As a supporter of marijuana decriminalization and the benefits it will bring, such as natural medicines and a larger tax base, the last thing wants to see is new entrepreneurs in the space being snagged for avoidable issues. As the cannabis industry has grown rapidly in response to legalization in some states, concerns about tax implications have arisen. Cannabis entrepreneurs, on the other hand, can take proactive steps to reduce their tax liabilities with a little advance planning and understanding of some codes. If our experience with cannabis clients has taught us anything, it’s that if you’re going to start somewhere, it should be section 280e.
26 code section 280e of the internal revenue code states that a business that traffics in a schedule or controlled substance (cannabis!) Is ineligible for tax deductions or credits. In short, cannabis entrepreneurs must pay taxes on all of their revenue and do not have the option of deducting business expenses from their taxable income.
The exception for ‘cost of goods sold’
When section 280e passed, was concerned about potential constitutional challenges to the law. To avoid such challenges, an exclusion was added that allowed a deduction for the cost of goods sold even if the goods were illegal under federal law. The term “costs of goods sold” refers to inventory costs, which include the cost of the product, the cost of shipping it in, and any directly related expenses.
Although the cost of goods sold is still deductible, the IRS applies its definition more narrowly to cannabis businesses. It does not, for example, permit the use of tax changes that allow more indirect costs to be included in costs of goods sold because they were implemented after section 280e went into effect. This means that cannabis businesses may not be able to use the same accounting methods as other businesses, potentially resulting in less favorable IRS treatment.
Working around 280e to get the most deductions
It’s great to learn from successful businesses, especially with these complex tax laws. But it’s really quite simple. Accountants for cannabis companies are avoiding section 280e through clever business structuring. That is, the company has been divided into two distinct entities.
The first company is directly responsible for cannabis production and distribution. The first company files a tax return without taking the deductions prohibited by section 280e.
The second business conducts any legal under federal law activities that would not trigger section 280e. This could include providing care services, selling ancillary products like t-shirts, or owning and managing the building where the first business is located. The second company files a tax return and claims all ordinary deductions.
Don’t forget about the states
While section 280e has created a clearer federal ruleset for cannabis entrepreneurs, many states that have legalized marijuana are taking a different stance on tax deductions than the federal government. In short, section 280e severely limits the deductions that cannabis businesses can take because they must pay full income taxes. However, with careful (and legal!) In accounting, cannabis activities can be separated from unrestricted activities, allowing the taxpayer to claim some federal deductions. This is before you factor in state taxes and their distinct deduction rules.
If you have any questions about the 280e tax code, don’t hesitate to contact our team of experts at Polston Tax.