Internal Revenue Code Section 280E
Internal Revenue Code Section 280E states "[n]o 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." Unlike hemp and hemp products, marijuana and products derived from marijuana are subject to this section of the IRS Code.
This means that ordinary and necessary deductions that are afforded to businesses that do not participate in "trafficking" according the IRS, are not entitled to take deductions for advertising, labor, rent, administration, improvements, among other expenses that a "normal" business is entitled to take.
The IRS is actively enforcing IRS Code 280E across the country, which is resulting in marijuana operations paying substantial amounts of additional, unanticipated taxes, penalties, and interest. A reseller of marijuana is only entitled to deduct the Cost of Goods Sold (COGS) in arriving at taxable income, which means the price paid for the product and reasonable transportation costs to retrieve said product. Producers of marijuana are entitled to a few more deductions, but bear in mind, the only expenses that are deductible are those crucial to producing the end product.
On November 29, the Tax Court issued its latest position on application of IRS Code 280E and Medical Marijuana in Patients Mutual Assistance Collective Corporation d/b/a Harborside Center vs. Commissioner of Internal Revenue, 151 T.C. No.11 (2018). This matter may still be appealed to the Ninth Circuit Court of Appeals, but currently stands for the following:
- The IRS considers Harborside a drug trafficker, not entitled to the usual deductions a legitimate business can claim, unable to even capitalize its direct costs into inventory.
- When a court of competent jurisdiction has entered final judgment on the merits of a cause of action, the parties to the suit and their privies are thereafter bound "not only as to every matter which was offered and received to sustain or defeat the claim or demand, but as to any other admissible matter which might have been offered for that purpose."
- A single trade or business can have several activities and that IRS Code 280E applies to an entire trade or business if any of its activities is trafficking in controlled substance
- The services must be substantially different from and stood on their own, separate and apart from dispensing marijuana-to be considered another business-the below will be considered a single trade or business:
i. Additional services provided complimentary to the sale of marijuana
ii. Price only charged for marijuana
iii. Set price based on the amount and type of marijuana sold
iv. The cost of services bundled into the price
v. Same employees who sold marijuana also provided the services
vi. No additional wages, rent or other significant costs connected exclusively with services
vii. Single bookkeeper and accountant
viii. If services were "incident to" the sale of marijuana and the two activities had a "close and inseparable organizational and economic relationship"
4. When accounting for COGS, the taxpayer has to capitalize an item cost in year of acquisition or production and either amortize it or wait until the year the items sold to make the corresponding adjustment to gross income.
5. Any cost (expense) which (but for this section) could not be taken into account in computing taxable income for any taxable year shall not be treated as a cost (expense).
6. Notwithstanding the foregoing, the Court found Harborside acted with reasonable cause and in good faith when taking tax positions for the years at issue, and therefore is not liable for accuracy-related penalties.
A number of significant tax planning opportunities nevertheless remain in this otherwise barren landscape concerning the nexus of IRS Code and cannabis businesses. For further information, contact Hoban Law Group.