How to Navigate the Dreaded Tax Code 280E
Inside insight on how cannabis businesses can navigate the code ahead of this year's tax season.
When it comes to running a cannabusiness, one glaring problem persists: the IRS says cannabis businesses are illegal and cannot deduct most expenses when filing taxes, despite being legal at the state level. Adding insult to injury, most banks won’t work with anyone in the industry, whether they are or aren’t plant-touching.
How is filing taxes possible for an illegal business? To understand, you have to go back to the 1980s. An illicit drug dealer named Jeffrey Edmonson sued the United States Tax Court while deducting business expenses from his highly illegal cocaine, amphetamine, and cannabis trafficking scheme.
You’d think the court would have quickly dismissed the case, but the U.S. Tax Court actually ruled in his favor. Edmonson was allowed to write off certain business expenses for his illegal drug trafficking business, including the cost of goods sold (COGS), home expenses, packaging, phone expenses, and even his vehicle usage.
Enter Tax Code 280E
After this embarrassing failure in court, the U.S. Tax Court scrambled to fix things, and courts overturned the case the following year. The IRS then implemented Tax Code 280E, which states that drug dealers cannot write off business expenses from illicit activity, specifically drugs listed on the Schedule I and Schedule II substances lists. It makes logical sense that the courts should never have given Edmonson the authority to write off expenses in the first place as a criminal. However, the IRS guidance further ruled that even illegal businesses, which still owe taxes, can deduct a few specific items from their gross income. This article goes into more detail about deductions and audits.
When individual states began legalizing cannabis and lawful businesses were created, legally operating cannabis businesses suffered and couldn’t write off nearly as many expenses as businesses in other industries. The U.S. government reported a mind-boggling $4.7 billion collection in cannabis taxes during 2017, despite cannabis businesses reporting a little less than $13 billion in total sales, which signals an imbalance.
The policy is unfair and makes zero sense. It’s easy for cannabis business owners to get frustrated and complain that taxes should be easier, but the best course of action, for now, is for companies to use their voices to advocate for change while navigating the nuance of tax law in a technically illicit industry. Here are some tax tips for 2021.
Document, Document, Document
The number one thing cannabis businesses can do to combat Tax Code 280E is to document every move you make thoroughly.
It’s not sexy to talk about, but the cost of goods sold (COGS) are the only business expenses eligible to deduct from gross income and lower tax liability. To successfully deduct this expense from taxes, businesses must have thorough documentation that proves their numerical claims. Ensure that there is more than one person in your operation who knows the financial data, back up all of your data, and remember that spreadsheets only tell part of the story. Utilizing a cannabis-specific ERP or track and trace software can make sure you have tax and audit information on hand and that it is easily accessible to anyone who needs it in an instant.
Alterman vs. Commissioner is a 2018 case that highlights the importance of fail-proof recordkeeping in the cannabis industry. The service ended up denying Laurel Alterman’s appeal to deduct cannabis-related business expenses from her retail shop in Colorado. The court, in fact, determined deficiencies and accuracy-related penalties for 2010 of $157,821 $31,564, and for 2011 of $233,421 and $46,684. She did not separate her cannabis expenses from her non-cannabis ones, and therefore couldn’t deduct business expenses from either venture.
Get good software
It is not difficult to properly document. We are already forced to have software in place for track and trace regulations, so why not utilize the same software to meticulously document for tax purposes? The cannabis industry needs every tax break available, and we have only been given one category. If the IRS knocks on your door, the correct data from the right software sends them packing.
Know what to Deduct Under 280E
Here are some things cannabis businesses need to keep track of and can deduct from their business expenses:
- Invoice price for cannabis;
- Transportation (including cost and shipping costs of cannabis, and cost travel costs to purchase it);
- Electricity (can only be deducted in inventory areas, not sales floors);
- Raw materials and supplies for cultivation (like seeds, clones, fertilizer, etc.);
- Direct labor before the sale (cleaning, packaging, trimming, harvesting, etc.); and
- Indirect costs like equipment maintenance, tools used to grow cannabis, etc.
Standalone dispensaries are limited to deducting: the cost of the product and the costs of acquiring the merchandise, including transportation costs to buy wholesale.
Don’t Let Human Error Ruin Tax Season
It’s not wise to rely on humans to compute such tedious information. This anecdotal observation proves the deep need for cannabis-literate, multi-functional, and deep-seated software that integrates with all businesses and serves their unique needs as a “technically illegal” business.
Colton Griffin is CEO of Flourish Software, a technology provider of enterprise supply chain and inventory management software built for cannabis, CBD and hemp operations. He may be reached at email@example.com.