Why Section 280E Matters for Cannabis Businesses Under Federal Law
If you’re a cannabis industry business owner, you are familiar with Section 280E of the Internal Revenue Tax Code. If you’re entering the cannabis industry and aren’t yet familiar with Section 280E, read on to learn more about why it matters to cannabis businesses and how it will impact your business.
What is Section 280E?
Before delving into why 280E matters for cannabis businesses, let’s clarify exactly what 280E is. Section 280E of the Internal Revenue Code targets companies that traffic controlled substances. Marijuana, derived from cannabis, is a controlled substance…
Marijuana is a Controlled Substance
According to the Department of Justice Drug Enforcement Administration (DEA), marijuana is a Schedule I substance under the Controlled Substances Act. That means it has a high potential for abuse, no currently accepted medical use in treatment in the United States, and a lack of accepted safety for use under medical supervision. While many states allow the use of marijuana for medicinal purposes – and some allow recreational use – the U.S. Food and Drug Administration (FDA) has yet to approve marijuana products for clinical use.
So, Section 280E applies to any business that deals with cannabis or related products. Specifically, 280E disallows businesses from deducting typical and ordinary business expenses that any other company would be able to deduct. For example, legal expenses like rent, salaries, and telephone expenses are not eligible as deductions under 280E for cannabis-related businesses.
Where did 280E Originate?
Section 280E originated from a 1981 court case in which a convicted cocaine trafficker asserted his right to deduct ordinary business expenses under federal tax law. The following year, in 1982, Congress created 280E to prevent other drug dealers from doing the same. Therefore, no deductions are allowed “in carrying on any trade or business if such trade or business consists of trafficking controlled substances.”
Although 33 states, the District of Columbia, Puerto Rico, the U.S. Virgin Islands, and Guam have legalized cannabis for medical use, and 11 states, the District of Columbia, and the Northern Mariana Islands have legalized cannabis for recreational use, the substance continues to remain illegal at the federal level. Thus, Section 280E impacts a significant number of business owners.
How Does Section 280E impact Cannabis Businesses?
For a legitimate cannabis business today, Section 280E is a hurdle to navigate because it was intended to prevent drug dealers from claiming tax deductions for “business” expenses. It means that even state-legal cannabis businesses are subject to the reduced deductions associated with controlled substance sales. This leads to increased taxable income and higher federal tax rates between 40 and 80% versus the much lower 21% corporate tax rate. In short, Section 280E creates a significant tax burden for cannabis industry businesses and prevents them from re-investing in their business, making upgrades, and expanding.
What Can a Cannabis Business Deduct?
Cannabis businesses can deduct the cost of goods sold (COGS), which means the amount it costs to produce the products or services a company sells. That sounds straightforward; however, determining COGS can be tricky. For example, COGS does not include overhead, sales, or marketing expenses. Further, COGS does not include operating expenses. With so many nuances associated with Section 280E, it is essential to carefully navigate the code, so your business remains in good legal standing.
How to Navigate Section 280E if You Run a Cannabis Business
If you operate a business in the industry, it is critical to have a knowledgeable cannabis accountant to help you navigate the tricky tax laws you face. They can help you determine your COGS, what can be deducted, and what is not allowed as a deduction. Ultimately, this saves you time and money, which is critical in an industry with many legal gray areas and regulations.