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Using IRC Section 471(c) to Reduce the Impact of IRC Section 280E on Cannabis Companies

by Mike Goral

Companies in the cannabis industry can only deduct the cost of goods sold (COGS) from gross receipts under IRC 280E. Recently COGS for cannabis companies has been limited by case law to COGS calculated using IRC Sec. 471 and the regulations thereunder. Attempts to use the more favorable allocation method allowed under IRC Sec. 263A have been struck down by the tax court.

However, in a little-noticed provision of The Tax Cuts and Jobs Act, it included a section entitled Small Business Accounting Method Reform and Simplification. This tax law enacted a series of provisions that allowed small business taxpayers that have less than $25M in revenue to no longer be required to use the accrual method of accounting. It also provided a provision that disallowed the IRS from changing the inventory accounting method used by the taxpayer under audit as long as the taxpayer’s method of treating inventory is supported by its financial statements or in the case of a non-publicly traded company, the books and records of the taxpayer.

Therefore, there may be an opportunity to use this combination of tax statutes to use the allocation methodology allowed under IRC Section 263A. Moreover, Section 471(c)(4) provides that a taxpayer that is changing its method of accounting to take advantage of Section 471(c) gets automatic IRS consent to the change in method. This provides a unique opportunity for many taxpayers to review their accounting methods to determine the most beneficial method of computing COGS.

There is further support for this position from the AICPA which has asked the IRS to limit examinations for taxpayers with average annual gross receipts of $25 million or less that involve issues for capitalizing costs and methods of accounting for inventory.

What does this mean for your cannabis company?

  • Changing your accounting method from cash to accrual may reduce your taxable income
  • This combination of tax statutes may be used to make adjustments to COGS
  • The IRS will generally accept these changes as long as your books and records support the change in the accounting method
  • The statute has only two major limitations: a) your company must have gross sales less than $25M and b) you can only take this position on the original return

For further information please contact Mike Goral, National Cannabis Tax Partner in Charge.

June 02, 2020

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