Cannabis businesses face tough tax challenges. Here’s what you need to know:
- 280E blocks most business expense deductions for cannabis companies
- Only Cost of Goods Sold (COGS) can be deducted
- Cannabis businesses pay 40% to 80% effective tax rates
- Expert guidance is crucial for compliance
Key tax strategies:
- Maximize COGS deductions
- Keep detailed records
- Choose the right business structure
- Stay informed on tax laws
- Prepare for IRS audits
| Business Type | Typical Tax Rate | Cannabis Business Tax Rate |
|---|---|---|
| Standard | 21% (corporate) | 40% to 80% |
Work with cannabis tax experts to minimize your tax burden.
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What is Section 280E?
280E is a tax rule that hits cannabis businesses hard. Created in 1982, it stops businesses from deducting normal expenses if they’re involved in "trafficking" controlled substances, including cannabis.
280E Origins
The law came after a cocaine dealer tried to claim tax deductions. Congress passed 280E to close this loophole.
Today, 280E applies to legal cannabis businesses because marijuana is still a Schedule I drug federally.
Key Terms
| Term | Definition |
|---|---|
| Controlled Substance | Drugs classified by the federal government, including cannabis |
| Schedule I | Most restricted drug category, includes cannabis |
| Cost of Goods Sold (COGS) | Direct costs of producing goods, can be deducted |
| Ordinary Business Expenses | Indirect costs like rent and marketing, can’t be deducted |
280E’s impact is huge. Cannabis companies often pay 40% to 80% tax rates, while other industries pay 21%.
"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 consists of trafficking in controlled substances." – James Thorburn, Thorburn Law Group
Cannabis businesses pay taxes on gross income, not net income. This means much higher taxes.
Example: A dispensary that lost $455,000 from 2009 to 2011 still got hit with a $641,000 tax bill due to 280E.
Cannabis businesses can only deduct COGS, not:
- Rent
- Marketing
- Most employee salaries
- Utilities
This creates a major financial hurdle. Despite $32 billion in expected 2023 U.S. cannabis sales, many businesses struggle with profits due to 280E.
To manage 280E’s impact:
- Work with cannabis tax experts
- Keep detailed expense records
- Structure operations to maximize allowed deductions
- Stay informed on potential federal law changes
280E remains a key challenge until cannabis laws change federally.
How 280E Affects Cannabis Businesses
Deduction Limits
280E blocks most common business deductions for cannabis companies. They can’t write off:
- Rent
- Marketing costs
- Most employee salaries
- Utilities
This means paying taxes on gross income instead of net income. Result? Much bigger tax bills.
Example: A cannabis business with $2,000,000 revenue and $600,000 COGS has $1,400,000 gross profit. Even with $1,100,000 in other expenses, they’d owe taxes on the full $1,400,000.
Tax Rate Comparison
| Business Type | Gross Profit | Deductible Expenses | Taxable Income | Tax Rate | Tax Owed |
|---|---|---|---|---|---|
| Cannabis | $1,400,000 | $0 | $1,400,000 | 21% | $294,000 |
| Non-Cannabis | $1,400,000 | $1,100,000 | $300,000 | 21% | $63,000 |
This shows how 280E can lead to a 98% effective tax rate for cannabis businesses, vs 21% for others.
"The effective income tax rates for marijuana-related businesses can soar to as high as 90% or more due to the limitations imposed by 280E." – National Cannabis Industry Association
To manage this burden:
- Focus on maximizing COGS deductions
- Work with cannabis tax experts
- Keep detailed expense records
- Consider filing amended returns
Some companies have found success. Trulieve got $113 million in 280E refunds by filing amended returns.
280E remains a major hurdle until federal laws change. Work closely with tax pros to navigate these complex rules.
What Can Be Deducted Under 280E
Cost of Goods Sold Basics
For cannabis businesses, Cost of Goods Sold (COGS) is the main way to reduce taxable income under 280E. COGS covers expenses directly tied to producing or acquiring inventory.
Cultivators’ COGS typically includes:
- Seeds and soil
- Water and electricity for growing
- Labor for cultivation and harvesting
- Testing costs
- Production equipment
Retailers have more limited COGS deductions:
- Invoice price of purchased cannabis
- Transportation costs to acquire inventory
- Storage and packaging equipment
Increasing COGS Deductions
To maximize COGS deductions:
- Keep detailed records
- Separate "trafficking" and "non-trafficking" costs
- Use GAAP accounting
- Invest in cannabis-specific software
- Consider your business structure
| Business Type | Potential COGS Deductions |
|---|---|
| Cultivator | Seeds, soil, grow lights, planting/harvesting labor |
| Manufacturer | Raw materials, production equipment, quality control |
| Retailer | Product cost, transportation, storage equipment |
"Section 280E does not, however, prohibit a participant in the marijuana industry from reducing its gross receipts by its properly calculated cost of goods sold to determine its gross income." – IRS
The impact of maximizing COGS can be huge:
| COGS Level | Gross Receipts | Taxable Income | Effective Tax Rate |
|---|---|---|---|
| High | $776,772 | $340,953 | 44% |
| Low | $776,772 | $726,772 | 94% |
Work with a cannabis-specific accountant to navigate these complex rules and maximize deductions.
