With states across the country legalizing cannabis, the industry is growing at a significant rate. As more states consider legalizing, experts expect the industry to reach $30 million by 2025.
While states are legalizing cannabis for medical and recreational use, it’s still illegal on the federal level. The federal government lists cannabis as a Schedule I drug in the Controlled Substance Act (CSA). And, even though the federal government lists it as an illegal substance, cannabis businesses are still required to pay federal income taxes. The thing is, they’re subject to Section 280E of the Internal Revenue Code, a code that isn’t likely going anywhere anytime soon.
What Exactly Is IRS Code 280E?
IRS Code 280E is often the bane of cannabis companies. This code prohibits businesses from deducting any expenses from their gross income that are related to the “trafficking” of Schedule I or Schedule II controlled substances. The only thing that cannabis companies can deduct from their federal income taxes is the cost of goods sold (COGS).
What Happens if 280E Goes Away?
Eliminating 280E would mean that cannabis businesses could take the same deductions as other businesses. Rather than only deducting the cost of goods sold, they’d be able to deduct overhead and administrative costs, as well as take advantage of federal tax credits. It would also mean that businesses dealing legally with other Schedule I and II controlled substances could do the same.
Why Won’t the IRS Eliminate It?
Cannabis businesses would definitely benefit financially from the elimination of 280E. Since cannabis companies can only deduct the cost of goods sold, their effective tax rate is much higher than that of other businesses.
Let’s say both a cannabis and a non-cannabis business make a gross revenue of $1 million and have a cost of goods sold totaling $700,000. The non-cannabis business can also deduct business expenses. If those expenses total $200,000, their taxable income becomes $100,000.
The cannabis company, on the other hand, has a taxable income of $300,000. At a 30% tax rate, the non- cannabis business only pays $30,000, where the cannabis business pays $90,000. That’s a very big difference.
By eliminating 280E and allowing cannabis businesses to take the same deductions as other businesses, your company could save a substantial amount of money. The thing is, the code isn’t going anywhere.
One reason why 280E isn’t going away is that it applies to businesses dealing with other controlled substances, not just cannabis. Another reason is that by only allowing the deduction of the cost of goods sold, cannabis companies have more taxable income. While this is less than ideal for businesses who have to pay those taxes, it provides a greater revenue source for the IRS. By getting rid of 280E, the IRS wouldn’t bring in nearly as much money.
Important Upcoming Tax Deadlines
9/15/2020 – Partnership and S-Corporation Extended Tax Filing Deadline
10/15/2020 – Individual Tax Return and C-Corporation Extended Tax Filing Deadline