As of 2022, cannabis use (medical and/or recreational) has been legalized or decriminalized in 39 US states and the District of Columbia. But cannabis is still illegal at the federal level, all cannabis-related businesses (CRBs) are in violation of federal law, even when they are legally operating under the rules and regulations of their state. Because the product is considered a Schedule I controlled substance, cannabis businesses are prohibited from deducting many expenses for federal income tax purposes.
As a billion-dollar business, cannabis entrepreneurs find themselves in a complicated position when it comes to tax time. The biggest question cannabis entrepreneurs have is: Can any expenses associated with cannabis businesses be deducted for federal income tax purposes?
Read on to learn more about best practices for cannabis accounting and tax management.
What Is IRC Code §280E?
IRC §280E is the IRS code that addresses deducting costs associated with cannabis and other controlled-substance businesses. The law outlines that no deductions or credits are permitted if the business trafficks in controlled substances that are prohibited by federal law. Because cannabis exists in the liminal space of being legal at the state level but illegal at the federal level, there are many restrictions about what can and can’t be deducted. Because of §280E restrictions, cannabis businesses face significantly higher tax burdens than other businesses – 40-80% versus the average 21% corporate tax rate for comparable industries.
Are There Exceptions To §280E?
§280E applies to growers and every plant-touching cannabis business type along the supply chain, including but not limited to:
-Cultivations and Grow Operations
-Processors, Infusers and Extractors
-Vertically Integrated CRBs (licensed in every area of the cannabis life cycle, from seed to sale)
-Transport and Logistics
-Testing Laboratories
-Retail dispensaries
Because the law directly relates to ‘trafficking’ and the sale of cannabis-related products, retailers are most impacted. However, to reduce the tax burden on CRB owners, many states have adopted deduction allowances for CRB expenses. These exceptions may be applied to personal or corporate income taxpayers, depending on the state.
At present, the following states have state tax exemptions for CRBs:
Colorado
California
Hawaii
Louisiana
Maine
Michigan
Minnesota
Montana
New Mexico
Oregon
Vermont
For a more comprehensive look at state tax exemptions, contact an Accountabis pro to schedule a free consultation.
What Is a COG?
Cost of Goods Sold (COGS) are also called inventory costs. COGS refer to the cost of the actual product and any directly related expenses. While CRBs can’t deduct ordinary and necessary business expenses like salaries or rent, they can deduct the COGS associated with their product – as long as they are compliant under inventory valuation rules. Identifying business expenses that are compliant and can be deducted as COGS can significantly minimize the burden of §280E on your CRB. But for cannabis businesses, it can be tricky to know which COGS can be deducted, and which are restricted under §280E.
What Can I Deduct Under IRC Code §280E?
Because cannabis compliance laws are complicated and change frequently, it’s always a good idea to consult a professional cannabis accounting service like Accountabis to review your COGS and ensure compliance.
The COGS your business can deduct are directly related to the type of CRB you operate. Cultivators, producers, and retailers each have different business expenses that are deductible COGS that may not overlap across verticals.
Cultivator COGS Include:
-Material costs, like seeds and plants
-Labor costs, like planting, harvesting, and trimming
-Some indirect costs, like equipment repairs, maintenance, or quality control
Manufacturer COGS Include:
-Indirect materials and supplies, like packaging and supplies
-HVAC, fire protection, alarm and security systems
-Insurance costs
-Property taxes on the production facility
-Certain salaries, like quality control and janitorial services
Dispensary COGS Include:
-Cost of acquiring merchandise, like transport
-Certain utilities, like electric for designated inventory areas
-Invoice price of cannabis, minus trade and other discounts
What Isn’t Deductible Under IRC Code §280E?
The short answer is, anything that isn’t considered COGS isn’t deductible. What is and isn’t considered COGS varies by vertical, so to make sure you don’t miss out on any deductions (or risk compliance), it’s always a good idea to consult a cannabis accounting professional to review your COGS before filing your taxes.
Non-deductible expenses include, but are not limited to:
-Advertising and marketing
-Sales team salaries and wages
-Health insurance
-License or permit fees
-Rent on space not associated with production
-Utilities not associated with production
To learn more about IRC Code §280E, visit the official IRS resources.
Better yet – contact an Accountabis pro to schedule a free consultation, and see how we can help you make the most of tax time.
