Running a cannabis business poses some unique challenges. One of the biggest has to be paying taxes in an industry that is still illegal under federal law.
Even though cannabis is federally illegal, the IRS still wants their cut of cannabis-related businesses. They created Internal Revenue Code section 280E to clarify how this is handled. It specifically deals with reporting income and paying taxes on sales of “illegal drugs.”
It’s not only that being cannabis-related makes an audit of your records more likely. The patchwork of federal and state rules enforcing cannabis prohibition created a complex regulatory environment. Understanding how to best operate in such an environment is the difference between profit and loss.
While this post contains information about Internal Revenue Code 280E, it is only for informational purposes. It should not be considered tax advice. Always consult a professional.
What is Internal Revenue Code 280E In cannabis business ?
Section 280E of the United States Internal Revenue Code is titled “Expenditures in connection with the illegal sale of drugs”.
The section consists of a short paragraph (76 words) dictating that deductions shall not be allowed for businesses involved in trafficking in controlled substances. As long as the federal government continues to misclassify cannabis as having no medical use, businesses selling cannabis products are considered to be “trafficking”.
The section is summed up well by IRS literature: section 280E “disallows all deductions or credits for any amount paid or incurred in carrying on any trade businesses that consist of illegally trafficking in a Schedule I or II controlled substance within the meaning of the federal Controlled Substances Act.”
The language is clear enough to those fluent in legalese: businesses involved with cannabis don’t get deductions or credits. However, nothing is simple with the Internal Revenue Service.
The first thing to consider is who Code 280E affects.
Who is affected by Internal Revenue Code 280E?
There’s good news for businesses not involved in the “plant-touching” cannabis industry. This rule only applies to companies involved in the production or sale of cannabis or cannabis-infused products. While you may face other strict regulations under state and local law such as packaging or advertising, 280E doesn’t apply to ancillary businesses.
There’s also good news for businesses that sell only non-THC cannabis isolates like cannibidiol, or CBD. Since the passage of the 2018 Farm Bill, products that contain less than 0.3% THC aren’t classified as controlled substances. Businesses that sell only these or other hemp products don’t have to worry about 280E, either.
Internal Revenue Code 280E applies to every business involved with whole-plant cannabis, from seed to sale. That means anyone dealing in seeds, clones, growing cannabis, extracting essential oils, and selling cannabis, whether wholesale or retail.
Does Internal Revenue Code 280E make your cannabis business entire gross income taxable?
As we said earlier, it’s not so simple.
While a plant-touching cannabis business can’t deduct expenses for things like sales and advertising, you can still deduct the cost of goods sold (COGS). IRS literature also specifies that the COGS should be calculated in line with section 471 of the tax code. That section dictates that a business take inventory at the beginning of the year, add purchases and production costs during the year, then subtract year-end inventory.
“This means taxpayers who sell marijuana may reduce their gross receipts by the cost of acquiring or producing marijuana that they sell,” writes the IRS.
Since many different types of cannabis businesses exist, what can be included in that cost can vary based on a company’s nature. Hiring a professional can be very beneficial.
Do I need professional help to navigate Internal Revenue Code 280E?
While you’re free to try to figure out the tax code on your own, the cannabis industry is a constantly changing environment. Professional support may help to avoid bigger problems. Since the cost of goods sold is the only deduction allowed, care should be taken to ensure it is calculated properly.
RADD CANN keeps up with ongoing changes in cannabis policy and guidance, building on decades of experience in auditing and compliance. We can help you minimize your tax burden and keep your company competitive.
Schedule a free consultation to find out how we can help your cannabis business today.
(Source: Internal Revenue Service website, accessed 4/22)