CANNABIS TAXATION

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).

DISCLOSURE

This material is for informational purposes only and not for the purpose of providing legal advice. You should contact your attorney to obtain advice with respect to any particular issue or problem. Use of these materials do not create an attorney-client relationship between Howard Tax Prep LLC and the user/reader. The opinions expressed in this document are the opinions of the individual author.

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Running A Cannabis Business

Entity Creation

The cannabis industry is one business that owners should consider the C corporation entity structure, especially if the owners are in a tax bracket greater than 24 percent.

Howard Tax Prep LLC helps with choosing the appropriate business structures and facilitates these business formations for you.

We make sure that your organizational documents include methods for removing partners, provisions for tax distributions, and asset distribution at the close of the business.

Bookkeeping

GAAP Cost Accounting should be used to maximize your deductions. Generally accepted accounting principles, or GAAP, are a set of rules that encompass the details, complexities, and legalities of business and corporate accounting.

Our professionals know how to properly allocate indirect costs to Cost of Goods Sold pursuant to IRC 471, so that your business will be allowed the maximum deductions allowed by law. Proper bookkeeping is the key to lowering your taxable income, which will also lower your taxes.

Federal Taxation

Thanks to a little-known provision in the tax law known as Section 280E,
you are denied all ordinary and necessary deductions against your marijuana sales income. Section 280E was created during President Ronald Reagan's administration, when in 1981 a convicted cocaine trafficker asserted his right under federal tax law to deduct ordinary business expenses.

Section 280E applies to you only when your business is “trafficking in controlled substances.”4 A “controlled substance” for purposes of this provision is any substance listed in Schedules I or II of the Controlled Substances Act.

Owners Tax Returns

One of the application requirements for an Illinois cannabis license is the submission of tax returns.

Complete copies of all federal, state and foreign (with translation) tax returns filed by the principal officers of the proposed dispensing organization for the last three years, or for the period each principal officer has filed tax returns if less than three years.

Howard Tax Prep LLC can prepare your personal returns, partnership returns, corporate returns, s-corporation returns, trust returns, and more. Contact us today for more information.