The mail had just been delivered to the reception desk, and I went up to the front to collect it. As I walked slowly back to the office, flipping through the envelopes, mentally noting the utility bill that would need paying and the junk catalog that would need pitching, I suddenly stopped in my tracks. There was something from the IRS, and it was suspiciously thin. This was nothing like their usual correspondence, which seems to have an entire ream of paper crammed into one envelope. I opened the letter and read it standing there in the hallway. The world closed in around me.
As the saying goes, nothing in life is certain except death and taxes. And possibly an IRS audit.
I may never know exactly how 530 Collective was picked for an audit, but it was. Receiving that letter in 2015 stating that the business had been selected and that I could expect contact from the local IRS office was heart-stopping.
In retrospect, I’m really not sure why I was alarmed. It was probably a knee-jerk reaction to societal preconditioning. I mean, I don’t think there’s a single person who gets all warm and fuzzy inside when they see or hear those three little letters strung together. A more common reaction might be slight involuntary regurgitation.
I had used the same CPA for all income tax filings, both corporate and personal, and she, of course, was the first person I called with the news. I may have been her first client to be audited. I know I was her first cannabis client to receive the honor.
She reassured me that she would be with me through the entire process, that it would be a process, and that we would just do our best. Easy to say when you’re not the one in the hot seat.
As with any government bureaucracy, nothing happens terribly fast, and as much as I just wanted it to be over, I was in the unenviable position of hurrying up to wait.
The day finally came when I was to take the requested records to the local IRS office and meet with the auditor along with my CPA. She was a rock: smart, well-spoken, and most important, knowledgeable about the intricacies of cannabis tax law.
Never having been through an audit before, I wasn’t sure what to expect, which was probably where some of the terror came from—that dreaded fear of the unknown.
I have been told I have a very expressive and transparent face, so I’m sure I looked as uncomfortable as I felt. Undoubtedly the auditor was used to this reaction from her victims. I honestly couldn’t understand why anyone would want that job. Talk about a thankless governmental service.
The stereotypical auditor of my nightmares was a conservatively dressed, rigidly postured, prune-lipped individual with a perma-frown. But I learned firsthand how wrong stereotypes could be. As I sat there in the Redding IRS office looking at my auditor, I noticed the cute skirt she was wearing and her hip hairstyle. She completely contradicted my preconceived notion, and I was struck by a surprising realization: the auditor was a nice person. She was respectful and professional; she was thorough and direct. She made it all seem very black and white, which of course it was.
She told me I could expect the audit to last many months, maybe even up to a year (there’s that slight involuntary regurgitation again). Not because she was spending all of that time entirely on my file, but because I was simply one of about thirty other victims—I mean, cases—that she was working on, and we each got about one day a month of her time.
One day a month for several months, maybe twelve of them. That seemed reasonable. I began to breathe again.
I have always been, in my adult life at least, an organized person, and my books for the store and all of its records reflected that trait. I had kept my records accurately, saved all my receipts, documented all transactions, both with the customers and with the vendors, and every penny going out or coming in had its paper trail. Everything was accounted for; it always had been.
As we got up to leave, I realized there was really nothing for me to worry about. The only real wild card was how this auditor would tackle the 280E issue.
IRS tax code 280E is the code by which any deductions for regular business expenses like rent, payroll, and utilities are disallowed if you are engaged in illegal drug trafficking. Since the inception of medical cannabis in the United States, the IRS has applied tax code 280E to all cannabis businesses, regardless of whether or not you’re state licensed, because cannabis still remains illegal under federal law. Consequently, the fallout of 280E is that, without those substantial standard business deductions, the entity is taxed on artificial profits—profits that simply don’t exist.
Unfair? Absolutely.
Unreasonable? Definitely.
Several battles over 280E had been waged in court, but the outcomes were not favorable to the cannabis industry. This is one of the industry’s biggest challenges, even today, and relief will only come with full federal legalization.
The story of 280E’s inception reads like an urban legend, or a really twisted fairy tale:
A long, long time ago (1981) and in a place far, far away (Minnesota), there was a drug dealer named Jeffrey Edmondson.
Jeffrey was a good, responsible drug dealer, and like all good, responsible drug dealers, he filed his tax returns with the IRS.
Because his little drug-trafficking enterprise was how he put food on his children’s table (or jewelry around his escort’s neck, perhaps), he claimed his go-fast boats, his mules, and his office on a Caribbean island as standard tax deductions (actually, I don’t know what he claimed or if he used escorts; I just made those parts up) on his nice annual tax return and mailed it off to the big, grouchy IRS.
When the big, grouchy IRS saw this responsible drug dealer’s tax return, it frowned and told him, “Oh no, Mr. Edmondson, you can’t do that you silly, silly person. While you’re required to file your returns and pay your taxes like all other happy Americans, you are naughty, and we can’t allow you to claim deductions on expenses from your naughty, naughty drug business.”
Well, our responsible drug dealer thought the big, grouchy IRS was mean and not playing fair, so he took it to court.
And, wouldn’t you know it, the court was a kind court, and they agreed with our nice drug dealer man and said that he was allowed to claim all those standard business deductions (Edmondson v. Commissioner).
And Mr. Jeffrey Edmondson, the drug dealer, lived happily ever after.
The end.
Or at least it was the end until Congress got wind of this unacceptable ruling and created IRS tax code 280E in 1982 to prevent future drug dealers from following suit. Yes, that happened.
For the most part, this is where things still stand today. Thanks, President Reagan, for this legacy of your failed war on drugs.
There are now a few exceptions to 280E, and some deductions allowed as a result of hard-fought litigation, but by and large, 280E is one of the biggest financial challenges that any cannabis operator in the country faces.
In filing the returns, my CPA and I have always been mindful of 280E and have always played by the rules, knowing that those rules can change and that they are often subject to interpretation by the likes of auditors. That’s what made it the wild card in the audit.
How would the auditor assigned to my case interpret 280E, and how would she apply it to the returns? Would she agree with our filings?
I will summarize succinctly by saying that in the end, after almost a year, and after the auditor looked at three separate years of tax returns, I got through the process. The company survived, and the auditor’s adjustments were fair.
I’d say that’s probably the best outcome one can hope for as the result of an IRS audit. The process was one that I can now chalk up on my list of experiences, filing under the subcategory of “Do Not Need to Repeat.”
There was one more surprise for me at the end of the audit, however. When the audit was wrapping up, she told my CPA that my books and records were absolutely meticulous and that had it been any other business besides a cannabis business, she would’ve been done in a single day.
I have to admit that her unexpected compliment did give me a warm, fuzzy feeling . . . kind of.