on its personal invoice. Enactment consequently stays questionable since 60 Senate votes could also be required for passage, and, within the meantime, the Tax Courtroom will proceed to take the place that it isn’t accountable to resolve the technical tax points that the deduction disallowance presents.

ENDNOTES

[1] T.C. Memo. 1981-623.

[2] IRC §280E.

[3] No. 2022-8668 (Jan. 7, 2022).

[4] IRC §471(c)(1)(B)(ii). 

[5] IRC §448(c)(1).

[6] IRC §448(b)(3).

[7] U.S. Const. sixteenth Amend.

[8] Treas. Reg. §1.471-1(b)(6)(i).  

[9] Nationwide Ass’n. of Dwelling Builders v. Defenders of Wildlife, 551 U.S. 644, 662 (U.S.,2007).

[10] T.C. Memo. 2022-14 (Mar. 1, 2022).

[11] IRC §168(a).

[12] IRC §168(ok).

[13] IRC §263A.

[14] Mann Development, Inc., v. United States, 2022WL 619822 (sixth Cir. Mar. 3, 2022) (IRS Discover invalid); Liberty International, Inc. v. United States, No.1:20-cv-03501-RBJ (Fed. Dist. Ct. Col. Apr. 4, 2022) (short-term regulation below IRC §245A invalid).  

[15] Marijuana Alternative Reinvestment and Expungement (MORE) Act (117th Cong., H.R. 3617).  

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