Cannabis Accounting

The Impact of 280E on a cannabis business

By March 17, 2021March 26th, 2021No Comments

A cannabis business is required to remit income taxes to the federal government. Because cannabis is a schedule 1 substance, cannabis businesses are subject to the code section IRC 280e. In this next chapter, we will go over what IRC 280E is, important IRS court cases and memos that have impacted how the IRS looks at cannabis businesses.

Section 280E of the Internal Revenue Code was enacted in 1982. 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.”

While cannabis has been legalized in several states for adult use and medical use, it is still considered a Schedule 1 drug under the Controlled Substance Act and remains federally illegal.  As a consequence, rules regarding Schedule I Drugs apply to the cannabis business when it comes to your Federal tax return. 

Cannabis businesses are taxed on their gross income and are only allowed to deduct the Cost of Goods Sold on their federal tax returns.  Remember that most expenses are not deductible in the entity that is trafficking cannabis. This means that you cannot deduct the marketing, selling, general and administrative costs on the federal level.   

Most states allow the cannabis business the normal business credits.

What is the impact of 280E on the cannabis supply chain?

Cannabis Cultivators/Producer

The majority of expenditures a cultivation business will make are related to costs necessary to grow their plants (inventory). Common inventory costs include:

  1. Soil
  2. Water
  3. Nutrients
  4. Direct Labor (master cultivator)
  5. Indirect costs (rent, utilities, equipment depreciation, etc.)

Cannabis Manufacturers/Processors

The majority of expenditures a processing business will make are related to costs necessary to manufacture or produce their inventory. These costs may include:

  1. Cannabis Flower or Trim
  2. Terpenes
  3. Solvents
  4. Other direct materials of a product (i.e. ingredients to make gummies or chocolates)
  5. Direct Labor
  6. Indirect Costs (rent, utilities, depreciation, etc)

Cannabis Resellers or Retailers

By the time cannabis products reach the distributor or the retailer, the products are essentially already “ready for a sale”. Distributors and Retailers have very few remaining costs besides the cost of purchasing the products for resale. Other costs related to inventory could be:

  1. Testing
  2. Packaging
  3. Inventory inspection or storage

It is important for a cannabis operator to understand the impact of IRC 280E on their operations and their cash flow.

How to Stay Ahead of IRC 280e

With minimal deductible expenditures at the federal level, a cannabis operator needs to have a solid tax and operational strategy and have strong controls over spend and inventory.

Cannabis Finance Bootcamp will teach you how to navigate IRC 280e and build an effective strategy for your business.