Big Tax Changes Could Be Coming for the Cannabis Industry

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Craig W. Smalley, EA
Founder/CEO
CWSEAPA LLP
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If you have clients in the cannabis realm, you know that you have to deal with Code Section 280E. Briefly, Section 280E states:

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 House and the Senate now have introduced joint bills, called “Path to Marijuana Reform,” that may cause Section 280E to be a thing of the past. Embedded in the legislation is the Small Business Tax Equity Act, which says:

This legislation would repeal the tax penalty that singles out state-legal marijuana businesses and bars them from claiming deductions and tax credits.

The legislation is also looking to deschedule, tax, and regulate cannabis. 

What’s happening now to those in the legal cannabis business is that they can only deduct their cost of goods sold (COGS) – basically the cost of the cannabis. They can’t even use the new and improved way to calculate COGS; they have to use a calculation dated back to 1982. They cannot deduct any other expenses.

However, the US Tax Court did leave the door open and allowed for two businesses to operate under one roof. What some cannabis dispensaries did was separate the caregiving part of their business from their sales of cannabis for medicinal purposes. They would then put most, if not all, of the ordinary and necessary business expenses on the caregiving business, leaving the cannabis business with only COGS to deduct.

Section 280E was a response to the failed “War on Drugs” campaign of the 1980s. At that time, drug dealers would serve their sentence, and the IRS would then reconstruct their income in order for them to pay taxes on the sales of drugs. 

In 1981, there was the famous Tax Court case, Edmondson v. Commissioner. Jeffery Edmondson was a drug dealer who did time and was then slapped with a Notice of Deficiency from the IRS after he left federal custody. Edmondson took his case all the way to the Tax Court, where he testified that he sold drugs on consignment. 

Using the “Cohen Rule,” the court gave Edmondson credit for travel expenses, telephone expenses, and some other expenses. In 1982, Congress, upset with the Tax Court ruling, passed Section 280E.

Descheduling cannabis means that legal cannabis dispensaries and growers can open bank accounts, and the public can buy cannabis without concern of breaking federal law. 

The legislation calls for Congress to not only deschedule cannabis, but to tax it. 

Apparently, the federal government is taking notice of states’ taxation of cannabis, which can be as high as 15 percent. 

Will these bills go anywhere? Who knows. Remember that President Trump still needs to sign off on these bills even if they make it through Congress, and Attorney General Jeff Sessions has issued recent statements about rebooting the war on drugs.  

Related articles:

Marijuana and Taxes: Is There a Way Around Section 280E?
Tax Court Corner: How the US Tax Court Views Legalized Marijuana
Tax Court Corner: Significance of the ‘Cohan Rule’

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