How Does 280E Impact Marihuana Businesses?
If you are already in the medical cannabis industry, or just beginning to get your toes wet, you have probably heard about the high taxes your business will face. Or the special 280E accounting the business will face. This is mostly true.
The reality is some marihuana industry business models will have very little difference in the taxes they pay compared to non-marihuana businesses. Others however will be greatly impacted.
Let’s start with the basics. IRS code 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.”
Further explanation following in Congress’s report states: “All deductions and credits for amounts paid or incurred in the illegal trafficking in drugs listed in the Controlled Substances Act are disallowed. To preclude possible challenges on constitutional grounds, the adjustment to gross receipts with respect to effective costs of goods sold is not affected by this provision of the bill.”
See more information and the source of the above here.
This means cannabis businesses cannot take deductions for expenses. They can only adjust their revenue and effectively reduce it by their cost of goods sold before federal taxes are calculated.
In a nutshell, cost of goods are those costs that go into manufacturing or producing a product in order to make it ready for sale. Cost of goods may also include certain overhead allocations and other costs that are necessary in order to make a product sellable or service able to be provided.
Cultivators, processors and retailers all have different types of costs they will incur. Different costs mean differences in what can and cannot be considered cost of goods sold, or “COGS”.
Impact of 280E Accounting for Marihuana Cultivators (Manufacturers):
Marihuana cultivators typically include and support most of their costs in COGS. This means that most cultivation related costs are deductible. Negative tax consequences of 280E are significantly less for these business models.
The majority of expenditures a cultivation business will make are related to costs necessary to grow their plants (inventory). These costs may include soil, water, nutrients, testing, and direct labor. Electricity, equipment depreciation, inventory management software, and building rent may also be included in COGS. These costs are to grow and produce the plant inventory. However, a cultivator would not be able to deduct “administrative” type expenses like office management or marketing expenses.
Impact of 280E Accounting for Marihuana Processors (Manufacturers):
Marihuana processors can include and support most costs as part of COGS. This means that most processing related costs are deductible, just like most cultivation costs. Negative tax consequences of 280E are significantly less for this business model.
The majority of expenditures a processing business will make are related to costs necessary to manufacture or produce their inventory. These costs may include extraction materials, edible and topical ingredients, testing, and direct labor. COGS include costs for electricity, extraction or kitchen equipment depreciation, inventory management software, and building rent if accounted for properly. These costs are to produce inventory, including concentrates, edibles, and tinctures. However, a processor may not deduct “administrative” type expenses like office management or marketing expenses either.
Impact of 280E Accounting for Marihuana Provisioning Centers (Retailers):
For Marihuana provisioning centers, the high tax “horror stories” are a reality. Negative tax consequences of 280E are significant for this business model.
By the time Marihuana products reach the provisioning center, the products are essentially already “ready for sale”. Provisioning centers have few remaining costs included and supported as COGS. This means that most provisioning center costs are not deductible.
The important concept to apply here is whether expenditures are necessary to make the inventory ready for sale to a patient (or retail customer). The majority of expenditures a provisioning business will make are related to selling activities – costs incurred after the product is already ready. However, some costs a provisioning center may have are directly necessary to make the marihuana inventory ready for sale. These direct costs may include secure transportation to get the inventory to the provisioning location, testing, and packaging. COGS also often includes inventory inspection, storage, and inventory management costs.
A provisioning center cannot adjust for costs related to marketing and selling (including Bud Tender wages). The business also cannot expense depreciation on sales related furniture (like display cases) or building space. Most rent costs do not qualify as COGS either.
Excise taxes qualify as COGS.
It is important for all marihuana business models to plan with a CPA and industry accounting expert. An experienced CPA can help your business allocate costs to COGS appropriately.
What about Marihuana Safety Compliance (Testing) Facilities and Marihuana Secure Transporters?
Are safety compliance and transportation business models impacted by 280E?
The answer here is that no one knows for sure until tested by IRS response. Michigan was the first state to write into law the requirement for safety compliance and secure transporter facilities as part of the Medical Marihuana Facilities Licensing Act in 2016. Given that state law establishes and requires these activities (at least in Michigan), are they subject to 280E at all?
There is no feedback yet on what stance the IRS will take and enforce.
A safety compliance or secure transportation business owner should discuss these issues with their industry CPA. Discuss thoroughly the impacts and risks of following or not following 280E. The business should have the appropriate knowledge to decide ahead of time.
Assuming the worst and that the IRS will say these businesses must follow 280E since they are marihuana touching-
Impact of 280E Accounting for Marihuana Safety Compliance Facilities (Service Provider):
Marihuana safety compliance businesses may be able to include most of their costs as part of cost of services provided. This means that most testing related costs are deductible, just like most cultivation and processing costs. Negative tax consequences of 280E are significantly less for compliance facilities.
The majority of expenditures a safety compliance business are for costs necessary to provide testing services. These costs may include testing materials and inputs, product transportation, equipment depreciation, and direct labor. These costs are to provide safety compliance services. However, a safety compliance facility may not deduct “administrative” type expenses like office management or marketing expenses either with 280E applicable.
Impact of 280E Accounting for Marihuana Secure Transporters (Service Provider):
Marihuana secure transporters may be able to include most of their costs as part of cost of services performed. This means that most transportation related costs are deductible, just like most cultivation, processing and testing costs. Negative tax consequences of 280E are significantly less for transportation business models.
The majority of expenditures a secure transporter will have relate to costs necessary to providing their transportation services. These costs may include vehicle maintenance and depreciation, fuel expense, and direct labor. These costs are to provide transportation services. A secure transportation facility may not deduct “administrative” type expenses like office management or marketing expenses either with 280E applied.
There you have it! A business owner should always discuss in detail with their marihuana industry CPA or EA. There are many areas in accounting and the tax code that allow for reasonableness. One CPA may believe a cost is reasonably part of COGS, while another may think otherwise.
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