U.S. Supreme Court Refuses to Resolve IRS Cannabis Lawsuits for a Second Time

For the second time, the U.S. Supreme Court has decided not to help resolve an ongoing legal battle between the Internal Revenue Service (IRS) and various cannabis businesses in Colorado. The Court’s justices have repeatedly declined to hear the appeals from Eric Speidell, owner of the Green Solution, as well as Denver-based cannabis company Standing Akimbo and various other legally operating businesses.

The tedious argument centers around Section 280E of the federal tax code and the negative implications that it has on the $61 billion U.S. cannabis sector. Plaintiffs unsuccessfully made their best effort to encourage a positive hearing that might result in the overthrow of the federal tax provision. 

Understanding the Impact of Section 280E on Cannabis Businesses

Section 280E was established back in the 1980s in an attempt to prevent illegal market drug dealers from making tax deductions associated with the trafficking of controlled substances. To put it simply, Section 280E of the IRS tax code makes it unlawful for cannabis businesses to deduct the same standard operating expenses that are permitted by mainstream businesses.

Although cannabis companies in Colorado function legally at the state level, it remains impossible for business owners to sidestep the rules laid out under Section 280E of the IRS tax code. Well, until lawmakers deschedule cannabis at the federal level, that is. To put things into perspective, Section 280E of the IRS tax code makes it compulsory for state-legal cannabis businesses to pay sky-high federal tax rates, sometimes as steep as 80% to 100%. 

Since legal cannabis companies are forced to pay such extortionate tax rates, scaling and generating healthy profit often proves difficult; particularly for companies that lack sufficient capital. Many business owners even choose to operate illegally as a way of saving money.

The Outcome of the Cannabis Tax Court Case

Justice Clarence Thomas announced in June that federal cannabis prohibition “may no longer be necessary.” Considering his powerful words, it is understandable why the plaintiffs felt hopeful about their case. Sadly, in spite of the fact that the IRS has unfairly slammed the plaintiffs with additional tax assessments, their hopes were still shot down.

Based on Standing Akimbo’s argument, the IRS lacked the legal power to access the cannabis company’s state tax records amid a federal tax audit. Speidell tried to convince the justices that the IRS overstepped its boundaries when it claimed that the Green Solution’s business operations were forbidden under the Controlled Substances Act and federal law.

The Supreme Court has rejected the plaintiffs’ hearings on two more occasions and it’s likely that the argument will now be dismissed indefinitely. Initially, the cases fell flat last year at the 10th U.S. Circuit Court of Appeals. 

IRS Cannabis Business Audits: How and Why?

Unlike other mainstream industries, businesses that operate in the legal cannabis space are much more likely to be audited by the IRS.

Earlier this year, the IRS declared that they have been focusing their time and effort on implementing extensive initiatives for auditing cannabis businesses. Referred to as “Compliance Initiative Projects” (CIPs), the IRS’s cannabis company audits assessed business scores in no less than four states based in Detroit and the West. At least five multi-year audit programs were prioritized during 2021.

CIPs, the IRS affirms, are being proposed and executed following ongoing incidents involving cannabis companies violating Section 280E of the federal tax code. The audits were reportedly carried out by three distinct IRS field offices with one main goal in mind: to implement federal tax code compliance. 

The U.S. Department of the Treasury disclosed information pertaining to several of the CIPs in an official report that was issued in 2020. However, more documents have since come to light; four of the five cannabis-focused IRS audits were released to the public after MJBizDaily filed a request under the Freedom of Information Act (FOIA), which requires the government to provide access to certain federal agency records.

Cannabis Companies Should Prepare for an IRS Audit

The process of filing taxes is not exactly enjoyable. This is particularly true for cannabis business owners since the cost of filing taxes can seriously cut into profit margins and overhead budgets. Unfortunately, due to cannabis’ federally illegal status, business owners specializing in this nascent market are four times more likely to be audited than businesses in other more “ordinary” sectors.

Regardless of the expense(s) associated with being federally tax-compliant, business owners ought to follow the rules if they wish to operate legally and avoid hefty fines — which unfortunately means adhering to 280E. Companies that misappropriate expenses will almost always be tracked down by the IRS, which utilizes an algorithm capable of detecting tax returns with a larger probability error.

To avoid potential pitfalls, cannabis business owners should focus on document retention and organization. Legal and licensed companies must refrain from discarding supporting documentation for a minimum of seven years since documentation counts as proof that a company is abiding by Section 280E.

No matter how promising the outlook for U.S. cannabis reform might seem, the IRS is closely monitoring the cannabis industry. Data gleaned from the U.S. Treasury Inspector General for Tax Administration’s March 2020 report suggests that 59% of cannabis companies in California, Oregon, and Washington deprived the IRS of payments under Section 280E. Report authors estimated that the IRS is owed at least $48.5 million.