Arguments keep coming up that small cannabis taxpayers can simply look around for the deduction waiver under Section 280E of the Tax Code due to the new tax accounting rules in Section 471 (c) of the Fiscal Code, and that the new regulations that prohibit this strategy do little more than a speed bump.
These arguments seem to fall into two camps: the first camp aggressively seeks to circumvent the full tax legislation under Section 280E by simply treating everything as storage costs, and the second camp, more modestly, seeks just another parity between resellers and manufacturers by adding there are some additional indirect costs on inventory. Articles promoting the workaround are not clear on this point and appear to overstretch both aggressive and moderate interpretations of Section 471 (c) of the Tax Code.
Courts will find aggressive 280E avoidance strategies absurd and unreasonable
Using Section 471 (c) of the Tax Code to completely circumvent the no-deduction rules is not a viable strategy even without the new rules. This is partly because courts previously defined the cost of goods sold as the cost of items that were acquired or made for resale. See Hultquist versus Commissioner. The cost of goods sold, like the adjusted basis, is “the measure of the taxpayer’s unredeemed investment in property”, often its cost. Lenihan versus Commissioner. See also Section 1.61-3 (a) of the Treasury Regulation, which specifically excludes “Selling Costs, Losses, or Other Items Not Normally Used in Calculating the Cost of Goods Sold” from the cost of goods sold. Tax Code Section 471 (c) did not change the definitions of gross income or cost of goods sold.
The aggressive strategy also makes the mistake of ignoring the place of Section 280E of the Tax Code in the Tax Code as one of many non-deduction provisions, even if it is the most unfair. As a result, even if the aggressive interpretation of Section 471 (c) of the Tax Code were inherently reasonable (it is not), courts would see an absurd outcome, as any non-deduction provision in the Tax Code suddenly becomes disputed for small business taxpayers, such as z Code § 262 (prohibition of deduction for personal expenses). If small taxpayers could choose to repeal Section 280E of the Tax Code, they could also repeal these other provisions and, for example, capitalize on a family vacation or a home mortgage paid through company accounts.
In addition, courts previously found a similar result and rejected it. Readers need only check out Patients Mutual Assistance Collective Corporation v. Watch Commissioner (PMACC) where the court rejected an interpretation of Section 280E of the Tax Code that would have made the provision “ineffective and absurd”. It is not difficult to imagine how a court would treat an interpretation of Section 471 (c) of the Tax Code that renders any non-deduction provision ineffective for both resellers and manufacturers.
A moderate 280E avoidance above 471 (c) probably isn’t even worth it
On the other hand, the argument that Section 471 (c) of the Tax Code allows a retailer to capitalize only costs associated with making or acquiring inventory is at least reasonably reasonable. This more moderate argument does not conflict with Treas. Registration number. Section 1.61-3 (a) or definitions of the manufacturing costs of the goods sold, nor is any deduction prohibition provision in the tax code overridden. Nevertheless, this position would probably not result in any cost savings that could be defended in court, especially in relation to the new regulations.
It is argued that Section 471 (c) of the Tax Code “removes the barrier that prevented retailers from capitalizing on costs like manufacturers”. The “obstacle” may be the succinct language of the Tax Code Section 263A (a) which prohibits the use of the Uniform Capitalization Rules (UNICAP) to circumvent the no-deduction provisions such as Tax Code Section 280E. In PMACC the petitioner tried to assign indirect costs to the inventory using the UNICAP rules. The petitioner had a “processing room” where he re-inspects, repackages and labels his products and wanted to activate these indirect costs to reduce 280E, but the tax court refused such treatment because it found it to be with the petitioner was a reseller and not a manufacturer.
Even without the succinct language of Section 263A (a) of the Tax Code, the UNICAP rules would not even be as helpful to cannabis companies in providing tax breaks for indirect costs as their potential benefits would be limited.
