How 280E is Killing the Cannabis Industry
January 19th, 2017
Policy, Top News
The legal cannabis industry is growing rapidly, with many analysts believing it could soon be a multi-billion dollar business. A recent report from The Arcview Group stated that the United States canna-business could be worth $22 billion annually by 2020. However, there is a big problem looming over cannabis companies – Section 280E of the IRS tax code, which severely limits which business-related expenses can be deducted.
“In layman’s terms, Section 280E is a federal tax law that says businesses involved in drug trafficking cannot deduct their normal business expenses when calculating their federal income taxes,” explained Tiffany Wu, an attorney with Harris Bricken.
“While most businesses can deduct their ordinary and necessary business expenses (e.g. rent, utilities, insurance, marketing fees, legal fees, employee salaries, etc.) from their annual revenue when calculating the federal income tax they owe each year, cannabis businesses are prohibited from taking these deductions. The result is that many cannabis businesses pay extremely high effective tax rates, with some claiming to pay as much as a 90% tax rate.”
What is the History of IRS 280E?
Section 280E was introduced in 1982 during the development of TEFRA—the Tax Equity and Fiscal Responsibility Act. During this time, the Finance Committee discovered a U.S. Tax Court case where a major drug trafficker had been allowed to deduct multiple expenses related to his illegal businesses, including phone bills and travel costs.
“Congress found this offensive, so they introduced 280E – the purpose being to make sure that if you’re trafficking you’ll be punished,” said James Hunt, an attorney and Managing Member of the Law Offices of James G. Hunt PLCC.
During the time of 280E’s passage, the “War on Drugs” was at a fervent pitch. However, in the three decades since, 28 states and the District of Columbia have legalized cannabis in some form. Due to the fact that marijuana remains a Schedule I controlled substance and is illegal at the federal level, Section 280E continues to cause a major headache for cannabis businesses owners across the country.
What Can be Deducted by Canna-Businesses?
There is one area where some companies in the marijuana industry remains similar to other businesses in the eyes of the IRS – the cost of goods sold.
“All businesses are allowed to deduct their costs of goods sold (COGS) when calculating their taxable income,” said Wu. “COGS includes the direct costs of producing a good that is sold by the businesses. For cannabis cultivators, almost all of their costs go into producing the final cannabis for sale – seeds, soil, rent for the grow space, electricity for the grow lights, salaries for trimmers, etc. – and they therefore are less impacted by Section 280E.”
Retailers of cannabis products are affected more by IRS 280E, as they have far different COGS than a grower or processor.
“For dispensaries, they may only be able to deduct the costs of their inventory and will not be allowed to deduct their other business expense, such as rent, electricity, salaries, or advertising,” explained Wu.
The issue of what COGS are allowed to be deducted has caused a lot of confusion for cannabis business owners across the board. However, the IRS has offered some clarification.
“There is a roadmap that has been outlined,’ stated Hunt. “Section 471 and related regulations(of the IRS tax code) has rules to determine what goes into COGS. Businesses can go to those rules and see a list of expenses that can be used.” Hunt added that while Section 471 isn’t crystal clear, it’s a start for business-owners trying to determine their COGS.
The Negative Impact of Section 280E and Other Regulations
As mentioned earlier, Section 280E leads to high taxes and lost profits for cannabis businesses. This is not the only area where the federal government has affected the finances of this industry; due to cannabis’ Schedule I status, the majority of banks cannot do business with growers, producers, and retailers. If they choose to, they may be at risk of losing their FDIC insurance and could face sanctions. This has lead to several issues for cannabis entrepreneurs who have a lot of cash with nowhere to put it.
“Without a business bank account, simply paying our bills is a challenge,” said Dieneka Manzanares, who owns Sweet Leaf Pioneer Dispensary in Eagle, Colorado, in a recent CFN interview. “Every month, we have to drive to Denver to pay our sales tax with physical currency, where we must be escorted by a security officer. Businesses like ours need a regulated financial system because being forced to operate as a cash-only business is both a major hassle and makes the most routine parts of our business – like paying taxes and bills – a major safety issue.”
280E Tricks – How to Reduce Liabilities
Until Congress and the IRS decide to amend Section 280E, it is up to canna-business owners to remain vigilant and informed regarding their allowed expense deductions. This means meticulously looking through and analyze every single cost.
“Businesses should only allocate and deduct legitimate expenses, otherwise they run the risk of their deductions being overturned by the IRS during a tax audit,” suggests Wu. “If the IRS concludes that a business did not properly report and pay its income taxes, it will not only assess the amount owed but also add on interest and penalties resulting in an even higher tax liability. Thus, we recommend that cannabis businesses work with tax attorneys and accountants to determine legitimate ways of reducing their taxes based on their unique circumstances and business operations.”
Hunt added that businesses need to look at their individual states’ tax codes and regulations.
“People focus on 280E for good reason, but you also have to focus on what state law you’re under – you have to deal with a state income tax return of some sort, and more important, you have to deal with other types of taxes – they can be just as problematic.”
Hunt went on to state that IRS 280E should be looked at when developing business plans in order to see what the financial impact could be in the future, just as payroll or advertising costs would be factored in.
“Treat Section 280E as any other constraint – start with the detail and that will drive how to proceed.”
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CFN launched in June of 2013 to initially serve the growing universe of publicly traded marijuana companies across North America. Today, CFN Media is also the digital media choice for the emerging brands in the space.
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