If you’re a cannabis investor or cannabis CEO, you need to be aware of Internal Revenue Code Section 280E. Section 280E disallows any business that “traffics in controlled substances” from taking regular tax deductions or credits.
The legislation makes it more difficult for drug “traffickers” to operate profitably. While it may have been effective in its original context, the impact of Section 280E on legal cannabis businesses is a significant source of contention. Despite this, there are some compelling reasons why cannabis CPA investors and CEOs should pay attention to IRC 280E. Here we look at what Section 280E is and how it affects cannabis companies.
What is Section 280E, and how does it impact cannabis businesses?
Section 280E is a federal statute that prohibits businesses who traffic controlled substances from deducting expenses or credits from their taxable income.
The law states that:
“No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances (within the meaning of schedule I and II of the Controlled Substances Act) which is prohibited by Federal law or the law of any State in which such trade or business is conducted.“
The purpose of Section 280E is to prevent drug traffickers from writing off their expenses on their taxes, but the law has had a significant impact on state legal cannabis businesses.
The history of Section 280E and how it’s evolved over time
Internal Revenue Code Section 280E was inspired by a 1981 court case—Commissioner vs. Edmundson. Edmundson sold cocaine, amphetamines and cannabis and maintained his entitlement to deduct regular business costs under federal tax law. In response to the case, then-Treasury Secretary Donald Regan pushed for a legislative amendment that would “disallow deductions or credits for any amount paid or incurred during the taxable year in the carrying on of any trade or business if such trade or business consists of trafficking in controlled substances.”
As a result, in 1982, the change was added to the Internal Revenue Code. It has been a thorn in the state legal cannabis businesses’ side. While there have been attempts to repeal or amend Section 280E, it still stands today, leaving cannabis companies at a disadvantage compared to other businesses.
What can cannabis businesses deduct?
The tax court ruled that cost of goods sold is not deemed to be a deduction for the purposes of IRC 280E, but rather is considered to be an adjustment at arriving at gross income. Accordingly, we have a technicality and predicated upon this technicality, cannabis businesses can take cost of good sold deductions, but that’s all they can take. There are different ways and strategies that cannabis businesses can work around the restrictions of Section 280E. This may include GAAP accounting to increase cost of good sold deductions for growers and processors, and to meticulously document and account for non-cannabis sales for dispensaries. A good cannabis CPA would be able to assist you in legitimately maximizing your deductions.
Why is Section 280E significant to cannabis investors?
IRC 280E is significant to cannabis investors and owners because it limits the amount of expenses a business can deduct when filing its taxes. It means that companies in this industry will have to pay more taxes than businesses in other industries.
We at The Canna CPAs help our clients overcome the challenges posed by Section 280E. We possess the expertise, knowledge, and experience to guide you to help navigate this rugged terrain and optimize your business operations to minimize the adverse effects of this legislation. If you are a cannabis CEO, please do not hesitate to contact us for more information or assistance with your taxes. Thank you for reading!