What is IRS Code 280E?
Internal Revenue Code 280E is a law that was specifically written for businesses that file taxes that are involved in criminal and federally illegal activities, but still need to file income taxes. The law disallows the deduction of normal operating business expenses when calculating a company’s taxable income at the end of the year.
How does this affect businesses that operate in the legal cannabis industry?
Companies that are plant-touching (retailers, growers, processors) are not allowed to deduct actual, necessary expenses that they incurred during the year to run their business. Some of these expenses may represent the biggest costs to operate a business including Advertising Costs, Salaries, Transportation and Delivery Costs, Licensing and Professional Fees and many others.
By not allowing a deduction for these expenses, a business in the cannabis industry ends up paying taxes on income that they technically did not really earn. On paper, and in real life, a company can lose money but then end up owing a six figure tax bill to the IRS due to not being able to accurately deduct their actual costs of doing business.
Where did this crazy law come from?
In 1975, Jeffrey Edmonson, a Minnesota resident who was self-employed in the trade/business of selling amphetamines, cocaine and marijuana, filed a tax return for the 1974 tax year to include his income from these illegal activities. This was done to be in compliance with the IRS law that all income, regardless of source or legality, must be reported and then have taxes paid. When he filed this tax return, he included all of the income derived from his product sales the prior year (1,100,000 amphetamine tablets, 100 pounds of marijuana and 13 ounces of cocaine) – but also deducted all of his business expenses incurred including the cost of his product, travel costs, telephone expenses and part of his home rent due to the home office he ran his illegal businesses from. He even reported an ending inventory of 8 ounces of cocaine that had gone unsold during the year.
The IRS initially denied all of his deductions by claiming that he was dealing in an illegal trade (selling federally illegal narcotics) and therefore was not entitled to the normal deductions other law-abiding businesses took on their tax returns. Edmonson’s attorneys successfully argued that the 16th amendment in The Constitution allows all taxpayers to deduct their Cost of Goods Sold from their Gross Income when calculating their taxable income, so the court allowed most of the deductions to remain.
Although Edmonson won his case and was allowed to use his expenses as deductions on his tax return, the IRS was not very happy with the Tax Court’s decision and a few years later enacted IRS Code 280E, which was initially supposed to apply to drug dealers like Edmonson, but actually applies to businesses dealing in all federally scheduled controlled substances. This is how the law became applied to Cannabis and now is an issue for all companies that operate within the legal industry but touch the plant in part of their daily operations, even in states where Cannabis has been made legal.
Is there a solution?
The best solution is having a proper 280E strategy in place for your Cannabusiness. This can be accomplished by making sure that you have the best professional team (Accountant, Lawyer, etc.) in your corner that are both knowledgeable and experienced in the Cannabis space to properly advise your company. Unfortunately, 280E will be an issue until we have federal legalization, but with the right guidance, steps can be taken to mitigate the impending tax effect on your company.
Important Upcoming Tax Deadlines
March 16, 2020 – S-Corporation Tax Returns and Partnership Tax Returns Due
April 15, 2020 – C-Corporation Tax Returns Due
April 15, 2020 – Individual Tax Filing Deadline