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  • Andrew Hay

IRC 471(C) INVENTORY ACCOUNTING ALTERNATIVE FOR CANNABIS COMPANIES

In the February 1, 2019 edition of Tax Notes Today, there was an article titled “Small Business Inventory Accounting Exception May Not Fit Pot”.[1] Nathan Richmond, the author, references the IRC 471(c) election may not be a good fit for Cannabis companies, because of the potential to lose Cost of Goods Sold deductions by electing out of the standard tax inventory accounting regime.


The Tax Cut and Jobs act created an inventory exception for small businesses with under 25 million of gross receipts (indexed for inflation) by creating IRC 471(c).


This Code Section states “In the case of any taxpayer …which meets the gross receipts test of section 448(c) for any taxable year, section 471(a) shall not apply and the taxpayer’s method of accounting for inventory shall not be treated as failing to clearly reflect income if such method is either (1) the non-incidental materials and supplies method or (2) conforms to the taxpayers method of accounting reflected in an applicable financial statement or if there is no applicable financial statement, the books and records of the taxpayer prepared in accordance with its accounting procedures.”


The Internal Revenue Service has asked for public comment through Rev. Proc. 2018-40[2] in the interpretation of the provision books and records of the taxpayer prepared in accordance with the taxpayer’s accounting procedures. Asides from this Revenue procedures, as of the publishing of this article, there is no other guidance on the implementation of IRC 471(c).


The plain reading of the IRC 471(c) states that a taxpayer without an applicable financial statement won’t fail to clearly reflect income, for inventory purposes, if its tax return inventory accounting method is in accordance with the taxpayer’s book method of inventory accounting.


Numerous court cases have pointed to IRC 471 as the controlling statute when it comes to what expenses can be classified as Cost of Goods Sold and deducible by a Cannabis Company[3].


The tax court has pointed to the plain language meaning of the statute to interpret how it should be followed unless the interpretation would produce an absurd result.[4]

In this case, congress meant to relieve the burden of tax inventory accounting for small businesses and through IRC 471(c) allowed them to follow their own method of inventory accounting. If cannabis companies choose cost accounting for their internal records that maybe more favorable than the standard inventory tax regime, per IRC 471(c), the IRS should respect it.

There is an old saying that Pigs get fat, hogs get slaughtered. I apply that to IRC 471(c) and the plain language reading of the statute. If a small business gets too aggressive and starts allocating purely selling costs to Cost of Goods Sold like advertising, it probably was not the intent of congress in writing the statute. However, if the taxpayer chooses a method of accounting for book purposes, such as an industry practice and applies it for tax purposes, the IRS should respect such method and allow deductions that run through Cost of Goods Sold.

 

[1] Nathan J. Richman, “Small Business Inventory Accounting Exception May Not Fit Pot,” Tax Notes Today, February 1, 2019, 2019 TNT 22-5 [2] Rev. Proc. 2018-40, Section 5, asks for public comment on how “books and records of the taxpayer prepared in accordance with the taxpayer’s accounting procedures” should be interpreted in § 471(c)(1)(B) [3] Patients Mutual Assistance Collective Corp, (2018) 151 TC No. 11 and Alterman, Laurel, (2018) TC Memo 2018-83, RIA TC Memo ¶2018-083, 115 CCH TCM 1452. [4] Roberta Borenstein v. Commissioner, 149 TC 263,


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