Today, I have the pleasure of responding to one of our viewer's questions about a video that we did previously on Cannabis Business Accounting. The question was, "How do you justify the use of 263A when the IRS Chief Counsel Advice memorandum 201504011 takes the position that a taxpayer who traffics in a Schedule I or Schedule II controlled substance must determine cost of goods sold, using the applicable inventory-costing regs under 471 and that the IRS does not allow 263A?"
Video Transcript - Cannabis Question Response
It's time to get down to the brass tacks. My name is Mel Sams, and I'm the managing associate of Sam's CPA. Today, I have the pleasure of responding to one of our viewer's questions about a video that we did previously. It's a great question, and that question is regarding cannabis accounting, and what we can and can't do.
The question was, "How do you justify the use of 263A when the IRS Chief Counsel Advice memorandum 201504011 takes the position that a taxpayer who traffics in a Schedule I or Schedule II controlled substance must determine cost of goods sold, using the applicable inventory-costing regs under 471 and that the IRS does not allow 263A?"
That's a great question, and before I answer that, I'm going to just take a moment to say under Section 263A, it says that, "A taxpayer is generally required to capitalize to inventory, in addition to their direct cost, or their cost of goods sold, certain indirect costs and mixed service costs that would typically not have been required to be capitalized under Section 471." But essentially what that says is that 263A was something that surpassed some of Section 471 that says that a person in manufacturing, or producing, has to incorporate some of those indirect and mixed service costs into their inventory so that they can't manipulate their bottom line, and so it's an accurate representation of their true cost of goods sold.
But, my response to that question and why I said what I said would be twofold. Number one, when it comes to U.S. tax law hierarchy in terms of the sources and how authoritative they are, it should be noted that IRS positions are at the bottom of that list, next to secondary sources. IRS positions would be private letter rulings, determination letters, and chief counsel advice memorandums. So, by definition these are customized or a single taxpayer, and no other taxpayer should rely on these. However, they do give us some insight into what that particular ... a person in the IRS was thinking, or the people that were involved in a particular audit, what they may have been thinking, or their interpretation. But again, in terms of the sources and the quality, they're the second last next to secondary sources.
We can't by definition rely on these wholesale for everybody. Then number two, when it comes to that Chief Counsel Advice memorandum number 201504011, there was another excerpt from that particular memorandum which states, and I'll read this to you, Section 263A is simply a timing provision that, "Does not change the character of any expense from nondeductible to deductible or vice versa." The way I interpret that is that to the extent that Section 263A applies to a producer or reseller or any kind of property under 280E that capitalization of those indirect expenses under 263A does not make them be deductible, nor does it make them be non deductible, it is simply saying that this person's following the rules of 263A and it's a timing difference, it doesn't change the character of an expense to deductible or to non deductible.
With all that said, my reading of this, and my position on that would be that I would follow Section 263A because it does surpass 471 on the matter of capitalizing in direct and mixed service costs, regardless of whether it's a 280E issue or not.
This is a great example of in the cannabis industry there are a lot of emerging issues, even though some states like California have had legal cannabis for many, many years, the fact that it is still federally illegal leads to these questions all the time, where we're trying to figure out how to apply the code, how to give our clients the best advice. Thank you again to our viewer for that great question. I really appreciate it. That is what is going to help improve all of us, and improve this industry is through a discussion of these issues. If you have any further questions, comments are ideas for future videos, please let us know. We'd love to get your feedback. It helps us improve our programming, and improves the content that we get out to you guys. If you would like to watch any of our other videos, or be notified when a new video becomes available, please subscribe to our YouTube channel.
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