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IRC Section 280E of the Internal Revenue Code is a daunting hurdle for cannabis businesses, including retail dispensaries.
Author: Dr. Lucas C. McCann
In short, 280E is a code used to make cannabis businesses less profitable by making them pay more of their overall profits in taxes. Rooted in the 1980s, this outdated tax legislation was crafted to prevent drug dealers from any claiming business expenses on their taxes.
In a modern twist of coincidence, today’s cannabis businesses operate legally under state law but are still treated as illicit businesses federally speaking because cannabis is still listed as a Schedule I substance (meaning that it is federally interpreted as having no medical use whatsoever).
Unlike other adjacent industries such as food, tobacco, and alcohol, cannabis businesses are denied regular business deductions for labor and reasonable marketing expenses.
How do dispensaries pay federal taxes?
As a consequence of Section 280E, businesses in the cannabis sector, including adult-use retail dispensaries, are prohibited from deducting standard business expenses from their taxable income, meaning that dispensaries must pay tax on gross profits (all the money they actually make) rather than net profits (the money left over after running their business).
Cannabis businesses must pay more tax and will consequently make a lot less money.
The types of deductions this would apply to include:
- Employee salaries
- Utilities
- Health insurance premiums
- Advertising
- Lease payments
- Payments to subcontractors, such as bookkeepers, accountants, lawyers, and even cannabis consultants.
Luckily, Several U.S. states have decoupled Internal Revenue Code 280E (IRC 280E) from their state tax codes so that cannabis operators. will be able to deduct business expenses on their state taxes. Massachusetts, Maryland, Missouri and New York are among recent states to exclude the 280E tax code.
The following states have implemented some form of tax code decoupling from IRC 280E:
- Arkansas
- California
- Colorado
- Hawaii
- Louisiana
- Maryland
- Massachusetts
- Maine
- Michigan
- Minnesota
- Mississippi
- Missouri
- Montana
- New Mexico
- New York
- Oregon
- Texas
- Vermont
- Virginia
Did you know?
New York State recently passed a bill, that amends the state law to no longer enforce federal tax law Section 280E. This allows businesses authorized to sell, produce, or distribute adult-use or medical cannabis to claim deductions previously disallowed by Section 280E, enhancing their financial standing and growth potential.
Below is an example comparison of a Cannabis Business with a Non-Cannabis business
Last month, here in New York City, the State passed a bill that amended the. act and effectively decoupled the state from enforcing. 280E. S.B. 7508, passed by the Senate on a 43-18 vote reads:
“…for taxpayers authorized pursuant to the. cannabis law to engage 8 in the. sale, production, or distribution of (i) adult-use. cannabis 9 products, as defined in article twenty-six-C of the tax law, or (ii) 10 medical cannabis, as defined in section three of the cannabis law, the 11 amount of any federal deduction disallowed pursuant to section two 12 hundred eighty-E of the internal revenue code related to the sale, 13 production, or distribution of such adult-use cannabis products or such 14 medical cannabis not used as the basis for any other tax deduction, 15 exemption, or credit and not otherwise required to be added back by 16 paragraph (b) of this subdivision in computing entire net income.”
Under the 280E tax code, the ‘280E loophole’ provides cannabis producers an opportunity to deduct the Cost of Goods Sold (COGS) helping to mitigate the impacts of high taxation.
There are other viable strategies that we would recommend that can help ease the 280E profit impact. These involve accurately structuring businesses, wrapping all eligible expenses into the Cost of Goods Sold (COGS), and using cannabis compliance professionals and consultants to ensure you achieve and maintain compliance in the industry.
Let’s examine this further. The COGS is one of the few tax deductions that are available to legal cannabis businesses. To leverage this, businesses must record all direct and indirect costs associated with the production or distribution of cannabis. Expenses like raw materials, packaging, direct labor, certain software/hardware, such as Point-of-sale systems, alongside other overhead costs that can legitimately be included in COGS, if done properly.
An important strategy involves imaginative business structuring. Depending on the nature of the business, we have recommended that some our clients work towards establishing two distinct business entities – one entity that carries out the cannabis business with as few deductions as possible, and the other a non-cannabis business that hires and trains staff, runs payroll, does the marketing, and pays for other expenses and deductions. This setup allows the non-cannabis entity to claim deductions that 280E would prevent for the entity labelled as a ‘cannabis business.’ The C-corporation is a common entity structure for cannabis businesses. C-Corp may be better option for plant touching companies than an LLC, whereas if you are looking. to operate a retail dispensary, the LLC may be preferable. The LLC’s are very common for simpler organizational structures, and are much simpler to set up and to maintain from a bookkeeping perspective.
Lastly, seek professional advice early and often! A great cannabis professional can recommend important strategies early on to minimize the potential impact of the archaic tax law, 280E. Our specialized knowledge can save you tens if not hundreds of thousands of dollars in the long run. Although it’s been previously discussed, federal lawmakers have not yet passed a bill of excluding cannabis businesses from 280E entirely.