A brief overview of the UNICAP rules from a cannabis retailer’s perspective is illustrative:
For retailers, indirect costs under UNICAP are other than acquisition costs that directly benefit or arise from conducting resale activities. Trees. Registration number. Section 1.263A-1 (e) (3) (i) (A). These costs typically include purchasing, handling, and storage, which should sound familiar to readers of the PMACC decision. See safes. Registration number. Section 1.263A-3 (c) (1).
Purchasing costs are associated with running a purchasing department or office, including: personnel costs associated with the selection of goods; the maintenance of the stock range and volume; the placing of orders; the establishment and maintenance of supplier contacts; and comparing and testing goods. This is kind of helpful, but some of these costs can already be activated through Treas. Registration number. Section 1.471-3 (b) as “Other Necessary Fees In Acquiring Possession of the Goods”. See also safes. Registration number. Section 1.263 (a) -2 (f) (2) (iv) (B).
Processing costs relate to processing, assembly, repackaging, transport and other similar activities for properties acquired for resale. It is important that UNICAP handling costs do not include handling costs at a retail point of sale, such as costs for unloading, unpacking, marking and labeling goods where a taxpayer sells goods exclusively to retail customers on-site. Trees. Registration number. Section 1.263A-3 (c) (5) (ii) (B). Many pharmacies would not benefit from UNICAP’s rules on handling costs unless they had a separate facility.
Storage costs are also capitalized according to the UNICAP rules, but only to the extent that they can be traced back to the operation of an external warehouse or storage facility. Trees. Registration number. Section 1.263A-3 (c) (5) (i). Again, not great.
Compare this cost to the laundry list of expenses specifically excluded in Treas. Registration number. Section 1.263A-1 (e) (4), too numerous to list here.
In particular, a court could easily determine that the indirect costs of the cannabis business under UNICAP are not normally used to calculate goods required by Treas. Registration number. Section 1.61-3 (a), as no taxpayer is able to use the UNICAP rules to circumvent the arrears. PMACC, see above; Tax Number Section 263A (a); see also Treas. Registration number. Section 1.263A-1 (c) (2) (i).
The harsh reality
Regardless of the method proposed, the supporting arguments are inconsistent with the legislative intent of Section 471 (c) of the Tax Code. Just look at the conference report on HR 1, 115-466, where the purpose of Section 471 (c) of the Tax Code is to “expand the universe of taxpayers authorized to use the cash payment method, and certain taxpayers of to exclude the obligation to preserve “. Inventories and extend the exception to the uniform activation rules. ”Arguments seem to read into it the“ avoidance of withdrawal refusal ”, but they shouldn’t.
Companies that pursue the aggressive strategy outlined above will be harmed by interest and penalties, while the promoters will not share their burden. See e.g. Treas. Registration number. Section 1.6664-4 (c) (1) (reliance on a tax professional must be reasonable). In addition, simply disclosing the position is not enough to avoid penalties. Trees. Registration number. Section 1.6662-3 (c) (1) (Disclosure Exemption does not apply to positions without reasonable basis). Cannabis companies may therefore find the moderate strategy more attractive given its relative appropriateness, but it is equally unlikely to survive a challenge.
To be fair, both strategies have reasonable premises, as state-regulated cannabis companies should be taxed like everyone else. The Tax Code is not a place for public policy rules like the Tax Code, Section 280E, but the reality is that state-regulated cannabis companies will be subject to different tax treatment until marijuana is removed from the Controlled Substances Act, which is included in Appendix III or higher becomes. or until Congress finally gets around to changing that ridiculous provision. Until then, it is better for government regulated cannabis companies to cut non-deductible operating costs and align their businesses with the tax code rather than waste time and money aligning the tax code with them.
This column does not necessarily represent the opinion of the Bureau of National Affairs, Inc. or its owners.
Information about the author
Kat Allen is a tax attorney with Wykowski Law in San Francisco.
Bloomberg Tax Insights articles are written by seasoned practitioners, academics and policy experts who discuss developments and current issues in the tax arena. To make a contribution, please contact us at TaxInsights@bloombergindustry.com.