401(K) 2012

Understanding Internal Revenue Code Section 280E, Part 2

This is the second installment of our series investigating Section 280E of the Internal Revenue Code (IRC).

In Part 1, we explained how this overreach has made it nearly impossible for state-legal cannabis businesses to thrive in the long run — the interpretation of Section 280E by the IRS means that businesses in this industry are not allowed to claim the deductions to which most other businesses are entitled.

Here is how Section 280E affects federal tax liability for state-legal cannabis businesses.

State-legal Cannabis Businesses Pay More in Taxes

While state-legal cannabis businesses are permitted to deduct Cost of Goods Sold (COGS) and capitalize indirect costs, such as inventory, state excise taxes, and administrative costs, most deductions receive extra scrutiny from the IRS.

These deductions include:

  • Utilities
  • Health insurance
  • Maintenance
  • Advertising and marketing
  • Rent
  • Repairs
  • Contractor payments
  • Employee salaries

State-legal Cannabis Businesses Face IRS Challenges to Deductions Claimed

In addition, deductions that were previously claimed by state-legal cannabis businesses for state excise taxes, administrative costs, and the storage, purchase, and depreciation of cannabis are now likely to be challenged. In 2015, the IRS Office of Chief Counsel issued Chief Counsel Advice (CCA) 201504011. The IRS Office of Chief Counsel determined that these businesses were not allowed to use more recent provisions from IRC Section 263A, which expanded the types of expenses that could be included in COGS.

As a result, cannabis-related business owners are left to worry about the IRS challenging their deductions each time they file their taxes. The IRC is open to interpretation, which means that most businesses are unable to definitively prevent a challenge from the IRS, even after preparing their tax filings under the guidance of a qualified tax professional.

In the third and final part of this series, we will discuss the impact of 280E on the cannabis industry and the state economies that have been impacted by this legislation.

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