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What IRS Code Section 280E Means For Cannabusinesses

When it comes to taxes, cannabusinesses don’t have it easy

When it comes to taxes, saying that cannabusinesses don’t have it easy is putting it lightly. Currently, licensed marijuana businesses have to file federal taxes under IRS tax code 280E because marijuana is still classified as a Schedule 1 drug under the Controlled Substances Act at the federal level. This was a code created specifically for businesses that partake in the federally illegal trafficking of a Schedule I or II substance to file under. If it seems crazy to you that the IRS expects illegal business entities to pay taxes, you’re not alone. But, alas, money is money, and the IRS wants their fair share.

 

Effects of 280E on Licensed Cannabusinesses

The downside to filing under 280E is that licensed cannabusinesses end up paying much more in federal taxes than any other businesses do. That’s because 280E explicitly bans any tax deductions besides the cost of goods sold. Any cannabusiness that tries to deduct any other business expenses, like all other normal business entities would, faces a potential audit. An IRS audit is a civil action, not a criminal one. But that doesn’t mean there still aren’t going to be massive repercussions if a cannabusiness is found to be out of compliance with section 280E of the tax code. Technically, in order to impose any penalty for a violation of 280E, the defendant must be proven to have illegally trafficked a controlled substance prohibited under federal or state law. Because marijuana remains illegal at the federal level, the IRS can still come after cannabusinesses operating in legal states, convict them under federal drug law, and then section 280E applies to them.

 

Still Subject to Audits

Unfortunately, some cannabusinesses that have been fully in compliance with their state’s marijuana laws and regulations and have not been charged with illegal trafficking of a controlled substance, have still faced a “random” IRS audit from time to time. The IRS has recently been focusing on cannabusinesses that are misfiling Form 8300– a form used to report cash deposits of over $10,000- to be able to go after them for violating section 280E instead of filing formal drug trafficking charges. Many of the top 100 cannabusinesses in Colorado have faced “random” audits at the whim of the IRS, even though they are also in good standing with the state’s Marijuana Enforcement Division in addition to being free from any federal drug charges. These companies have been operating entirely legally and compliantly at the state-level, and the IRS still chooses to audit them.

 

What Cannot be Deducted

So, what can’t a cannabusiness deduct in order to avoid scrutiny from the IRS? Essentially, anything except for the cost of their goods sold. This means employee salaries, rent, marketing and advertising cannot be deducted as they would normally be at other businesses.  The IRS is also always on the lookout to make sure that cannabusinesses have reported all of their income, hence the recent focus on Form 8300 filing. This document must be filed when any business makes a deposit of over $10,000 in cash. In 2015, over 30 Colorado cannabusinesses were subject to IRS audits for not filing Form 8300 in a timely manner, or in some cases, not filing it at all. The tax burden on a particular cannabusiness depends on how the company is structured. In Colorado, companies that make only marijuana-infused products or edibles are able to deduct all of their costs, since they are manufacturers.  However, under Colorado state law, cultivation facilities must also have a retail shop attached; that type of structure doesn’t allow them to deduct all costs just because they are growing the plant. In this type of business structure, owners can deduct costs related to growing only, not any of their retail costs.

 

What the IRS Has to Say

According to a memo written by the director of Collection Policy at the IRS, the government agency doesn’t target state-legal cannabusinesses for audits because these state-level reforms have had no impact on how the federal tax code is enforced. Since there’s a conflict between federal law and these state-level laws, the IRS must follow federal law, which does not allow cannabusinesses to deduct normal business expenses for income tax purposes.  The IRS truly believes that it is correctly enforcing its tax code. However, that can’t be the case any longer when some cannabusinesses are facing tax rates of over 100%.

 

Why 280E Should Not Apply to a State-Legal Cannabusiness

Not allowing cannabusinesses to deduct normal business expenses often contributes to them operating at a loss. Add an IRS audit and possible bill into the mix and many companies just can’t cover their costs, facing closure. Every entrepreneur in the cannabis industry can benefit from tax reform when it comes to 280E. If the IRS continues to carry on as normal in their implementation and enforcement efforts, the taxes will eventually be too severe for the industry to withstand. It’s hindering legal, responsible growth and further legitimate regulation of the cannabis industry.

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