Issue 5: Marijuana and Hemp Taxation p. 40. Hemp uses: Paper Fiber Hemp Oil Hemp Rope Hemp Fabric Marijuana uses: Recreation Medicinal

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1 Issue 5: Marijuana and Hemp Taxation p. 40 Hemp uses: Paper Fiber Hemp Oil Hemp Rope Hemp Fabric Marijuana uses: Recreation Medicinal

2 State Laws p. 40 Many states allow medical and recreational use of marijuana. Many states have industrial hemp legislation allowing hemp research, studies and some allow commercial industrial hemp production.

3 State Laws p. 40 Eight states legalized recreational marijuana use: AK, CA (2018), CO, ME, MA, NV, OR, and WA Figure 1 lists marijuana law by state.

4 Industrial Hemp Laws p. 41 Nearly 30 states have passed legislation regarding industrial hemp. Generally defined to have a THC level of not more than 0.3%.

5 Industrial Hemp Laws p. 41 Industrial hemp research and/or pilot program Authorize studies of industrial hemp industry Establish commercial hemp programs

6 Industrial Hemp Laws p. 41 Industrial hemp produced under an authorized agricultural program is not a controlled substance.

7 Federal Law p. 42 Marijuana is a Schedule 1 controlled substance and sale is prohibited under federal law. Hemp is not excepted under the Controlled Substance Act Farm Bill provides legal research programs.

8 Federal Tax Deposits and Banking pp Allgreens, LLC v. Commissioner A Denver marijuana dispensary penalized for making estimated tax payments in cash. IRS ultimately abated penalties

9 Federal Tax Deposits and Banking p. 43 FinCEN Guidance Feb 4, 2014 guidance issued to banks as to how to serve marijuana businesses. Banks to make individual assessments; List of 7 items.

10 Currency Transaction Reports p. 44 CTRs are required for cash transactions of $10,000 per day, many marijuana business deal exclusively in cash Use FinCEN Form 8300 to report.

11 Taxation of Cannabis Business pp Various Code Sections are applicable to marijuana and hemp businesses: I.R.C. 61, 162, 280E, 263A, 471

12 Taxation of Cannabis Business p. 44 I.R.C. 61 Gross Income Though illegal under federal law, income is taxable. Edmondson v. Commissioner(1981) IRS disallowed expenses Court allowed as ordinary and necessary

13 Taxation of Cannabis Business p , Tax Equity and Fiscal Responsibility Act changed the law by adding I.R.C. 280E. Drug dealers can no longer deduct expenses because marijuana business is illegal.

14 Taxation of Cannabis Business p. 45 I.R.C. 162 and 280E Deductions 162 allows for ordinary and necessary business deductions 280E eliminates deductions under 162 because of the illegality of the business itself. Including: salaries, rents, utilities

15 Taxation of Cannabis Business p. 45 Cost of Goods Sold Under Treas. Reg , gross income is excess of receipts over cost of goods sold. But what about a Cannabis business? See C.C.A coming up.

16 Taxation of Cannabis Business p. 45 Accrual Method When required to use an inventory method accrual is required. Exceptions Certain businesses <$5,000,000 Other businesses <$1,000,000

17 Taxation of Cannabis Business p. 46 I.R.C. 263A was added 4 years after I.R.C. 280E requiring inventoriable costs of direct costs and a share of indirect costs to property purchased. C.C.A clarifies

18 Taxation of Cannabis Business p. 46 C.C.A Issue 1: How does a cannabis business calculate COGS? Issue 2: May Exam or Appeal require changes in inventory methods by a cannabis business?

19 C.C.A p. 46 Calculation of COGS C.C.A. considered other cases Peyton v. Commissioner Franklin v. Commissioner McHan v. Commissioner

20 C.C.A p. 46 Application of Section 263A When 263A and 280E are read together, the taxpayer is prevented from the tax benefit of capitalizing disallowed deductions. No joy for the drug dealer.

21 C.C.A p. 46 Application of Section 471 A drug dealer is entitled to determine inventoriable costs using applicable inventorycosting regs under 471 as they existed when 280E was enacted.

22 C.C.A p. 47 Indirect Costs under Treas. Reg May be able to deduct Cat. 1 and Cat. 3 indirect costs See list on bottom of page 46 and top of page 47.

23 C.C.A p. 47 Indirect Costs under Treas. Reg If marijuana or hemp business used GAAP to create financial statements, additional costs may be allocated to inventory; see list on page 47.

