The cannabis industry has experienced all sorts of ups and downs over the years. Marijuana was criminalized and then decriminalized in several states. Each year more and more states continue to decline it and allow for the sale of medical or recreational cannabis. With these states slowly accepting cannabis into their states, all sorts of legitimate businesses are slowly cropping up.
The ongoing legalization of cannabis seems to be paving the way to a future where cannabis will remain permanently decriminalized and possibly even federally legalized. Of course, with it remaining federally illegal, business operators have to go through all sorts of hurdles to set up their operations. If you were to take the chance to ask a cannabis business owner to name their most challenging financial barrier, they would likely tell you that it’s a banking issue and 280E.
The majority of cannabis businesses have to run an all-cash operation because financial institutions are unwilling to support a federally illegal industry. Only a small number of credit unions and state-chartered banks are willing to offer financial service for complaint business, but establishing these connections remains a massive hindrance for business owners.
The other frustrating financial issue has to be the IRS Tax Code 280E. For this post, we are going to delve into the IRS Tax Code 280E and tell you how it affects your business.
The issues presented by Tax Code 280E
Since the inception of tax code 280E, it has remained a significant barrier for cannabis entrepreneurs across the United States. The tax code was introduced during the Ronald Reagan administration when it declared war on drugs. The tax code itself came about in 1981.
During this particular year, there was a tax course case during which a drug trafficker by the name of Jeffrey Edmonson decided to fight for his rights under the federal tax laws. The rights this individual was fighting for were for the deduction of ordinary business expenses from his overall taxable income. This case is known as the Jeffrey Edmonson vs. Commissioner. The court had decided to rule in his favor.
That victory granted him the right to deduct most of his business expenses, including the cost of sold goods, such as home expenses, phone expenses, packaging, and vehicular expenses related to his business. During the following year, the decision was eventually overturned.
If a business owner was discovered selling Schedule I or II controlled substances, they were denied the right to deduct business expenses related to their illegal businesses. Under the Controlled Substance Act (ACT), Schedule I and II controlled substances are defined as drugs with no medical usage and the potential for abuse.
IRS Tax Code 280E still exists to this day and penalizes current cannabis business owners.
What is IRS Code 280E?
The Code Section 280E is a federal statute mandated by the IRS opposing illegal business. It means that Code Section 280E has forbidden businesses from deducting any expenses from their gross income if it has any involvement with trafficking schedule I and II controlled substances. That also extends from being able to take credits as well.
Unfortunately for most cannabis entrepreneurs, marijuana is still classified as a Schedule I controlled substance. That makes it federally illegal even though it has become medically and recreationally legal in many states. Federal law claims that cannabis businesses are all under the category of drug trafficking.
Furthermore, it also means that cannabis business owners are forced into paying taxes on every one of their business income. Plus, they are prohibited from writing off any business expenses to diminish their taxable income. Cannabis companies have to deal with a high federal tax rate of 40 to 80% compared to the corporate tax rate, which is 21%.
While some people may consider businesses that sell legal marijuana are swimming in profits but that far from the truth. This code can take a sizable chunk of a dispensary’s revenues, hinders the licenses business from being able to invest in a building improvement, benefits, raise pay, operational expenses, and so forth.
Cost of Goods Sold (COGS)
There is an exception to the rule that can slightly assist business owners, and it is known as the cost of goods sold (COGS). When the tax code was passed by Congress, there were concerns of constitutional challenges to the newly introduced law. To fight off any future challenges, they included a small exclusion to the tax code. That exclusion permits the deduction of the cost of goods sold, even if the product is considered illegal under federal law.
The cost of goods primarily pertains to inventory costs. That would include the value of the actual product, the cost of shipping to a retail location, and directly related expenses.
However, anyone would tell you that this exception isn’t that helpful with how the IRS applies the definition of cost of goods sold for the cannabis industry. For instance, the IRS entirely ignores any tax changes included after Code Section 280E was introduced, which permits more indirect costs to be applied to the overall idea of the cost of goods sold. That means any expenses connected to the distribution process are not included under the cost of goods sold.
Some other things it would include are outbound and inbound shipping, rent, overhead, maintenance and repairs, health insurance premiums, payments to contracts, marketing and advertising, employee expenditures, and utilities. Plus, the cost of goods sold solely applies to the purchase of soil seeds, nutrients, and water for planting and cultivation.
Tax Deductions and Deductible Expenses
Knowing where you can allocate the deduction to the cost of goods can significantly lessen the tax effect of 280E on your cannabis business. For instance, if the business is cultivating, extracting, or producing cannabis, the cost of goods associated with the growth and product of items that are then wholesale by your business could be subjected to the tax code. The massive amount of activities that occur from cultivation or extraction within an operation could be considered the cost of good sales.
Types of COGS for Tax Code 280E
A review needs to be conducted to guarantee a business owner is appropriately organizing these results while remaining compliant. Here is a list of the type of 280E deductible labor cost of goods sold can leverage for your business:
In the case of cannabis cultivators, they could also claim deductions in these areas:
- Supplies and material
- Equipment maintenance
- Utilities used for growing cannabis
- Supervisor wages
- Quality control and inspections
In the case of a self-sustaining dispensary, the costs of goods sold are limited to the cost of a product and the cost of acquiring the merchandise. That includes the transportation costs for purchasing wholesale cannabis. It is also possible to claim a deduction for electric bills intended for inventory sections. At that point, almost everything else is subject to Section 280E inspection in the retail environment.
Keeping records for Tax Code 280E
Every business owner needs to keep accurate records when managing Tax Code 280E deductions. It also ensures that they end up saving hours of time and costly mistakes when dealing with this issue. Take the time to make sure you have technology that can assist with managing documents for your workforce, spending, inventory, and so forth. Every cash transaction should be reported, including:
- Any deposit over $10,000
- Any payment over $10,000
- Single cash sales that go over $10,000
- Sales, wages, and vendor payment
Keeping an accurate record of all of the specific costs of goods sold shall help you deduct for what you may and may not qualify. Every step you take can help you leverage the best practices and authentication for Tax Code 280E, which should help offset some of your tax overpayments.
Tracking software for Tax Code 280E compliance
Keeping accurate records of costs centers enables business owners to streamline identifying Sanction Code 280E workforce deduction, which can impact any of the terrible effects of the tax code. For instance, it is crucial to keep track of when a budtender rolls joints for a couple of hours in the morning (deductible) then begin selling those products in the afternoon (non-deductible according to the tax code).
Relying on software to keep track of employee time and attendance for cannabis can significantly improve a business owners capability to optimize labor deductions by providing:
- Seamless on-screen access to compliance-related information
- Built-in labor reports and audits trails
- Multi-format data exports for additional software
- Self-service for any device employees use to track jobs, tasks, and costs.
Fortunately for most cannabis owners, there already exist industry-specific cannabis software and systems that were developed to support the complicated marijuana regulatory environments and many tax complexities.
As a business owner in the cannabis industry, you need to be on your guard for the constant complications thrown your way. Tax Code 280E is one of the many issues that business owners need to deal with when running their businesses. If you are not properly managing the 280E, profits will begin to decline due to tax liabilities. That could eventually lead to you losing your entire financial resources and shutting down your doors. Understanding the implications of the tax code and keeping an accurate record is essential for running a compliant and profitable cannabis business.