Marijuana and Taxes: The Dark Reality of Cannabis Taxation
As of April 2022, there were only four states in the United States where cannabis was not decriminalized to some degree. Despite this fact, the federal government still treats it as a criminal enterprise.
While it’s common knowledge that cannabis is regulated by a punitive tax structure, what’s less understood is how difficult it is to run a legitimate business, be a good corporate citizen, pay your taxes and be profitable in legal cannabis. The cannabis economy is built upside down from a business perspective, with the biggest impact rooted in how it is taxed.
To start understanding taxes for the cannabis industry, you must first understand IRC 280E.
The federal government enacted 280E to punish drug traffickers; it was never intended as a viable tax option for legitimate businesses. 280E’s goal is to deter businesses from selling cannabis by removing all credits and deductions. Put simply, the government enacted 280E to reap the profits from illegal narcotics trafficking, but the byproduct of that is that state-legal cannabis businesses are taxed to death. Indeed, under 280E, these businesses are only allowed to deduct costs related to their inventory, and even that is uncertain.
280E states that, “No deduction or credit shall be allowed for any amount paid or incurred during the tax year in the carrying on of a trade or business if such trade or business (or the activities that includes such trade or business) consists of trafficking in controlled substances (as defined in Schedules I and II of the Controlled Substances Act) that are prohibited by federal law or the law of any state in which such trade where such business is conducted,” as seen in Pub L. 97-248, Title III, § 351(a), Sept. 3, 1982, 96 Stat. 640.
Consider a hypothetical C corporation with revenue of $3 million, cost of goods sold of $1.6 million, and expenses of $1.3 million. This business has a gross profit of $1.4 million and a net income of $100,000. A normally taxed C corporation will pay $21,000 in federal taxes, or 21% on net income of $100,000. However, this same cannabis industry company will pay $294,000 in federal taxes, or 21% on a gross profit of $1.4 million. Cannabis is taxed on 100% of expenses that a “normal” business could write off. It goes without saying that a tax bill higher than actual net income will create cash flow problems, and being taxed on gross profit also creates fictitious taxable income – and therefore fictitious profit.
This scenario repeats itself year after year, with the cannabis industry sinking ever deeper into tax debt, creating a stark choice: stay open or pay federal taxes. Meanwhile, state-legal cannabis competes with an illicit market that is thriving, stealing market share and paying no taxes. 280E continually puts legal business owners in the position to think about ways to “work around” current bureaucratic hurdles in order to keep their businesses open, and it effectively deters doing business above the line.
Selling, general and administrative (SG&A) expenses significantly affect the bottom line and contribute to good corporate citizenship. Deductible corporate donations to non-profit organizations, additional testing for product safety, product liability insurance, installation of additional safety and security measures, payment of a living wage, payment of payroll taxes and additional employee benefits are considered common SG&A expenses, as well as best practices. Cannabis businesses are not only unable to deduct these expenses, but are also taxed on these dollars.
This makes the expenditure economically unfeasible, even when the company is required to provide it. Consumer safety can also take a back seat when the cost of quality product testing or child-safe packaging is neither deductible nor required. Payroll taxes, health benefits and retirement adequacy are not feasible for companies marginalized by laws that tax them on these costs. All of this affects businesses that lack access to low-cost bank accounts and most sources of capital.
How do they survive? We advise them to use alternative trading strategies, such as:
- No expansion for expansion’s sake. There are few economies of scale available to cannabis businesses because they cannot transact across states.
- Seek investment or capital from people who want to see the industry succeed in the long term rather than high interest short term loans.
- Brand development with a local focus. Find other like-minded businesses and join forces to find synergy.
- Find local growers or producers who are Sun + Earth certified or using biodynamic and regenerative farming practices for a quality product.
- Make customers and suppliers aware of financial realities. Only cannabis from the illicit market can cost $10 a gram, an unsustainable price for tax-paying companies. People need to understand why paying more helps quality local stores and farms do the right thing.
- Ruthless spending control. If a non-deductible expense isn’t absolutely necessary, don’t do it. Stop expensive advertising, offering free meals, freebies or trips.
- Work with ethical, cannabis-specific CPAs and lawyers.
- Make sure your advisers have previous experience with 280E returns in similar markets and know your tax challenges. Find an advisor willing to work with you and explain how to make good spending choices.
The company enjoys good corporate citizenship. Laws should not prevent or punish companies from doing good for their employees, their communities and the environment. Federal law lags behind state legalization and society’s changing view of cannabis. This creates a hostile environment that makes it almost impossible to keep the industry legal. Without sensible policy reform at the federal level, 280E will continue to block the economic viability of legal cannabis. Regardless of the federal view, the legal cannabis industry is here to stay, and punitive tax rules have not deterred bad market players from quitting; instead they punish the quality innovators we want to anchor this emerging industry. As legal markets mature – and if they are to thrive – they deserve equality and the right to leave behind the pitfalls of federal prohibition.
This article does not necessarily reflect the views of the Bureau of National Affairs, Inc., publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Katye Maxson-Landis, CPA, owns and operates Moxy Accounting LLC in Portland, Oregon. She has been providing preparation, advocacy, and advisory services to legal cannabis businesses since 2012 and trains tax professionals on 280E-compliant tax work through The Moxy Accountant Cohort, a NASBA-certified CPE provider.
Katie Scates, CPA, JD, supports Moxy Accounting LLC in tax preparation, outreach, and advisory services. She co-teach and provide training through the Moxy Accountants Cohort.
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