A lot of These People are Going to be Getting Audited-Blunt Talks to Seattle Tax Accountant and Former IRS Agent Howard Choder.

Howard Choder was an IRS agent for close to 15 years before starting his own accounting practice in the late 1990’s. Based in Seattle, his clients now include cannabis companies. He discussed the cannabis tax landscape, including 280E the section of the tax code which restricts which expenses companies can deduct, which forces some cannabis companies to pay higher rates than mainstream businesses.

Alex Halperin:                     What do you think the IRS’ view of cannabis is?

Howard Choder:                 In Washington State, the agents know that it’s legal. They know that 280E exists. But a lot of times, what happens at the IRS is [that directives] come out of the national office, not regional, or local offices.

I saw recently that the audit rate for cannabis clients is 8%, versus the general population, where it’s down to 1%. I imagine that a lot of these people are going to be getting audited more and more because of the amount of revenue the IRS collects. That would be the number one factor, the amount of revenue.

Alex Halperin:                       Are cannabis businesses being audited for the same reasons as other businesses, or different reasons?

Howard Choder:                 It’s for same reasons. The IRS’s job is to make sure that tax returns are accurate, and if there’s inaccuracies or discrepancies they can collect money. Through years and years, they’ve gotten very good at recognizing what tax returns are more likely to have inconsistencies or not have substantiation, which could lead to a profitable audit.

Alex Halperin:                       Because so many of the companies don’t have access to banking, the IRS just has to rely on the company’s self-reporting? Is there any way to verify their numbers?

Howard Choder:                 That is the hard part. Restaurants are the same way. Sometimes there are audits where [an agent] sits there for four hours and watches the sales go through and then imputes based on that four hours what their daily sales would be, and from there monthly sales.

But in Washington State, the cannabis industry is regulated with BioTrack, the tracking system that everyone involved with pot has to use. It’s a reporting mechanism that goes to the state liquor control board. Always easier when you have a 3rd party software tracking revenue for you!

Alex Halperin:                       You’re saying that BioTrack makes verification fairly easy for the IRS.

Howard Choder:                   Exactly, because of Washington State regulations, it’s hard to get by the BioTrack. I’m sure there’s probably some inventory that slips through for employee pilfering, or use, whatever. But they’re not taking large sums of money out, because it can’t really happen unless you find a flaw in the reporting.

Alex Halperin:                       What’s your impression of how that’s different in Colorado and California?

Howard Choder:                   I just don’t know that. I’m only exposed to Washington State cannabis clients.

Alex Halperin:                      We all know how much the industry hates the 280E section of the tax code. Can you give an idea of the 280E burden on a cannabis business relative to a comparably sized business in the mainstream economy?

Howard Choder:                   It’s night and day. I always compare it to a coffee shop. You have a pot shop, and right next to it you have a coffee shop. You’re both selling a commodity. You’re selling cups of coffee, or selling cannabis cookies. The coffee shop can deduct the rent, whereas the pot shop can’t.

Alex Halperin:                       How do you anticipate access to banking changing the tax process for cannabis companies?

Howard Choder:                  If you would’ve asked me that prior to November 8th, I would’ve had a very different answer than what I have today. I think that everyone in this industry is a little scared, and a little anxious, and there’s a lot of unknowns. You have an attorney general coming in that says, “I don’t like it.”

Then, you have the majority of states that are making some type of money off of this. Those that have opened it up to recreational, well, they’re making a lot more than other states.

I think as these states start to apply pressure to the administration, — “Hey. You know, you’ve cut off so much to our funding, and now you’re going to put a crimp on that.” While you may have an ideological attorney general, you may have the economics of the states pushing back.

Alex Halperin:                     How do cannabis companies without bank accounts pay their workers and account for it at tax time?

Howard Choder:                       All of my cannabis clients have bank accounts. I believe every one of them uses Salal Credit Union and pays a high monthly fee to keep their account open. I’m not sure how other cannabis companies can survive without a bank account. Having that much cash is a liability for anyone.

Alex Halperin:                     In Washington state, what is banking access like for cannabis companies? 

Howard Choder: Not friendly at all. There’s Salal and I hear one more institution in eastern Washington accepts cannabis clients. Others have tried at Wells Fargo and Bank of America only to be shut down later.

Alex Halperin:                     Can you give a bit more insight into what operations and compliance are like for companies without bank accounts?

Howard Choder:                 Much more difficult.

There’s a great tax court case about a company in Colorado that was making employee tax deposits at the IRS using cash. They paid them all on time. The IRS assessed them with a penalty because they were supposed to do it electronically. The company appealed the penalty and lost. Then they took it to tax court and the tax court admonished the IRS for assessing the penalty when in fact they had the money.