Historic U.S. Tax Court Decision That Will Save the Cannabis Industry Millions

Oct 3, 2019 | Financial Strategy

Historic U.S. Tax Court Decision That Will Save the Cannabis Industry Millions

Harborside is an Oakland, California cannabis dispensary that has been in operation since 2006. A few years ago, they faced a major IRS audit of their 2007 to 2012 tax returns. Once the audit concluded, the IRS found that Harborside underpaid their taxes by tens of millions of dollars.

Reasons for the IRS’ findings  

Two primary reasons contributed to these findings. The first reason was related to improper application of deducting business-related expenses. The second reason was related to an incorrect calculation of Cost of Goods Sold (COGS). These errors drove down their tax liability, much lower than it should have been. Based on these two errors and other evidence presented, the U.S. Tax Court sided in favor of the IRS.

Harborside Appeals the U.S. Tax Court

 Harborside appealed the court’s decision and by the end of 2018, the court changed part of their ruling. The court no longer held Harborside liable for accuracy-related 280E penalties. This landmark decision helped save the dispensary millions of dollars. And it can help other companies in the cannabis industry save as well. The court overturned their original ruling because they found that Harborside acted “reasonably and in good faith.” Not only did Harborside file their tax returns on time, but they also kept accurate financial records.   

Even though this was a significant overturn, the court maintained its original ruling about 280E. Since Cannabis is a Schedule 1 drug under the Controlled Substances Act, Harborside must follow the provisions of 280E. This tax code states that cannabis businesses are not eligible to deduct ordinary business expenses on their tax returns. Yet, 280E does permit them to deduct COGS, when calculated correctly.   

Comments from Harborside’s Founder

Steve DeAngelo, the founder of Harborside, put out a statement about the court’s ruling. “We’re still working on knocking out 280E entirely, but at least for now we have established that cannabis businesses who operate in reasonable, good faith compliance with existing law will not suffer from additional unjust penalties.” DeAngelo continued, “what we are asking for is simple and fair. For the IRS to treat us like every other legal, tax-paying business in the United States. Since the IRS has made it clear they are unwilling to do that on their own, Congress should step in and pass clear 280E reform legislation.” 

Although Harborside, along with other cannabis businesses, must adhere to 280E, the U.S. Tax Court decision was still monumental because it saved Harborside from paying severe tax penalties. Rather than proclaiming tax fraud, the judge simply found Harborside’s returns inaccurate since they didn’t follow 280E. Ultimately, what saved Harborside from receiving a harsher ruling, was the fact that Harborside maintained impeccable accounting records and filed their tax returns timely.  

The Importance of Working with Cannabis Industry Financial Experts 

Cannabis businesses can learn a lot from the Harborside case. The outcome of their case made one point very clear: without strong, capable accountants, Harborside could have faced high tax penalties.  

To reduce your company’s risk of getting audited, or to ensure that you’ll pass an audit and avoid severe penalties, it’s important to seek help from experienced cannabis professionals. The Northstar Financial Consulting Group has helped numerous companies, and can help your cannabis business with finances as well. 

For one, we can accurately maximize your COGS calculation, which in turn lowers your tax liability. Plus, we advise on how to keep proper and accurate accounting records. In the event an audit did take place, your company would have defensible books.  

Reach out to Northstar today if you’d like to learn more about our specific services. 

 

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