Expenses You Can’t Deduct
Cannabis businesses face unique tax challenges due to 280E. This law blocks standard business deductions for companies selling Schedule I and II controlled substances.
Typical Non-Deductible Costs
Under 280E, cannabis businesses can’t deduct:
| Expense Category | Examples |
|---|---|
| Operational Costs | Rent, utilities, equipment repairs |
| Employee-Related | Most salaries, wages, health insurance |
| Marketing | Advertising, branding expenses |
| Professional Services | Legal fees, accounting costs |
| Administrative | Office supplies, software licenses |
These limits mean cannabis companies pay taxes on gross income, not adjusted income. This leads to 40-80% effective tax rates vs the standard 21% corporate rate.
Managing Non-Deductible Expenses
To handle these limits, cannabis businesses can:
- Focus on Cost of Goods Sold (COGS)
COGS remains deductible. Work with cannabis-specific accountants to maximize allowable COGS deductions.
- Separate non-cannabis activities
The 2007 CHAMP case showed that expenses for non-cannabis activities might be deductible. Consider separate entities for different business aspects.
- Stay informed on legal developments
Some companies are challenging 280E. Trulieve Cannabis Corp. claimed a $113 million tax saving by finding a way around 280E.
- Keep meticulous records
Accurate bookkeeping is crucial for potential audits and future tax law changes.
"Literally everything except COGS is not deductible for cannabis entrepreneurs, including (but not limited to): Rent, Salaries, Contract labor, Equipment/equipment repairs, Inventory costs, Storage, Interest, Display cases, Utilities, Insurance, Professional fees, Licenses and fees, Other ordinary business expenses not listed above." – Flowhub
Understanding and planning for 280E’s impact is key for cannabis business success.
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State Tax Issues
Cannabis businesses face complex tax rules due to state and federal law conflicts. This creates challenges for multi-state operations.
State Tax Differences
Cannabis tax rates and structures vary widely:
| State | Tax Rate |
|---|---|
| Alaska | $50/oz. mature flowers; $25/oz. immature flowers; $15/oz. trim, $1 per clone |
| California | 15% excise tax (levied on wholesale at average market rate) |
| Colorado | 15% excise tax (wholesale); 15% excise tax (retail price) |
| Illinois | 7% excise tax (wholesale); 10-25% tax based on THC content |
These differences impact profits. California made over $1 billion in marijuana tax revenue in 2023, while New Jersey collected only $41.8 million.
Multi-State Business Tips
For operating across state lines:
- Consult experts: Work with cannabis-specific CPAs and tax attorneys for each state’s rules.
- Separate entities: Consider distinct legal entities for operations in different states.
- Keep detailed records: Maintain thorough records for each state to prepare for audits.
- Stay informed: Keep up with changing laws, as states may adjust tax policies.
"States collected nearly $3 billion in marijuana revenues in 2022." – Tax Foundation
Be aware of local taxes too. In California, there’s a 15% state excise tax, 25% state retail sales tax, plus local taxes.
Rescheduling cannabis to Schedule III could remove 280E limits, benefiting retailers significantly.
Until then, navigate carefully. The Harborside vs. IRS case shows the scrutiny cannabis operators face, highlighting the need for strict compliance and expert guidance.
Tax Planning for Cannabis Businesses
Cannabis businesses face unique tax challenges due to 280E. This law limits deductions for businesses involved in "trafficking" controlled substances, including state-legal cannabis. Here’s how to navigate:
Choosing a Business Structure
Selecting the right structure is crucial:
| Business Structure | Tax Implications | Considerations |
|---|---|---|
| LLC | Pass-through taxation, flexibility | Often best for startups, less formality |
| C-Corporation | 21% federal tax rate, double taxation | Preferred for raising capital, going public |
| S-Corporation | Pass-through taxation, potential tax savings | Limited to 100 shareholders, one class of stock |
LLCs are popular for cannabis startups due to flexibility and simplicity. Single-member LLCs are "disregarded" for taxes, while multi-member LLCs have pass-through taxation.
"The limited liability company (LLC) structure is often the best choice for cannabis startups due to its flexibility, less formality, and strong limited liability protection." – Cannabis Industry Tax Expert
Corporations might be better for going public or raising significant capital. Tax comparison:
- C-corp earning $100,000 pays $21,000 federal tax. If all earnings are distributed as dividends, shareholders pay up to $23,800 in taxes, totaling $44,800.
- LLC with same earnings results in $37,000 in taxes for owners.
