Pervasip Corp (PVSP)

[Bjones2]

280E cost cannabis companies a tax liabilities of up to 70% of their income!!!

How Section 280E is hindering the cannabis industry
Feb 03, 2021

Cannabis
Following the November 2020 elections, 15 states and Washington DC have legalized adult use of recreational marijuana. Beyond that, a continuously growing number of states allow their residents to purchase legal medicinal marijuana, and many have also decriminalized adult recreational marijuana use. However, marijuana remains a Schedule I substance to the Controlled Substances Act and is therefore illegal on all accounts at the U.S. federal level; thus, creating a number of issues for businesses in the cannabis industry duly operating in states where marijuana has been legalized. Not only is it difficult for cannabis companies to avail themselves of alternative banking solutions, but there are also obstacles in place preventing these companies from taking advantage of notable tax deductions.

Chief among these hurdles is Internal Revenue Code (IRC) Section 280E

What is Section 280E?
Section 280E is only a few lines, but carries significant impact for the cannabis industry. The law reads as such:

“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 or 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.”

More simply, the law denies cannabis businesses any U.S. federal income tax deduction for ordinary and necessary business expenses, despite being duly licensed as a legal business in their state of operation. U.S. Congress enacted the law in the 1980s following a court case which disallowed a convicted cocaine trafficker from claiming deductions from ordinary business expenses under federal tax law. While the law intends to target illegal drug dealers, it simultaneously generates considerable problems for cannabis companies legally operating in their respective states because marijuana is a Schedule I substance.

What is a Schedule I controlled substance?
In 1970, President Richard Nixon signed the Controlled Substances Act (CSA). The CSA is part of the Comprehensive Drug Abuse Prevention and Control Act, a federal drug policy to regulate the manufacturing, importation, possession, use and distribution of certain narcotics, stimulants, depressants, hallucinogens, anabolic steroids and other chemicals. Under the CSA, there are five schedules at the federal level used to classify drugs based on their abuse potential, accepted medical applications in the U.S., and safety and potential for addiction.

The DEA defines Schedule I drugs, substances or chemicals as those drugs with “no currently accepted medical use and a high potential for abuse.” Examples of Schedule I drugs include:

Heroin
LSD
Marijuana
Ecstasy
Methaqualone
Peyote
How does Section 280E affect legal cannabis businesses?
Typically, the ability to deduct ordinary business expenses means that a business is subject to federal tax on its net income (i.e., gross receipts minus expenses). However, the definition of Section 280E and the classification of cannabis as a Schedule I substance severely hinder legal cannabis companies from taking advantage of tax deductions for actual economic expenses incurred in the ordinary course of business, which results in a significantly higher effective tax rate as compared to other businesses. In fact, businesses within the cannabis industry are left with tax liabilities of up to 70% of their income. Section 280E has increased scrutiny on the most common business expenses, including:

Employee salaries
Utility costs such as electricity, internet and telephone service
Health insurance premiums
Marketing and advertising costs
Repairs and maintenance
Rental fees for facilities
Payments to contractors
Importantly, Section280E affects all state-legal businesses that engage in the cultivation, sale or processing of the cannabis plant. For example, cultivators, medical dispensaries, marijuana retail stores and infused product manufacturers, as well as concentrates and cannabis oil manufacturers, all feel the economic effects of Section 280E on their businesses.

What are the exceptions to Section 280E?
While Section 280E greatly restricts the tax deductions of state-legal cannabis businesses, there is still a small bit of reprieve. Current IRC provisions permit state-legal cannabis businesses, such as marijuana growers, producers, wholesalers or retailers, to deduct the Cost of Goods Sold (COGS) in computing their US federal income tax liability, despite the application of Section 280E. This was upheld through Olive, 139 T.C. 19 (2012) as well as through Chief Counsel Advice (CCA). COGS generally entails inventory costs, including the cost of the product itself, shipping the product and certain other directly related expenses, depending on whether the cannabis business constitutes production or resale. Currently, the IRS does not allow any other amount as a deduction or credit for amounts paid or incurred with respect to cannabis business operations.

Have there been any recent legal challenges to Section 280E?
More than half of the states in the U.S. legally allow some form of marijuana sale or consumption, whether that be medicinal or both medicinal and recreational. As such, there is a considerable amount of legal businesses dealing with the excessive tax burden of Section 280E. In response, companies are turning to the courts to challenge the status quo.

Alpenglow Botanicals and the U.S. Supreme Court
Alpenglow Botanicals LLC is a medical marijuana dispensary in Colorado – a state where medical and recreational marijuana is legal. The business elected to deduct ordinary business expenses beyond COGS on their federal tax returns. However, following an audit of Alpenglow’s tax returns between 2010 and 2012, the IRS denied the deductions and charged the company over $50,000 for those taxes not paid. Alpenglow argued that the IRS exceeded its authority because rejecting the deductions due to Section 280E regulations implicitly determined that Alpenglow trafficked in an illegal drug, despite the fact that that marijuana is legal both recreationally and medicinally in Colorado.

Subsequently, the taxpayer sued for a refund in district court and lost. Then in 2018, the Tenth Circuit sided with the IRS. Alpenglow did not give up. They pushed the case all the way to the highest court in the land, the United States Supreme Court, with a February 2019 Petition for Writ of Certiorari.

However, the U.S. Supreme Court issued a denial of certiorari, declining to hear the case. The Supreme Court offered no explanation for denial, which to some signaled that the Court agreed with the Tenth Circuit judgment that the IRS was simply enforcing existing law.

As such, Section 280E remains a thorn in the side of cannabis-related businesses.

https://www.bakertilly.com/insights/how-section-280e-is-hindering-the-cannabis-industry