History of 280E
Congress enacted Section 280E in 1982 at the beginning of the Reagan administration’s “War on Drugs” in response to a Tax Court decision that upheld deductions claimed by a drug dealer for both cost of goods sold and other business expenses.6 The IRS has never issued any regulations or other interpretations of Section 280E. The only guidance on what it means includes a few Tax Court cases (which constitute authority) and a Chief Counsel Advice issued in 2015 (which does not constitute authority).
How does Section 280E hurt state-legal cannabis businesses?
Federal income taxes are calculated using a seemingly simple formula: You take your gross income, deduct business expenses to figure your taxable income, and then pay taxes on this amount. Owners of businesses that don’t involve the sale of Schedule 1 drugs use ordinary general and administrative deductions to maximize their profits, but Cannabis business owners have to pay taxes on gross income.
What types of business expenses are scrutinized under 280E?
• Employee salaries
• Utility costs such as electricity, internet and telephone service
• Health insurance premiums
• Marketing and advertising costs
• Repairs and maintenance
• Rental fees for facilities
• Routine repair and maintenance
• Payments to contractors
EXAMPLE: Let’s say your marijuana dispensary grosses $500,000 per year, with a cost of goods sold of $325,000 and other deductible business expenses of $100,000. If you were a business that sold non schedule 1 products, you would only pay taxes on $75,000. However, as a cannabis business, you will pay taxes on $175,00 because you aren't allowed to deduct general and administrative expenses.
TIPS TO MAXIMIZE COST OF GOODS SOLD: Consider the following to maximize your cost of goods sold in a marijuana dispensary:
SPACE: If you enlarge the space dedicated to inventory storage, then you will create a larger prorated expense for that space (rent, utilities, etc.) that can be allocated into cost of goods sold.
LABOR: Labor is always a large business expense. With clearly defined job descriptions and detailed hours tracking, you can maximize the amount of employee wages allocated to inventory management (and, thus, deductible as cost of goods sold).