Many companies choose to pay stipends to employees as a method of compensating them for incurred business expenses. This is especially true in construction companies, where it is widely viewed as a common industry practice. While the approach of using stipends in this manner is widespread, many construction companies fail to properly plan for and/or execute them, which can result in additional taxes owed by both the company and the employee.

In the simplest terms, a stipend is a monetary advance to an employee that allows an him or her to pay for various business expenses. Depending on how the stipend is structured, it can either be taxable income to the employee, or a non-taxable reimbursement. In order to keep the stipend non-taxable, a company must implement an accountable reimbursement plan, whereby employees complete expense reports proving that all business-related expenses are being reimbursed through the payment of the stipend. If a company does not have an accountable plan, or it is not followed (e.g. expense reports are not submitted or do not provide the appropriate documentation to support the expenses claimed), then the stipend paid to the employee may be re-characterized as taxable income.

One area where companies may run into difficulties with employee reimbursement stipends is in the area use of a personal vehicle for business purposes. The easiest method to use is to base the reimbursement on the number of business miles driven multiplied by the IRS standard mileage rate, which is currently 57.5 cents per mile. If a company provides a stipend to an employee prior to the business usage of the car, the company will need to take great care in reconciling the expense report provided by the employee. If business usage is less than the stipend provided, the employee should reimburse the company for the excess funds received.

It’s clear that establishing an accountable reimbursement plan is essential for any company providing stipends to employees for business expenses. For more information, please contact Richard P. Mishock at RMishock@hbkcpa.com or reach out to your HBK advisor.

In an October 2019 U.S. Tax Court ruling, the IRS denied federal tax deductions proposed by the petitioner in the case, Northern California Small Business Assistants Inc. (NCSBA) v. Commissioner of Internal Revenue, 153 T.C. No. 4 (October 23, 2019).

NCSBA, a California corporation that operates a medical-marijuana dispensary legally under California law, argued the following points:

(1) Internal Revenue Code (“IRC”) Section 280E (“280E”) violates the Eighth Amendment to the US Constitution;
(2) Only ordinary and necessary business expense deductions (under IRC Section 162) are disallowed and does not apply to other sections of the IRC; and
(3) NCSBA was operating legally under state law and therefore is not subject to 280E.

The Eighth Amendment states that, “excessive bail shall not be required, nor excessive fines imposed, nor cruel and unusual punishments inflicted.” If it was determined that 280E violates the Eighth Amendment, the following would be viewed as facts: the Eighth Amendment applies to corporations; 280E functions as a penalty; and the penalty is excessive.

The Court ruled that 280E is not a penalty because the denial of a tax deduction is not a punishment or penalty. Further, the Court stated 280E was meant to limit or deter certain actions of a taxpayer (selling controlled substances).

NCSBA argued that 280E only disallowed ordinary and necessary business expenses (under Section 162). The Court determined Congress “could not have been clearer” when it stated, “No deduction or credit should be allowed.”

Finally, the petitioner argued that 280E applies only to businesses that engage in illegal or disreputable sales of controlled substances. They contend that the word “trafficking” in 280E implies some illicit purpose in the business’ operations. The Judge pointed to case law such as Canna Care Inc v. Commissioner, which set the precedent that the sale of medical cannabis pursuant to California law constitutes trafficking within the context of 280E.

In its conclusion, the Court stated that it is limited in its powers based on the law, and that the proper avenue to redress petitioner’s grievances is through Congress because changing tax laws is a legislative process that must originate with Congress. The fight to allow tax deductions for dispensaries operating legally under state law is a legislative fight not a judicial one.

To contact a member of HBK’s Cannabis Industry Group about this or related tax issues, please call 330-758-8613.

EDITOR’S NOTE: This article was written by HBK Senior Associate Dominic Pinina and reviewed by HBKVG Director Stacey Udell.