Good Books and Good Records Could Keep the IRS At Bay

Just when we thought it was safe to file a tax return, we find the IRS’s strikes again!

In TC Memo 2018-83 (Laurel Alterman and William A Gibson, Petitioners v. Commissioner of Internal Revenue, Respondent, filed June 13, 2018), the Court ruled that non-COGS deductions connected with selling non-marijuana goods should be disallowed. The Court viewed that selling “pipes and other paraphernalia” would be complementary to the sales of marijuana, and would, therefore, not be considered a separate business—which is a requirement of IRC 280E.

However, the details overlooked by the press show that the taxpayer claimed $32 of non-COGS deductions for every $1 sale of non-marijuana in 2010.  The actual figures were $12K of sales versus $385K of deductions.  In 2011, even though sales climbed to $23K, $385K of deductions were claimed again.  We should also consider that the non-marijuana-related sales amounted to only 1.4% and 3.6% of total sales in 2011 and 2012, respectively.  Not only are the deductions, on appearance, egregious, but it’s laughable to claim these non-marijuana items, when so little was sold, as truly a separate business.   To be sure, both the non-marijuana and marijuana products were sold at the same location.  The Court also found that the taxpayer “did not act with reasonable cause or in good faith” with respect to accounting mistakes—such as getting inventory balances wrong and underreporting gross receipts—and it therefore allowed the IRS’s 20% accuracy penalty assessment to stand.

This ruling contrasts with the Californians Helping to Alleviate Med. Problems, Inc. v. Commissioner (CHAMP) case whereby the Court did accept that the taxpayer had operated “substantially” separate businesses (caregiving services and medical marijuana dispensing). It viewed the taxpayer’s operations as having the primary purpose of functioning as a community center for seriously ill patients and secondarily as a place where these patients could access their medicine.

My advice: if you venture to selling non-marijuana goods and services along with marijuana, you need to determine if they complement each other.  If so, then splitting up the non-marijuana items and selling them in an adjacent, but separate premise, under a separate LLC, would appear to be just enough to meet the “separate business” test.  The Court makes it clear that one should not try to attempt to sell complementary items in the same premise.  Further, if you do find yourself in Court or in an IRS audit, it is important to act in good faith by ensuring that good books and records are prepared, and that the relationship of sales to deductions has some merit.

John V. Pellitteri John V. Pellitteri is a Partner at Grassi and leads the firm's Healthcare and Cannabis Service Practices. Possessing over 30 years of experience in accounting, auditing, tax planning and business consulting, John is now applying his talent to the burgeoning cannabis industry. John possesses comprehensive accounting and taxation knowledge, which combined with his healthcare consulting experience, allows him to provide an all-inclusive assessment of... Read full bio