Tax Man and the Cannabis Business
Tax day looms next week, signaling it’s time again for mathematical gymnastics and mental frustrations. The cannabis industry now exists in most U.S. states; however, marijuana remains a Schedule I drug. The toll of this classification has canna-businesses paying 70-80% higher taxes, all thanks to 280E.
This 37-year old tax code originated following a now infamous court case involving Jeffrey Edmondson, who like most Americans deducted expenses associated with his business operations. The trouble was Edmondson was a narcotics dealer and the deductions included a 29,000 mile road trip to San Diego, food, lodging, rent and his scale to name a few. While behind bars, he filed his taxes with standard deductions, which were denied. He sued the IRS, which brought the ire of Congress. In 1982, the Edmondson loophole—IRS Tax Code Amendment 280E—was enacted.
It states, “No deduction or credit shall be allowed for … any trade or business … consist[ing] of trafficking in controlled substances.” The challenge is in 2019 cannabis is a legal business practice granted by states rights to legalize regulated access. So, law-abiding citizens are shackled with a penalty tax above and beyond any other proprietor with the exact same expenses—rent, salaries, transportation, utilities and the like.
While taxes and 280E are a current day reality, the annual practice of preparing taxes does provide an opportunity to examine ways to optimize savings opportunities. One of the ways cannabis businesses can compensate is to more tightly control their costs of good. There’s incentive for a cannabis business to be vertically integrated – meaning the business operations cover more of the plant supply chain. For example, a business that cultivates, manufactures, and operates a cannabis retail business. This enables control of expenses from start to finish and optimizes costs for goods sold rather than business expenses. Like many parts of cannabis, the ability to vertically integrate is contingent on the state. Some states require vertical integration, while others prohibit it. Another example of the industry hurdles.
Now would also be an appropriate time to look at the internal infrastructure and the management of business operations. Implementing a true enterprise resource planning software allows for a granular and routine examination of costs and expenses to optimize record keeping for tax purposes. It automates daily reporting tasks and tracks them as a system of record. Plus, more robust operations can more easily navigate all the complex and differing tax structures from the state, county and city levels.
It should be noted that this mire of tax hurdles could become antiquated soon. In fact, tax amendment 280E could easily be history for the cannabis industry this year. Washington is embracing the legitimacy of cannabis like never before. The SAFE Act is out of committee and headed for a House floor vote. If passed, federal banking regulators can no longer penalize financial institutions for banking marijuana businesses that are legal under state laws. The U.S. Senate has a bill in committee, entitled S. 420, which would legalize cannabis, and there’s been whispers that the President may consider an Executive Order to end prohibition. Positive momentum doesn’t change the needs for today, but it does make thinking about 2020 taxes a bit less daunting.