Everything Cannabis Business Owners Need To Know About Tax Code 280E
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Amid all the excitement of a greener, more prosperous future for the cannabis industry, there’s one hurdle that seems frozen in time: the IRS’ stronghold over its tax regulations regarding “illegal” substances. “. Namely, section 280E of the tax code.
Even if cannabis were to be de-scheduled tomorrow, the proper accounting procedures that would serve as the industry standard would still take time to implement. In the meantime, all cannabis business owners should familiarize themselves with the 280E tax code.
Related: California Governor Considers Cannabis Tax Reform To Prevent Industry Rebellion
What is Item 280E?
Congress passed Section 280E of the Internal Revenue Code in 1982 to end tax-deductible expenses by taxpayers for the sale of illicit substances such as amphetamines and cannabis.
While these substances were 100% illegal, there was still a large, uncontrolled market for them. There were also numerous legal loopholes that allowed entrepreneurs in this unregulated and highly illegal industry to fake an honest life on paper for tax purposes, including a laundry lift of deductible expenses such as packaging, transport, shipping and even equipment like the scales used to weigh the substances and the bags used to contain them.
The thought process behind tax code 280E was: Well if we can’t catch you, at least we’ll get our share. Once the code went into effect, there were virtually no more business-related write-offs.
Section 280E and Cannabis
Today, the boundaries are still legally blurred. Medical cannabis is legal almost everywhere at the state government level. But it’s still not legal under federal law, which creates an overlap with a legal obligation for cannabis business owners to pay federal taxes on the profits of their businesses.
The main issue comes from the “discernibility” of whether the source of a cannabis business owner’s total income was generated legally.
Simply put, the IRS itself does not distinguish between legal and illegal income from the sale of cannabis under federal law. This means that while you can legally own and operate a medical and even adult cannabis business if your state legally permits it, under federal law you are technically still “trafficking” an illegal substance.
Therefore, there are no business expenses you can legally deduct – with one recently changed exception: cost of goods sold (COGS).
COGS refers to all expenses directly related to the production of the plants for growers and the amount paid for cannabis products for dispensary owners.
Lessons from past court cases
As a budding entrepreneur or even the owner of an established cannabis business, the legal implications of not complying with the laws of Section 280E of the Internal Revenue Code can seriously impact your livelihood.
You’ll see that there’s one major common denominator regarding why these cannabis companies have gotten themselves into legal trouble – and that’s that no one seems to understand precisely how the 280E tax code works. Of course, this is mainly due to the illegal nature of the industry.
Since cannabis businesses cannot take advantage of the regular deductions or credits that traditional businesses can, they must rely on IRC 471 to determine what expenses they can allocate from cost accounting to cannabis. inventory and COGS. It’s the only way to reduce tax liability in an incredibly complicated process that so many business owners end up getting wrong anyway.
Now let’s see where others got it wrong and what the consequences were:
The Sweet Leaf Case 2019
Owners of this Colorado-based dispensary chain were knowingly trying to circumvent general cannabis laws, resulting in four major compliance issues and jail time.
Their main crime was to allow certain customers to participate in a loop system, buy the maximum amount of products several times a day, return them and sell them themselves.
The “Olive versus Commissioner” case
In 2015, the Olive Medical Dispensary followed the common recommendation to bundle their healthcare services with the sale of their medical cannabis.
In theory, this would allow expenses associated with care services to be deductible under IRC 162, which would help reduce the dispensary’s tax liability by spreading their shared expenses. However, the company did not make a clear distinction between “trade and business”, meaning a separate business account for each type of expense.
Olive ultimately won their case. However, the Tax Court disagreed with the estimated expenses and ruled on its own that the business expenses were not tax deductible because the “misinterpretation of 280E” by the company could be attributed to running an illegal underground cannabis trafficking business.
Harborside case from 2018 which lasted until 2021
Another more recent and pivotal case for the cannabis industry is the Harborside v. Commissioner case. The court found that the company was “trafficking illegally,” like most other cannabis companies that make mistakes when accounting for their COGS.
The lawsuit against them alleged that property leased by Harborside for its operations was subject to forfeiture because they used it to “commit the distribution, cultivation and possession of cannabis in violation of Sections 841(a) and 856 of the 21 USC”.
However, in Harborside v. Commissioner, the company filed an appeal in which it explicitly found IRC 280E tax code to be unconstitutional. Harborside’s goal was to abolish the tax code, which unfortunately was defeated, costing millions of dollars.
What have we learned?
The common theme here is that as long as cannabis remains a scheduled substance under federal law, tax code 280E will not budge in favor of those businesses deemed eligible to exist but not normally operate.
As a cannabis business owner, your COGS is properly accounted for. Otherwise, you could lose a significant amount of money, your entire business, your business licenses, and face jail time.