Keeping Good Records
Accurate record-keeping is essential:
- Use specialized accounting software
- Separate costs: Distinguish between COGS and other expenses
- Document everything: Keep detailed records of all transactions
- Create a detailed chart of accounts
- Prepare for audits: Cannabis businesses face higher audit risks
"Accurate record-keeping will save hours of time and costly mistakes when managing 280E deductions." – Cannabis Tax Compliance Specialist
Following Rules and Preparing for Audits
Staying Tax Compliant
Cannabis businesses must be extra careful with tax compliance due to 280E. Key steps:
- Understand 280E: Only COGS can be deducted
- Keep meticulous records: Document all transactions for at least 7 years
- Report cash transactions: File Form 8300 for cash transactions over $10,000
- Separate COGS from other expenses
- File timely and accurate returns
- Use specialized software
| Common Mistake | How to Avoid It |
|---|---|
| Misclassifying expenses as COGS | Work with a cannabis tax expert |
| Failing to report cash transactions | Track and report all cash transactions over $10,000 |
| Inadequate record-keeping | Use cannabis-specific accounting software |
| Late or inaccurate tax filings | Set reminders for tax deadlines |
Getting Ready for IRS Audits
The IRS prioritizes cannabis business audits. Prepare by:
- Organizing financial records
- Reviewing past tax returns
- Preparing for on-site visits
- Documenting owners’ personal finances
- Staying informed on tax court cases and IRS guidance
- Hiring professional help
"Contact an experienced tax attorney, preferably one with knowledge of the cannabis industry, and/or a qualified accountant, if and when the business has been identified for audit." – Alexander J. Gase, Leech Tishman
During an audit:
- Cooperate with IRS agents, but protect your legal rights
- Communicate in writing
- Provide copies, not originals
- Avoid bringing documents from years not being audited
- Never lie to the examiner
Future Changes in Cannabis Taxes
New Tax Laws Being Considered
Big changes might be coming:
- Biden admin plans to reclassify marijuana from Schedule I to III
- This could eliminate 280E tax burdens
- SAFER Banking Act could give access to traditional banking
- HOPE Act aims to expunge minor cannabis offense records
"Congress must do everything we can to end the federal prohibition on cannabis and address longstanding harms caused by the War on Drugs." – Chuck Schumer
If Cannabis Becomes Federally Legal
Federal legalization would bring sweeping changes:
| Current Situation | Potential Future |
|---|---|
| 60-80% effective tax rate | Rates similar to other industries |
| Limited deductions (only COGS) | All ordinary business expenses deductible |
| $1.8 billion in excess taxes (2022) | Significant tax savings |
| Cash-only operations | Access to banking services |
This could reshape the industry:
- Lower prices
- Increased investment
- Interstate commerce
- Simplified taxes
"The end of 280E would save our company millions annually, which we could reinvest into growth and employee compensation." – Jon Levine, MariMed CEO
Cannabis businesses should:
- Keep detailed records
- File tax returns on time
- Consider filing protective refund claims for taxes paid under 280E
While change seems likely, stay prepared for various outcomes as federal policy evolves.
Conclusion
Navigating cannabis business taxation requires careful planning and expert guidance. 280E significantly impacts tax liabilities and financial operations.
Key takeaways:
- Cannabis companies face 40% to 80% federal tax rates vs 21% standard rate
- Only COGS can be deducted under 280E
- Accurate record-keeping is crucial
- Professional tax help is essential
Real-world example:
| Scenario | Non-Cannabis Business | Cannabis Business |
|---|---|---|
| Gross Profit | $1,400,000 | $1,400,000 |
| Other Expenses | $1,100,000 | $1,100,000 |
| Federal Income Tax | $63,000 | $294,000 |
| Effective Tax Rate | 21% | 98% |
"With careful preparation and professional support, you can anticipate a straightforward and hassle-free tax compliance experience come early 2024." – Abraham Finberg, 420 CPA
To stay compliant and minimize tax burdens:
- Work with certified cannabis law, tax, and accounting experts
- Maintain meticulous records
- Stay informed about tax law changes
- Consider free consultations from state tax authorities
- Save enough cash for potential tax liabilities
With the right approach and professional guidance, cannabis businesses can manage their tax obligations effectively while focusing on growth and success.
FAQs
What is the 280E strategy for cannabis?
The 280E strategy involves managing tax deductions within 280E constraints:
- Maximize COGS deductions
- Separate cannabis and non-cannabis activities
- Keep meticulous records
The 2007 CHAMP case allowed deductions for non-cannabis activities, setting a precedent for future strategies.
What is the IRS 280E guidance?
IRS 280E guidance outlines tax implications for cannabis businesses:
"Section 280E disallows all deductions or credits for any amount paid or incurred in carrying on any trade or business that consists of illegally trafficking in a Schedule I or II controlled substance within the meaning of the federal Controlled Substances Act."
Impact:
| Factor | Non-Cannabis Business | Cannabis Business |
|---|---|---|
| Tax Rate | 21% (corporate) | 40-80% |
| Deductions | Most business expenses | Limited to COGS |
| Audit Risk | Lower | 10-15% audit rate |
To navigate these challenges:
- Work with specialized cannabis CPAs and tax attorneys
- Implement robust accounting systems for accurate COGS calculations
- Consider alternative business structures to minimize tax impact
Stay informed about potential 280E changes. The Justice Department’s recent call for public comments on cannabis rescheduling could signal future shifts in tax treatment.
