Since 2016, rumors have circulated among cannabis tax experts of an undisclosed playbook the Internal Revenue Service (IRS) uses to audit the cannabis industry. Such a document isn’t unusual, according to Denver tax attorney Kevin Richards. In fact, the IRS maintains playbooks like these, called Audit Technique Guides (ATGs), for every legal industry in the U.S. They’re resources designed for IRS auditors, Richards explains, to help agents understand the accounting methods and possible tax issues specific to different industries. But ATGs are also extremely useful resources for businesses trying to stay in compliance with federal tax law.
While ATGs for most mainstream sectors are made publicly available on the IRS website, the agency never published one for the cannabis industry. Marijuana tax experts knew the IRS was using something to train the agents auditing cannabis businesses — but for years the actual document remained confidential.
That was until April of this year. When, in response to a Freedom of Information Act request by MJBizDaily, the IRS finally released a document known as a “Participant Guide” (PG) — a document just like an ATG, except for internal use only. And it’s just as restrictive as experts like Richards imagined.
“It is really, essentially, an [ATG],” says Richards. “Just under a different name.”
A large part of the cannabis industry’s PG outlines how IRS agents should use the infamous 280E tax code — a law that prevents cannabis companies from legally deducting any business expense besides the cost of goods sold. Richards calls 280E a “political weapon.” He says it was drafted in the Reagan administration to prevent drug traffickers from claiming business expenses, and revised in the Clinton administration to target the budding cannabis industry specifically.
“From the very start, that was the U.S. government’s tool to shut down the cannabis industry,” he says. “It was used that way all along.”
And he points out, a cannabis 280E audit is about three times more profitable for the IRS than any other kind of audit they do. It’s low-hanging fruit, and it’s why cannabis businesses pay an 80-90% tax rate, compared to the standard 30% tax rate for normal businesses.
Beyond the IRS’ means and methods for exercising the 280E tax code, the recently released PG also covers a lot of cannabis basics: describing different types of products, different strains of flower, general cultivation techniques, and how dispensaries handle cash. It even touches on more technical (and controversial) concepts like calculating a grow’s yield by examining its utility bills — an idea Richards calls “ridiculous.”
The PG also instructs IRS agents to start asking cannabis business owners as many questions as fast as possible before they contact an attorney. It’s a tactic Richards says is extremely common during IRS audits.
“They want to be able to charge in when a business owner doesn’t understand entirely what’s going on, ask a bunch of questions and get a bunch of important information before they can get educated,” he says. Which is why having a tax attorney to handle an audit is so important when it comes to the IRS, he explains.
“Don’t talk to the IRS,” Richards warns cannabis business owners. “They’re not out to be your friend. They’re out to determine the highest amount of tax they can apply.”
That’s something clearly laid out in the cannabis industry’s PG, he says.
Sadly, Richards doesn’t see much hope for the IRS changing its PG or the way it audits cannabis businesses, before federal cannabis reform is passed.
“There’s just no sympathy for the cannabis business that pays too much in taxes. Nobody cares about that,” Richards says. “And everybody thinks that the cannabis industry is making just tons of money, anyway — when they’re really not. Most of the companies are struggling to break even because of the 280E tax code.”
But, he points out, if cannabis is legalized, all of that goes away. 280E would dissolve, and with it the cannabis industry’s 80-90% tax rate; local businesses would see larger profit margins and could expand and grow faster, hiring more people and bringing more prosperity into their communities.
And the IRS would have to scrap this internal PG in favor of a formal, and public, ATG for the U.S. cannabis industry.
