Cannabis Business Owners Have a Way to Reduce Tax Liability

Cannabis Business Owners Tax Liability

For state-licensed marijuana operators, the three things primary concerns when it comes to owning a business are compliance, banking, and taxes.

That third element seems to give state-licensed cannabis businesses across the nation the biggest headache, and § 280E of the Internal Revenue Code has long been the source of the majority of that pain.

Why? Because it doesn’t allow marijuana retailers to count business expenses like rent, utility bills, and employee wages as tax deductible.

But thanks to an IRS-sanctioned alternative accounting method, marijuana businesses have a remedy for when it’s time to work on their tax returns.

How § 280E Puts Marijuana Businesses in a Restrictive Class ...

Normally, a “regular” company is able to make various tax deductions for money spent on “ordinary, necessary and reasonable” business expenses, including rent, utility bills, and employee wages. These deductions allow a business to legally lower profits and pay less in taxes, thus allowing a business to pay taxes on net income instead of gross income.

But § 280E, enacted in 1982 as a means to prevent illegal traffickers from claiming tax deductions on their ill-gotten gains, states that “no deduction or credit shall be allowed in running a business that consists of trafficking a controlled substance.”

This also applies to state-legal cannabis businesses because marijuana is a Schedule I substance under the Controlled Substance Act. And these ventures can’t advantage of the same tax credits or deductions for ordinary business expenses that regular businesses can.

... And How § 471 Offers a Different Way When it Comes to Taxes

Fortunately, cannabis businesses now have a solution. In its recently updated its marijuana industry FAQ page, the IRS notes that state-legal cannabis businesses can reduce their gross receipts by using an alternative accounting method under § 471 of the Internal Revenue Code.

The FAQ provides that § 280E does not prevent participants in the marijuana industry from reducing their gross income by subtracting the cost of goods sold (COGS) calculated pursuant to § 471 from their gross receipts.

Generally, § 471 of the Code allows qualifying small businesses with less than $25 million in annual gross receipts to use an alternative accounting method where the gross receipts of the business are reduced by the cost of inventory and other expenditures, ultimately reducing the tax liability of a small business by a substantial amount.

The FAQ provides further guidance for those in the marijuana industry looking to comply with federal income tax reporting requirements. These conditions include state-legal cannabis businesses tax filing obligations; potential penalties and adjustments; and payment plans for those businesses who cannot fully pay their tax obligation.

For the state-licensed cannabis industry, the implications of § 471 are significant. Rather than go through the detailed process of tracking inventoriable costs and losing the rest to the void of § 280E, companies can potentially adopt an accounting policy that treats all costs as COGS and receive a deduction for these expenditures on their tax returns.

Cannabis Ventures Still Navigating Rough Regulatory, Financial Roads

As mentioned earlier, cannabis businesses must still contend with banking and compliance issues.

Most licensed marijuana operations are all-cash businesses because the majority of banking institutions are not willing to support a federally illegal industry. A small number of state-chartered banks and credit unions have stepped in and offered financial services to compliant state-licensed operations, but establishing these relationships continues to be a significant challenge for many.

After licensure, it is even more crucial that marijuana ventures stay up to date on proposed rule changes; anticipate how these changes may affect and impact business; and adapt company practices accordingly. Doing so will help these businesses maintain a clean track record of regulatory compliance and stave off fines, sanctions, and the possibility of loss of license.

With the benefits of § 471 clarified, however, cannabis businesses have one less thing to worry about when it comes to taxes.

Please note, this treatise is designed to provide general information on marijuana operations. It is not intended to serve as legal, tax, or other financial advice. Because each individual’s legal, tax, and financial situation is different, specific advice should be tailored to the particular circumstances, from an attorney, CPA, and/or other advisor.

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