June 18, 2021
Since 2009, taxpayers have been incentivized by the Internal Revenue Service to voluntary disclose non-compliance with their federal tax filing and payment obligations. On September 28, 2018, the Internal Revenue Service modified and closed the previous 2014 Offshore Voluntary Disclosure Program (“OVDP”) with its launching of the Internal Revenue Service (IRS-CI) Voluntary Disclosure Practice. The objective of the Internal Revenue Service Criminal Investigation Voluntary Disclosure Practice – the newest program of the long-standing IRS disclosure procedures – is to provide taxpayers whose conduct involved willful tax or tax-related non-compliance a means to come into compliance with the law and potentially avoid criminal exposure. While the IRS-CI Voluntary Disclosure Practice does not guarantee immunity from prosecution, the Internal Revenue Service will consider and weigh a taxpayer’s voluntary disclosure along with other factors, which reduces the likelihood of criminal prosecution.
While the Internal Revenue Service offers the Voluntary Disclosure Practice to taxpayers who want to come into compliance, it is significant to note that there are eligibility criteria that taxpayers must meet. First, the IRS-CI Voluntary Disclosure Practice explicitly does not permit taxpayers who seek to voluntary disclose illegally sourced underreported or unreported income. Note that income sourced from activities determined to be legal under state law, but illegal under federal law, is still considered illegal for purposes of the IRS-CI Voluntary Disclosure Practice. Second, the IRS-CI Voluntary Disclosure Practice also makes clear that taxpayers are not allowed into the program, if they do not come forward before the Internal Revenue Service has information about the non-compliance. The Internal Revenue Service considers the following instances not timely and ineligible: the IRS has:
(1) Commenced a civil examination or criminal investigation on the non-compliant tax returns, (2) Received information from a third party alerting the Internal Revenue Service to taxpayers’ non-compliance, and
(3) Acquired information directly related to taxpayers’ specific non-compliance from a criminal enforcement action.
Although the eligibility criteria of the IRS-CI Voluntary Disclosure Practice may be straight-forward for most individual and entity taxpayers, the guidelines may be unclear for taxpayers in the cannabis industry. While cannabis is considered legal in some states, such as California, it remains an illegal substance at the federal level. However, with newly elected Democratic President, Joe Biden, the Democratic-majority House of Representatives, and the Democratic Party having the tie-breaking vote in the United States Senate, it is highly anticipated that cannabis will not be considered an illegally controlled substance at the federal level in the near future.
Internal Revenue Service audits of taxpayers in the cannabis industry has been a hot area of the law. Given the fact that cannabis growing taxpayers are not allowed to claim ordinary and necessary business expenses on their federal tax returns, but are still required to report all of their business income, taxpayers in the cannabis industry who comply with the tax laws pay an extraordinary amount of federal taxes. Because the Costs of Goods Sold deduction is excluded from the list of non-deductible prohibited business expenses, taxpayers in the cannabis industry have disguised and classified ordinary and necessary business expenses as Costs of Goods Sold expenses in efforts to reduce their tax bills. Purposeful disguising of prohibited business expenses could lead Internal Revenue Service auditors to refer the case to the IRS Criminal Investigation Department and expose taxpayers to criminal prosecution. Similarly, cannabis purposefully underreporting or not reporting income to the Internal Revenue Service, could lead to criminal exposure as well. Last, it is also plausible that taxpayers reporting income derived by selling cannabis across state-borders may also lead to criminal exposure.
In efforts to escape such exposure, taxpayers in the cannabis industry are encouraged incentivized “encouraged and incentivized” doesn’t make sense here – should this be “are encouraged and incentivized?” to voluntary disclose their non-compliance. However, it is unclear how the IRS-CI Voluntary Practice will determine the eligibility of taxpayers in the cannabis industry if (or when) cannabis is legalized. First, will the Internal Revenue Service consider taxpayers who were not compliant with the tax laws during tax years that cannabis was an illegal substance? In other words, will the Internal Revenue Service amend its guidelines to permit disclosure from taxpayers in the cannabis industry on a retroactive basis? Second, if the Internal Revenue Service only amends its eligibility criteria to include tax years when cannabis was legalized, how will the IRS-CI Voluntary Disclosure Practice deal with taxpayers that were non-compliant during years cannabis was illegal and during years cannabis was legal? Will they permit taxpayers that fit into that fact pattern fully in the program, only afford those taxpayers partial protection, or not allow taxpayers into the program altogether? Last, how will the Internal Revenue Service deal with situations where the IRS received information regarding a taxpayer’s non-compliance when cannabis was illegal in a previous tax year, but then received a voluntary disclosure submission when cannabis was legal? Would the submission be considered timely if cannabis is legalized?
Given the uncertainty in this area of the law, it is very important for taxpayers in the cannabis industry that have criminal exposure, consult with a tax attorney regarding their eligibility in the IRS-CI Voluntary Disclosure Practice. Having a basic understanding of the IRS-CI Voluntary Disclosure Practice and its eligibility criteria may assist taxpayers in reducing their likelihood of criminal prosecution.
If you are concerned about potential criminal exposure, please contact our experienced and skilled attorneys at Law Offices of A. Lavar Taylor at (714) 546-0445.
- October 1, 2021 Silver Sponsor of the 2021 Annual Meeting of the California Tax Bar and California Tax Policy Conference - November 3rd-5th
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- October 1, 2021 The UCLA 37th Annual Tax Controversy Institute - October 21st
- June 18, 2021 Internal Revenue Service Refund Statute of Limitations 101
- June 18, 2021 IRS-CI Voluntary Disclosure Practice and Cannabis Taxpayers