Filing taxes

What the IRS Has to Say to Cannabis Business Owners

written by Claudia Grant
reviewed by Robin T Young
June 27, 2022

If you run a clothing store or restaurant, you and your accountant would have no problem figuring out what kinds of taxes you need to pay and how much. There are a lot of rules, but you also get a lot of deduction options to reduce your final bill.

But cannabis business owners live in a murkier place, at least until the IRS finally released some guidance to help them out. After all, their product is still illegal at the federal level, despite being a thriving and legal business model in 37 states, the District of Columbia, and three territories.

The cannabis industry has several unique financial concerns from the inability to get bank accounts to the large number of cash transactions. These challenges mean the IRS has to count on a high level of voluntary compliance by owners to make sure those tax responsibilities are met. The recent guidance is part of an education effort to help them understand the rules.

Let’s take a look at what the IRS had to say about taxes for the cannabis industry.

Yes – You Have To Pay Income Taxes

While selling and growing marijuana is illegal at the federal level, you still make income from it, and income from any source — including illegal ones — is taxable. The courts have consistently ruled that’s the case and that dispensaries in states where cannabis is legal have taxable income.

Not only are you responsible for income taxes, but you also need to keep up with your federal employment taxes. This includes self-employed taxes for you as needed and payroll taxes for your employees.

Yes – You Can Make Tax Payments In Cash

Traditionally, cannabis businesses tend to be pretty cash-heavy, which is further complicated by the reluctance of some banks to work with the marijuana industry. That is starting to change, but if you find yourself in a situation where you can’t just write a check to cover your tax bill, cash is acceptable.

To do that, you need to call 30 to 60 days in advance to schedule an appointment at an office that can accept your payment. The IRS requests you bundle the money in the highest denominations possible. Plan to be there for an hour or two depending on how much you’re paying and how many types of taxes you have.

Evaluate your tax situation

By evaluating your tax situation, you can identify areas where you may be able to reduce your tax burden and make informed decisions about your financial future.

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Yes – You Can Make Quarterly Payments

Most self-employed business owners make quarterly estimated tax payments since they don’t have an employer taking money out for them every paycheck. Cannabis businesses can do the same, and you can use Form 1040-ES to help you figure out how much to pay.

It’s important to be making these payments as you can be charged a penalty if you haven’t paid enough income tax throughout the year. You can also incur a penalty if the quarterly payment is late, even if you end up getting a refund later.

Your estimated tax payments cover not just income tax, but also self-employment tax and the alternative minimum tax.

Yes – You Should Keep Good Records

As with any business, good records help you see how well your company is doing and where you could be improving. You’ll also need them for filing your taxes and justifying any expenses you try to deduct.

You’ll need them in case of an audit as well. The IRS has figured out that it can generate a lot more money auditing marijuana businesses than mainstream industries, so your odds of being audited are pretty high.

No – You Can’t Deduct That

Given the audit risk, it’s important to know just what you can and cannot deduct from your taxes. Unlike most businesses, the cannabis industry falls under IRC Section 280E, which denies standard deductions and credits for businesses that traffic in Schedule I substances, including marijuana.

That means the bookstore down the street can reduce its taxable income by deducting rent and insurance. Your cannabis business may not. The end result tends to be almost nonexistent profit margins in what should be a highly profitable business.

The only thing you can subtract is the cost of goods sold, which can offset your gross income. It’s not considered a deduction but a reduction in your revenue to get to your gross profit. You still end up paying taxes on your gross profit rather than net income, though.

If you operate on the growing side of the industry, 280E doesn’t apply to your business thanks to the 2018 Farm Bill. That bill defined hemp with 0.3 percent or less THC in such a way that it is no longer considered a Schedule I substance.

Yes – You Must Report Large Cash Transactions

Since the industry still tends to operate on a cash-only basis, large cash transactions aren’t uncommon. They don’t go through a bank and there’s no canceled check to show that payment was made, so the IRS requires them to be reported.

If you get a single cash payment of more than $10,000, you must file a Form 830 within 15 days of accepting it. As banks begin opening up more access to services, this requirement might become less important to your business.

Cannabis Business Owners Pay Taxes Too!

While it seems counterintuitive, business owners engaged in federally illegal activities like selling cannabis still have to pay federal taxes on their business income. The recent IRS guidance makes clear that payments are expected, but like other businesses, you can make quarterly payments rather than paying your tax bill all at once.

However, those in the cannabis industry have fewer options for taking deductions for regular business expenses to reduce their tax burden.

Have you fallen behind on your federal taxes because you thought you didn’t have to pay them? Contact us to talk to one of our specialists about how to get back in the good graces of the IRS.

Claudia Grant

Claudia Grant is a seasoned financial expert with a rich and diverse background. Holding a Master of Science in Taxation, Claudia's 15 years as a CPA and ten years as a financial manager have shaped her into a true industry authority. Departing from the traditional office setting, Claudia now thrives as a tax and financial consultant, catering to a wide array of companies. Her passion for sharing knowledge shines through her insightful articles, where she breaks down complex financial concepts into simple pieces. Claudia's expertise and dedication make her an invaluable resource for businesses seeking adept financial guidance in an ever-evolving landscape.
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