Banking & Finance

How A Piece Of War On Drugs Era Legislation Is Affecting Cannabis Companies In 2021

How A Piece Of War On Drugs Era Legislation Is Affecting Cannabis Companies In 2021

Cannabis legalization is moving fast but maybe, not quick enough. We’re witnessing the green rush as we speak. Since the 2020 elections, several states have legalized cannabis for recreational or medical use. Fifteen states, along with Washington D.C., have legalized recreational cannabis. However, the laws surrounding cannabis remain confusing for consumers, patients, and cannabis companies alike. State legalization doesn’t equate to federal legalization; therefore, many lawful marijuana operators are can still face repercussions or penalization for simply running their business.

One bill, in particular, has significantly taken a toll on cannabis operators. Principal at Bonadio Group, Jay Jerose, detailed the obstacles the cannabis industry faces in the legal market, primarily when it boils down to tax codes and finding banking solutions with Cannabis Industry Journal. Internal Revenue Code (IRC) Section 280E is a brief yet onerous provision that impacts taxable income for cannabis companies. The section explicitly prevents businesses engaged in the trade or business relating to trafficking substances under the Controlled Substance Act’s schedules I and II from deducting typical businesses expenses on their taxes. The War On Drugs-era policy put into action in 1982 continues to burden state-legal operations. Cannabis businesses have felt the impact of this bill, even as the multi-billion dollar industry expects to reach $30 billion in market value by 2025. One would have to consider the costs between the preliminary stages of applying for a license to opening a storefront or even a cultivation facility, in addition to how these laws affect a company’s bottom line with higher federal tax rates.

On the plus side, there have been exemptions in the rise of legalization. Though certain deductions limit taxable operators, state-legal cannabis businesses do have a bit of wiggle room when it comes down to their Cost of Goods Sold. The provision in the IRC allows certain state-legal cannabis businesses, such as retailers, growers, producers, and wholesalers, to deduct COGS when filing taxes.

Section 280E works in a way that prevents dealers — which unfortunately includes cannabis-related businesses — from deducting typical business expenses, which, in turn, creates higher federal tax rates. Under the IRC, cannabis businesses can’t deduct any costs or claim credits related to trafficking schedule I or II controlled substances, no matter how ordinary they may be. So, even though a business might be licensed and legal within their state, cannabis’ classification as a Schedule I drug prevents operators from taking advantage of the same tax deductions offered to any other type of business. Thus, increasing the amount of taxes paid by any MRB compared to other sales industries. 

Even as the cannabis industry grows, this remains one of the many headaches involved with opening up a shop. However, there have been attempts to challenge these laws. 2007’s Californians Helping to Alleviate Medical Problems, Inc., v. Commissioner case doubled down on the legal precedent that Section 280E doesn’t apply to the cost of goods sold, which the IRS describes as “expenditures necessary to acquire, construct or extract a physical product which is to be sold.” So, cannabis-related operations that typically purchase cannabis wholesale, or even pre-rolled cones, for resale can file their products as the cost of goods sold. They aren’t allowed to declare regular expenses like rent, utility, wages, and insurance on federal taxes. In a state like New York that recently legalized recreational cannabis, they’ve planned on following section 280E for taxable incomes.

There has been an increasing headache for marijuana businesses as the Tax Courts come down hard on their operations. MRBs are diligently working towards differentiating cannabis-related expenses and non-cannabis-related expenses. At the same time, the courts claim that both types of earnings fall under the same category of trade or business. 

Cannabis-related businesses will face a more challenging time than any other business for the foreseeable future. The IRS tends to audit state-legal cannabis companies aggressively. Facing troubles with the federal tax agency might be inevitable, but there are ways to ensure you and your company’s safety from penalizations, fines, and potentially jail time. For one, maintain meticulous documentation of all of your calculations — costs and revenue. Secondly, have a tax adviser look over all of your costs to ensure that you’re maximizing what could be considered the cost of goods sold. The exemption in Section 280E is currently the only reliable source for deductions and credits for marijuana-related businesses.

Reading next

Federal Drug Official Admits Cannabis’ Classification As Schedule I Drug Preventing Critical Research
CDC Issues Guidelines Warning Of Risks Of Driving While High

Leave a comment

All comments are moderated before being published.

This site is protected by reCAPTCHA and the Google Privacy Policy and Terms of Service apply.