IRS Clarifies How Newly Finalized Tax Rules For Certain Insurers Impact Marijuana Businesses

The Internal Revenue Service (IRS) is offering clarification for marijuana businesses amid a rule change related to reporting requirements for certain transactions in an effort to curb tax evasion.

In a notice published in the Federal Register last week, IRS announced that it has finalized a rule concerning micro-captive insurers, which are small insurance companies created by businesses to insure their own risks. Micro-captive insurers can enjoy tax benefits by electing to only be taxed on investment income, meaning they’d be exempt from premiums they received.

In an effort to crack down on tax avoidance from businesses that abuse that system, the agency is applying a new review standard.

During the public comment period on the rule, IRS said there was one submission from a person who “asked for guidance on how the proposed regulations will impact the cannabis industry.”

The comment noted that marijuana businesses are broadly barred from claiming federal tax deductions because cannabis remains a Schedule I drug under the Controlled Substances Act (CSA). That also means they can’t claim deductions for “amounts paid for insurance premiums.”

IRS responded that a “cannabis business that enters into a Contract with a Captive would be an Insured under the proposed regulations if it treats amounts paid under the Contract as insurance premiums for Federal income tax purposes, even if it cannot deduct such amounts.”

“Accordingly, a transaction between a cannabis business and Captive may meet the definition of a Micro-captive Listed Transaction or a Micro-captive Transaction of Interest under the proposed regulations,” the agency said. “Any taxpayer engaged in such a transaction would be subject to the disclosure requirements set forth in the proposed regulations, except as otherwise provided therein, if their returns reflect the tax consequences of participation in the transaction.”

“The tax return of an Insured that cannot deduct an amount paid or incurred for purported insurance payments by operation of section 280E is not likely to reflect the tax consequences of participation in a Micro-captive Listed Transaction or Micro-captive Transaction of Interest, and therefore, the Insured will likely not be a ‘participant’ in the transaction under these regulations. However, others involved in the transaction, such as Captive, which generally will exclude amounts received as premiums from income based on the position that it is an insurance company, would therefore reflect the tax consequences of participation in their returns, and may nonetheless be considered ‘participants’ subject to the disclosure requirements set forth in these regulations.”

While IRS is signaling that the rule change that’s been finalized would not have an outsized impact on the marijuana industry, the agency has recently focused on addressing tax compliance issues with state-licensed cannabis businesses.

For example, last month IRS warned the industry that some companies have, without a “reasonable basis,” filled out a supplementary form in an attempt to take federal tax deductions that they’re prohibited from receiving under 280E.

State-licensed cannabis companies may be able to start taking broader federal tax deductions if the push to move marijuana to Schedule III that was initiated by the Biden administration is ultimately successful. But IRS separately advised last June that just because that possibility is on the horizon doesn’t mean the industry can start claiming deductions in the interim.

These notices come as certain multi-state marijuana operators have been seeking refunds for what they say are excess taxes paid in past years due to 280E.

Multiple states have taken steps to provide state-level tax relief to marijuana businesses that are subject to the IRS 280E statute, but the federal rule has not yet changed. And it’s unclear when the proposed federal marijuana rescheduling rule might take effect. An administrative hearing process has been delayed (and regulatory actions from federal agencies overall have been largely frozen under an order by newly inaugurated President Donald Trump).

Meanwhile, in 2021 the Congressional Research Service (CRS) noted in a report that the agency “has offered little tax guidance about the application of Section 280E.”

IRS did provide some guidance in an update in 2020, explaining that while cannabis businesses can’t take standard deductions, 280E does not “prohibit a participant in the marijuana industry from reducing its gross receipts by its properly calculated cost of goods sold to determine its gross income.”

The IRS update seemed to be responsive to a Treasury Department internal watchdog report that was released in 2020. The department’s inspector general for tax administration had criticized IRS for failing to adequately advise taxpayers in the marijuana industry about compliance with federal tax laws. And it directed the agency to “develop and publicize guidance specific to the marijuana industry.”

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