It seems like every day in the United States, another state is moves closer to passing a piece of legislation that supports further legalization of cannabis. States like Oklahoma and Michigan continue make progress toward legalizing recreational cannabis. However, despite the rising acceptance of legal cannabis, there remain several federal (and state) laws and tax codes that need to catch up to current times, including the IRC 280e.
The IRC 280e is a piece of tax code that forbids any business connected with Schedule 1 and Schedule 2 drugs from deducting business expenses. And, since cannabis is still considered a Schedule 1 substance at the Federal level due to the Controlled Substance Act, state licensed and legal cannabis businesses cannot claim normal business deductions like payroll, marketing expenses, or rent. Because cannabis businesses cannot deduct these items, they are at a financial disadvantage compared to non-cannabis businesses.
The experts at GreenGrowth CPAs have helped cannabis businesses save approximately $1.5 million on their taxes. Here's what we want you to know about the 280e.
How does 280e hurt legal cannabis businesses?
In order to calculate federal income tax, generally one should start with your gross income and then subtract business expenses to calculate taxable income. Non-cannabis businesses would then pay taxes on that final taxable income amount. The large number of business deductions benefits small business owners and non-cannabis businesses because their final taxable income is much lower after all business expenses are deducted.
Unfortunately, cannabis businesses are not so lucky. These businesses pay taxes on gross income and therefore do not get to subtract any deductions. The taxable amount of a cannabis business is often double that of a regular business. This means that a cannabis business does not have the extra funds that could potentially be used to reinvest in their own company or such things as employee raises. However, some supporters of 280e often cite that the extra tax income benefits the local economy by benefiting local schools, police departments and other public entities.
As always, there may be a few exceptions to the no deductions rule. For example, cannabis businesses are allowed to deduct cost of goods sold (COGS). Cost of goods sold refers to all costs involved in selling a product: for example, packaging, labeling, and other marketing costs related to the sale of cannabis. We have done a deep dive on what can be deducted under COGS in some of our previous posts:
- Marijuana Business Cost of Goods Sold ("COGS") Overview
- Cost of Goods Sold Adjustments for Medical Marijuana Related Companies
It is best to contact a professional who specializes in taxes within the cannabis industry to understand what you can take as a COGS deduction. If you attempt to deduct a business expense that is illegal by federal law, your business is subject to an audit by the IRS.
Why does 280e exist?
In the early 1980s, during the height of the war on drugs, a drug dealer won a case where he was legally allowed to deduct business expenses like car repairs and “business” supplies on his taxes. The government did like the precedent this set, and put in motion a tax code that prevented other drug dealers from doing the same thing. Thus, 280e was created.
Since the 1980s, the United States has come a long way in terms of cannabis legalization. Today, over 30 states have legalized medical marijuana and recreational marijuana has become legalized in 9 states. In fact, over 64% of Americans support legalization. Clearly, 280e needs to change in order to keep up with the demand for a legal cannabis market.
A revamped 280e tax code could benefit legal cannabis business owners and allow them additional funds to reinvest and grow their business. The marijuana industry is growing faster than ever and every day additional states, like Oregon, are allowing for legal cannabis business in their market.
If you have questions about cannabis taxes or opening a licensed cannabis business, please contact GreenGrowth CPA today.