What does tax code 280E mean for cannabis businesses?

What is tax code 280E? As things fall into place for Missouri’s industry, understanding the different tax regulations is crucial for cannabis businesses. 

In a nutshell, Section 280E prevents businesses that have hands on federally illegal substances from claiming tax deductions or receiving tax credits. 

State-legal, plant-touching cannabis businesses fall under this category, and entrepreneurs in the space must pay taxes on all of their earned revenue without using business expenses to reduce their taxable income. 

Section 280E originated from a 1981 court case when a convicted drug trafficker was allowed to deduct business expenses from selling illicit drugs. Congress very quickly created Section 280E in 1982 to prevent future drug dealers operating illegally from taking advantage of tax deductions. The passing of this tax code, though, has ended up hurting more legal cannabis businesses than illicit drug traffickers.

A variety of different business expenses are affected when it comes to Section 280E. Things like employee salaries, marketing, and advertising costs, rental fees for facilities, routine repair and maintenance, and health insurance premiums are all expenses that do not qualify for deductions under this tax code. In addition, general administrative costs like bookkeeping, storage of cannabis, depreciation of cannabis, and state excise taxes are all also likely to be challenged. 

   

However, state-legal cannabis businesses are allowed to deduct the Cost of Goods Sold (COGS). This can be very difficult to prove and the IRS tends to crack the whip a little harder on cannabis businesses, so thorough documentation and collaborating with a tax professional are key. 

“Recent court decisions related to excessive taxes, penalties, and fines under IRS code 280E may be opening a path to file a protective claim for refund tax returns,” said David Smith of Smith Patrick CPAs. “This process extends your right to claim tax refunds if and when these tax rules are reversed. Be sure to ask your CPA and attorney if this might be appropriate in your situation. Regardless of your tax planning strategies, it is imperative that you continue to follow impeccable accounting procedures.

Cannabis businesses can also deduct expenses made on their non-cannabis activities, as long as they are separate. For example, a medical center that provides members medical cannabis was allowed to deduct expenses associated with providing its members’ hygiene supplies, meals, and social activities. This is because this particular facility primarily operated as a caregiving service to its members, with medical cannabis being a secondary resource to the caregiving service. Alternatively, a dispensary selling t-shirts, smoking supplies, and books were not allowed to deduct expenses because their primary revenue was accrued from cannabis sales. 

Cannabis businesses are facing struggles that ordinary businesses do not because of this tax code. Traditionally, federal income taxes are based on this formula: start with gross income, subtract taxable expenses, then pay taxes on this amount. Cannabis businesses do not have taxable expenses to subtract, so they are paying on gross income alone and end up paying tax rates that are 70% or higher. Below is a chart with information from a white paper done by thecannabisindustry.org

As legal the cannabis business grows and evolves, restructuring this tax code is necessary in order for these businesses to succeed.