24 C.C.A p. 48 Inventory Method: Can IRS Exam or Appeals require a cannabis business to change inventory? Cash businesses generally deduct expenses in year paid. 280E disallows expenses

25 C.C.A p. 48 Because expenses are disallowed the taxpayer s income is distorted. Therefore, Exam and Appeals can, under 446(b) require a change that clearly reflects income. Inventory-costing is appropriate Change from overall cash to overall accrual may be required

26 Dual-Purpose Businesses p. 48 CHAMP v. Commissioner Court determined there were two distinct businesses: caregiving and marijuana dispensary CHAMP could deduct expenses that were otherwise precluded under 280E.

27 Risks for Tax Professionals p. 48 Under 18 U.S.C. 2(a) a tax professional who facilitates a marijuana-related or commercial hemp business could be in violation of the Controlled Substances Act.

28 Risks for Tax Professionals p. 48 Regarding Commercial Hemp, if the state has passed a law to allow for research, then hemp is NOT a controlled substance. See

29 Risks for Tax Professionals p. 48 AICPA created a list of questions for CPAs to consider and ask legal counsel if they have clients with a cannabis business. See list of 8 questions.

30 Issue 6: Depreciation Issues p. 49 Modified Accelerated Cost Recovery System (MACRS) Placed in service after 1986 See list of property that does not qualify for MACRS

31 Depreciation Systems p. 49 General Depreciation System (GDS) Alternative Depreciation System (ADS) See list: Use of ADS

32 Examples 1 and 2 p. 50 Example 1: Listed Property Purchased pickup and expensed $40,000 cost Business use fell to 40% in the 2 nd year. Example 2: Tax-exempt Use Property

33 Property Class Under GDS pp GDS divides property into nine property classes.

34 Practitioner Note p. 52 Dwelling Unit If any part of the building or structure is occupied for personal use, the gross rental income includes the fair rental value of the part occupied.

35 Recovery Periods p. 52 ADS GDS

36 Depreciation Conventions p. 52 Midmonth Nonresidential real property, Residential rental property, Railroad grading or tunnel bore Midquarter 40% of qualifying property paced in service in the final quarter Half-year

37 Depreciation Conventions p. 52 Half-year Taxpayers use this convention is the other two conventions do not apply.

38 Example 3 p. 54 Deferring Depreciation Deductions Acme Swabbing, LLC Swabbing units have an economic life of 15 years. Acme wishes to take the slowest depreciation possible. Elects SL over ADS recovery period

39 Electing an Alternative Method p. 54 Taxpayer can elect a different method for certain types of property 150% DB Election SL Election Election of ADS

40 Practitioner Note p. 55 Alternative Minimum Tax Using 150% DB method results in in the same depreciation deduction for both regular and AMT.

41 MACRS Percentage Tables pp MACRS Percentage Tables Example 4: Effect of Basis Adjustment Depreciation Formulas

42 IRC 179 pp Deduction limit: $500,000 ($510,000 for 2017) Investment Limit: $2,000,000 ($2,030,000 for 2017) Limit for Vehicles $25,000 See exclusion list

43 Related Party Transactions p. 57 Acquired by purchase Related party includes: Spouse, ancestors, and lineal descendants (not brothers and sisters) Example 5: R.P. Disqualification

44 Bonus Depreciation p. 57 Additional deduction after 179 and before regular depreciation. 50% -- Phased out in years after 2017 MACRS property w/ class life equal or less than 20 years.

45 Example 6 p. 57 Bonus Depreciation and MACRS 2017 Qualified property that cost $ 450,000 Did not elect 179 Did take 50% AFYD $225,000 Bonus $225,000 used to calculate MACRS

46 Depreciation Recapture Section 1245 Property Personal Property ( 167 or 168) Certain real property single purpose Ag. Structures Manufacturing, production or extraction ACRS nonresidential real property (accelerated depreciation was claimed) p. 57

47 Recomputed Basis p. 58 Includes adjusted basis of property plus the adjustments made to the basis as deductions for depreciation or amortization. List of 14

48 Example 7 pp : New Loader $ 105,000 Elected out of Bonus Chose to expense $10,000 using 179 Depreciation: MACRS 5-year property Half-year convention Sold loader in 2017 for $65,000

49 Example 7 p. 59

50 Example 7 p. 59

51 Example 8 p. 59 Same facts as Example 7 except instead of taking a $10,000 section 179 deduction, Rocky elected to take 50% bonus depreciation on the new loader in 2015.

52 Example 8 p. 59

53 Depreciation Component of Standard Mileage p. 60 Standard mileage rate (SMR) includes a depreciation component that reduces the vehicles basis. See figure 6 for depreciation component by year.

54 Example 9 p Purchased SUV for $36,000 that was used exclusively for hi landscape business. From 2013 through 2017 he used SMR to figure auto expenses on Schedule C Sold vehicle for $18,500 Drove a total of 87,000 miles

55 Example 9 p. 60