In our continuing series on Tax and Vice, we now discuss Cannabis Tax – the tax treatment of Cannabis Dispensaries and other businesses that sell cannabis, marijuana, and THC products like edibles. As this blog post will discuss, Section 280E of the Internal Revenue Code gives unforgiving tax treatment to cannabis dispensaries and other businesses that deal in or sell cannabis, marijuana, and THC products. This blog discusses how cannabis dispensaries and other similar businesses cannot deduct ordinary and necessary business expenses and limits place upon Cost of Goods Sold (COGS) deductions which marijuana and cannabis businesses can claim on their tax returns.
Let’s start with our usual disclaimer. Our goal of this series is not to be “holier than thou.” For what it is worth, the blog’s author is a UC Berkeley graduate. Nevertheless, we recognize cannabis use does have health risks and urge everybody to make well-informed and responsible decisions regarding cannabis use and any other lifestyle choices discussed in this series.
Under Section 280E of the Internal Revenue Code, businesses “trafficking in controlled substances” are not allowed to take tax deductions that most other businesses may take like rent, utilities, advertising costs, etc. While Cannabis is legal under the laws of many states (including California) and cannabis dispensaries operate out in the open in many neighborhoods throughout the United States, Cannabis is still illegal under federal law. Therefore, cannabis dispensaries and other businesses that deal in cannabis and other marijuana products are subject to the harsh treatment of Section 280E because they are deemed to be “trafficking in controlled substances.”
Cannabis dispensaries have issued many challenges against Section 280E in court. For the most part, these challenges have been unsuccessful. Among other things Cannabis dispensaries have unsuccessfully argued they are not “trafficking in controlled substances” because their activities are permissible under state law. They have also unsuccessfully challenged Section 280E under constitutional grounds.
If there is a silver lining to Section 280E, it is cannabis dispensaries and other businesses selling cannabis and other marijuana products are allowed to take limited tax deductions for Cost of Goods Sold (COGS). COGS are the expenses businesses incur when they purchase inventory. COGS may also include costs of producing inventory. Cannabis dispensaries often take aggressive positions on COGS. Courts have noted these aggressive positions and have expressed disapproval of these aggressive positions. For example, in one Tax Court Decision, the Tax Court did not allow a COGS deduction for the salaries of employees who merely, “packaged, trimmed, dried, and maintained the stock.”
The prohibition of business deductions under Section 280 can have some harsh tax consequences for a cannabis dispensary. A cannabis dispensary cannot deduct costs like rent, utilities, and other expenses ordinary businesses can deduct on their tax returns. Cannabis dispensaries will require large margins to meet their tax burden.
RJS LAW represents businesses of all types in IRS, FTB, and CDTFA Audits. RJS Law also provides tax planning advice to businesses. If you are in need of audit representation or tax planning advice, please reach out to RJS Law.
Written by Joseph Cole, Esq., LL.M.