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A Necessary Evil: The Highs and Lows of IRC 280E for Cannabis Businesses.

Let’s talk about the weed in the grow room for all cannabis businesses: the necessary evil of Internal Revenue Code (IRC) Section 280E. Whether you view it as the nemesis of cannabis businesses or the unavoidable boogeyman in the ever-expanding cannabis industry, one thing’s for sure – it’s a bane on our side that won’t go away no time soon. In this blog post, is my valiant quest to demystify IRC 280E, unriddle its backstory, shed light on what can and can’t be deducted, and offer some navigational guidance, all served with a touch of humor. Now join me on a journey through the complex world of cannabis taxation.

“Nothing is certain except death and taxes.”

– Benjamin Franklin

Understanding the Basics of IRC 280E

The IRC 280E is a tax code that governs businesses dealing with substances classified as Schedule I or Schedule II controlled substances under the Controlled Substances Act. Unfortunately, cannabis falls into this category, and IRC 280E explicitly states that businesses involved in the sale of Schedule I or Schedule II substances can’t deduct ordinary and necessary business expenses. To put it simply, IRC 280E is Uncle Sam’s way of telling cannabis businesses, “Hey, we’re glad you’re contributing to the economy, but you’re in the drug business, so we’re going to tax you like one. Smoke on that weedheads.”

The Origins of IRC 280E

The history of IRC 280E is a rather curious tale that gives us insight into how our tax system has adapted to the changing legal landscape of cannabis. The curious tale all began with a case involving a rather brazen drug dealer named Jeffrey Edmondson who decided to file his taxes. In the landmark case of Jeffrey Edmondson v. Commissioner in 1981, Mr. Edmondson was a convicted drug dealer who was selling amphetamines, cocaine, and marijuana out of his rented apartment when the IRS flagged him for failing to file taxes.

Mr. Edmondson attempted to deduct ordinary and necessary business expenses such as the costs of his drugs, his packaging, and his car’s mileage all work-related on his federal income tax return. Despite his honest testimony, the court wasn’t amused by his audacity and promptly shut him down. This case set the precedent that the IRS could deny deductions to businesses trafficking in illegal substances, even if those businesses were, in all other aspects, legal under state law.

Photo Credit: Sasun Bughdaryan | Unsplash.com

What Can and Can’t be Deducted Under 280E

Now let’s get into the nitty-gritty of what cannabis businesses can and can’t deduct. Here’s a concise bullet-point outline:

Deductible Expenses for COGS

  1. Direct Production Costs: These are the costs directly associated with the cultivation, harvesting, and manufacturing of cannabis products. They can include expenses like:
  • Seeds and seedlings
  • Soil and nutrients
  • Labor for planting and harvesting
  • Packaging materials specific to the product (e.g., jars or bags)
  • Hydroponic systems or grow lights
  • Security costs for the protection of the growing area
  1. Labor Costs for Production: The salaries and wages of employees involved in the actual production and processing of cannabis products can be included. This includes the cultivation team, trimmers, and processing staff.
  2. Raw Materials: The cost of any raw materials directly used in the manufacturing process, such as cannabis flower, extraction materials (e.g., butane), and solvents for processing, can be deducted.
  3. Rent and Utilities for Production Spaces: Expenses related to the areas used for cannabis production can be included. This covers rent or mortgage payments, utility bills, and maintenance costs for these spaces.
  4. Depreciation of Equipment: If you’ve purchased machinery or equipment used exclusively for cannabis production, you can deduct the depreciation of these assets.

Non-Deductible Expenses for COGS

  1. Marketing and Advertising: Any expenses related to advertising, branding, or marketing. This includes the costs of designing logos, creating promotional materials and running marketing campaigns.
  2. Employee Salaries for Non-Production Roles: The salaries of employees not directly involved in the production or processing of cannabis products, such as sales and marketing teams, cannot be deducted as part of COGS.
  3. Occupancy Costs for Retail Spaces: If your business operates a retail dispensary, the rent, utilities, and maintenance costs for the retail area are not considered part of COGS. These are operating expenses.
  4. General Administrative Expenses: Common business expenses like office supplies, legal fees, and accounting services are generally not deductible as part of COGS.
  5. Transportation and Distribution Costs: Costs related to the transportation and distribution of products to retail locations or customers are not included in COGS. These are also considered operational expenses.
  6. Interest Expenses: Interest on loans or credit used for any aspect of the business, whether it’s production or non-production-related, cannot be part of COGS.
  7. State Licensing Fees and Taxes: Though these are obligatory costs for operating a cannabis business, they are not deductible as part of COGS.
Photo credit: Getty.com

Navigating the Complexities of IRC 280E

So, how do cannabis businesses navigate the bane of IRC 280E? This is not easy, but here are some strategies to consider on the matter.

  • Know Your COGS Deductions: Your best seed of hope to remember in the battle against 280E is the Cost of Goods Sold (COGS) deductions. Make sure you fully understand what constitutes COGS in your specific business and keep precise records.
  • State Law Is Little Fish: Even if you’re operating within the bounds of your state law, IRC 280E still applies. The federal government has the final say in taxation, and Uncle Sam doesn’t care about your state’s views on cannabis. Big fish eat little fish all day.
  • Separate Entities: Many cannabis businesses have chosen to create separate entities for the different aspects of their operations. By segregating the plant-touching activities from the non-plant-touching activities (like branding and consulting), you might find some relief from the tax burden. Heads up, the IRS is keen on this tactic, so tread carefully.
  • Audit-Proof Your Records: Since COGS is the only deductible expense, it’s crucial for cannabis businesses to maintain meticulous records of their production costs, from seed to sale with an eye toward a potential audit. If not, you may end up paying more in taxes than you should. However, the more transparent and well-documented your business is, the less you’ll have to fear.
  • Seek Professional Help: Enlist the aid of a qualified tax professional who specializes in the cannabis industry. They can help you navigate the complexities of IRC 280E and ensure you’re not paying a penny more than you owe. This is a necessary good!
  • Advocate for Change: It’s essential to work towards IRC 280 reform. Support advocacy efforts that aim to change federal cannabis laws. The more support there is for legal reform, the greater the chance of substantial changes in this tax law.

In conclusion, it’s crucial for cannabis businesses to meticulously segregate their deductible and non-deductible expenses to comply with IRC 280E. The IRS takes a keen interest in ensuring that expenses are accurately categorized and will scrutinize businesses accordingly. So, keep your records clean, your COGS deduction close, and your eyes on the ever-changing landscape of cannabis law. Until then, stay high on knowledge and keep your wallets in check!

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