Cannabis Taxes: 280E & Cost of Goods Sold
October 10th, 2017
Policy, Top News
It’s no secret that cannabis laws in the United States are complicated at best. While it’s encouraging that more states are legally acknowledging the benefits of medical marijuana and a few passed laws that make it legal to ingest recreationally, the federal government still classifies it as a Schedule I drug, which means doing any sort of business with marijuana is challenging. And front and center among those complex challenges is a little tax code known as 280E; an IRS code that prohibits cannabis businesses from receiving deductions for cannabis expenses.
More specifically, section 280E of the Internal Revenue Code states that businesses that sell cannabis—be it for medical or recreational purposes—are forbidden from recording tax deductions and credits due to its Schedule I classification.
Prior to the increased accessibility and legality of marijuana in the United States, the obscure tax code was one that was rarely an issue for anyone. It was created in 1982 after a person convicted of trafficking cocaine took himself to court arguing that he had the right to deduct ordinary business expenses from his trafficking business. The code was written to prevent any future illegal drug traffickers from doing the same.
But now that cannabis has become a viable—even a bustling–business venture, the once rarely-addressed 280E code is getting all kinds of attention from cannabis entrepreneurs and the lawyers and accountants they’re hiring to manage and/or fight it.
Unfortunately, attempts to fight this code in court are, so far, not gaining much traction. For example, a medical marijuana dispensary in California called Canna Care Inc. was audited by the IRS and subsequently denied a deduction of all operating expenses under 280E, including significant employee salaries and vehicle expenses. The company appealed the IRS’ assessment to the United States’ Tax Court using the following basic arguments:
- Medical marijuana, in particular, is not a Schedule I controlled substance;
- The service Canna Care provided to patients could not be considered trafficking because it’s not illegal under the California Compassionate Use Act;
- The Tax Court’s decision on a former, comparable case was not correct.
Despite those arguments, the Tax Court denied Canna Care’s appeal and upheld the tax assessment against the company.
So, even though a growing number of states legally allow for the sale of medical and recreational marijuana, tax code 280E continues to negatively and substantially impact the finances of cannabis businesses because, at present, they can only deduct taxes for the cost of goods sold; nothing else.
That being said, if you’re a cannabis entrepreneur, all is not lost. For one thing, there are a number of pieces of legislation recently introduced by congresspeople who are actively working to combat this issue.
This year, Rep. Carlos Curbelo, Rep. Earl Blumenauer, Sen. Ron Wyden, Sen. Rand Paul, and Sen. Bennet introduced the Small Business Tax Equity Act of 2017 to congress. If this bipartisan legislation passes, then any cannabis businesses operating in a state where it’s legal to do so can deduct taxes just like any other legal business.
Another piece of legislation that’s currently being looked at is one entitled the Regulate Marijuana Like Alcohol Act, which was introduced to the House of Representatives by Rep. Jared Polis. Under this act, marijuana would be added to the section of U.S. Code that regulates “intoxicating liquors.” This would move the oversight authority away from the DEA—the organization responsible for cannabis’ Schedule I classification—and into the Bureau of Alcohol, Tobacco, Firearms and Explosives.
Additionally, Sen. Wyden and Rep. Blumenauer introduced legislation called the Responsibly Addressing the Marijuana Policy Gap Act (RAMP). The act covers a wide array of federal cannabis issues currently causing businesses problems including tax and banking fairness, civil forfeiture, and drug testing for federal employees.
Until any of that legislation passes, though, cannabis business owners are tasked with doing the best they can with the current laws as they stand. And while 280E is prohibitive, there are a number of measures entrepreneurs can take to reduce its impact on their business:
Hire a knowledgeable cannabis tax professional
The most effective measure any cannabis business owner can take to protect itself is to hire an expert on cannabis taxes. A lot of accountants aren’t familiar with the myriad legal complications associated with the growing cannabis industry, and even fewer have experience with the formerly-obscure 280E code. Make sure that the person you hire to manage your business’s finances is well-versed in canna-business and tax law so that they can offer your best options and minimize your risks and costs.
Maintain highly-detailed records of every transaction
The last thing you want as the owner of a cannabis business is to not be able to claim the few expenses the law allows, namely Costs of Goods Sold (COGS). If your business is audited and you don’t have detailed information about every single transaction, you risk forfeiting your COGS claim and you’ll have to pay a 20% fee for filing an inaccurate tax return.
Consider multiple businesses under one roof
If your business is a brick and mortar dispensary, then adding another business to that address, such as a marijuana advocacy business, is a worthy consideration. Because the second business wouldn’t be involved in cannabis sales, it wouldn’t be subject to 280E and therefore could claim normal tax deductions, which would likely increase your sales margins.
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