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How Section 280E Creates Big Tax Challenges for the Cannabis Industry

It is no secret that cannabis businesses must deal with substantially more rules and regulations as compared to most other businesses. Internal Revenue Code Section 280E is one of the biggest complications for businesses operating within the cannabis industry, causing an increased tax burden for cultivation facilities, medical marijuana manufacturers and dispensaries because of cannabis’ status as a Schedule I controlled substance.

Recently, however, there has been official talk from the Department of Health and Human Services of reclassifying cannabis from Schedule I to Schedule III. In this scenario, 280E would no longer apply, providing significant relief to the industry.

Our cannabis group is following these developments closely.

Until then, we recommend that you educate yourself on what expenses are deductible under IRC Section 280E, and which are not, to help your cannabis business make better financial decisions. Section 280E would no longer apply in the year in which rescheduling occurs therefore, we recommend cannabis operators plan on saving enough cash to cover their tax liabilities assuming rescheduling occurs in 2025. This would be a more conservative approach to ensure that enough cash is set aside for making estimated tax payments during 2023 and 2024.

What is Section 280E?

The IRS deems state-compliant cannabis businesses as being federally illegal and requires this to be reflected on the federal tax return. Section 280E of the tax code states that businesses that traffic in controlled substances cannot deduct any expenses incurred in carrying on the production, distribution, and sale of controlled substances. This means that businesses operating within the cannabis industry cannot deduct certain expenses, many of which are deductible for businesses operating within a legal industry.

One exception to this law is for costs of goods sold (COGS). COGS are an offset to taxable income, and only account for expenses associated with producing the product. Deductible expenses include such items as seeds, soil, water, nutrients, and expenses related to the cultivation and harvesting of the plant. Expenses that are part of the distribution process are not deductible, and include such items as rent, shipping, overhead and employee expenditures.

Because of Section 280E, most overhead costs associated with doing business in the cannabis industry are not deductible, resulting in cannabis businesses paying taxes essentially on gross profit instead of net income. This is a big challenge and means cannabis operators must achieve sufficient profitability or end up paying taxes that exceed net income.

280E Example

The example below outlines the impact of Section 280E for a corporation:

Revenue                                                                                             $2,000,000

Less: Cost of Goods Sold                                                                    –  600,000

Gross Profit                                                                                          1,400,000

Less: Other Selling, General & Administrative Expenses            –  1,100,000

Net Income                                                                                        $   300,000

Federal Income Tax Rate = 21%

Non-Cannabis Business

  • Net income of $300,000 taxed at 21% = $63,000
  • Results in net income after taxes of $237,000 and an effective tax rate of 21%

Cannabis Business

  • Gross profit of $1,400,000 taxed at 21% = $294,000
  • Results in net income after taxes of $6,000 and an effective tax rate of 98%

Thus, as a result of 280E, the state legal cannabis company ends up paying an additional $231,000 in taxes.

What Can I Do About Section 280E?

The best defense against Section 280E and other tax implications of the cannabis industry is to work with an experienced team of accountants and advisors. Anders has a team of CPAs and advisors well-versed in the industry who can help ensure your financial information is up to par with evolving regulations and your tax burden is minimized. Learn more about the Anders Cannabis Group or contact an Anders advisor below to find out how we can help you keep more money in your business.

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Our firm provides this information for general educational guidance only and does not constitute the provision of legal advice, tax advice, accounting services, investment advice, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional tax, accounting, legal, or other competent advisers. Before making any decision or taking any action, you should consult a professional adviser who has been provided with all pertinent facts relevant to your particular situation. Podcasts posted by Anders CPAs + Advisors are not intended to be used and cannot be used by any individual or business, for the purpose of avoiding accuracy-related penalties that may be imposed on the taxpayer. The information is provided "as is," with no assurance or guarantee of completeness, accuracy, or timeliness of the information, and without warranty of any kind, express or implied, including but not limited to warranties of performance, merchantability, and fitness for a particular purpose. Please note that some content may be generated using artificial intelligence and is intended for educational and informational purposes only. In no way does listening, reading, emailing or interacting on social media with our content establish a professional relationship.

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