The old adage “Nothing is certain but death and taxes,” is accredited to the American wise man, Benjamin Franklin. Used in a letter penned over 225 years ago, this is still true today. Today’s post will focus on the arguably less dark of life’s certainties – federal taxes. Currently, the nationwide trend toward legal access to medical cannabis has resulted in a growing regulated marijuana industry. However, entrepreneurs and government officials are still at odds over some tax codes that impose harsh penalties and disincentives toward investment or operation of a cannabis venture.
Federal Taxes and Business Expenses
One important deduction available to American business under current U.S. Tax Law is Internal Revenue Code Section 162. This provision allows for ordinary and necessary expenses for operating a business to be deducted from a business’ gross income. This allows most businesses to write off all the small purchases used to carry out normal operations. An office’s expenses would likely include paper, ink, pens, paper clips, and even water for the water cooler. This significantly reduces the amount paid in taxes when they become due, because the business is not paying taxes upwards of 15% on money spent in daily operations.
History of IRC § 280E - The tax-savvy drug dealer
Consider the Marijuana business and what materials would be required to start and operate it. The ordinary and necessary costs to produce marijuana would include dirt, nutrients, electricity, light bulbs, water and all the other standard expenses incurred in the operation of an agricultural or retail business. Although all these costs would generally fall under the business and trade expenses deduction allowed under IRC Sec. 162(A), Congress stepped in following a surprising result to drug trafficking trial. In Edmondson v. Commissioner, decided by the U.S. Tax Court in 1981, a business-savvy drug dealer in Minnesota kept precise records of his costs and expenses and claimed deductions under IRC 162 for his drug enterprise expenses. The Tax Commissioner disagreed and issued a tax deficiency; surprisingly, the tax court sided with Mr. Edmondson and allowed the deductions. Following that decision, Congress enacted IRC Sec. 280E, which barred any deductions or credits for business engaged in the trafficking of Schedule I and II controlled substances. This tax rule makes the DEA scheduling of Marijuana even more important, because an administrative change to decrease marijuana to Schedule III or lower would make sec. 280E inapplicable to marijuana businesses.
Cannabis & Corporate Construction
Because of sec. 280E, all marijuana stores legally operating under state law are barred from using one of the best tax benefits offered to American business. However, since the law was enacted, there have been two cases that have addressed this law in Court, and both decisions offered solid guidance to cannabis company’s problems with federal taxes. Olive v. Comm’r, decided in 2015 by the 9th Circuit, held that a business limited to the sale of marijuana was controlled by IRC 280E, and those expenses could not be deducted. However, the court noted the insufficiency of recordkeeping and failure to follow corporate formalities such as minutes, governing documents, and lease arrangements. On the other hand, the 2007 case Californians Helping to Alleviate Med. Problems, Inc. v Comm'r highlighted the benefit of competent corporate structuring and oversight in a marijuana venture. The corporation in this case properly separated its caregiving services from marijuana sales, and as a result was permitted the deduction for costs of caregiving not associated with marijuana. The varying results of these two cases show that cannabis companies must focus on corporate management, structure, and precise recording to allow for maximum tax deductibility for distinct costs unassociated with marijuana cultivation or sale. It is important to consult with a corporate attorney for organizing or incorporating your cannabusiness. Separating organizations into multiple business entities will allow more operational costs to be deducted under IRC 162 as part of a healthcare or support business separate and distinct from a small, less capitalized business that grows and sells the marijuana.
Current Congressional Efforts
Most people have heard of recent news regarding the major changes to federal taxes. Unfortunately, IRC sec. 280E is still in full effect. There is not likely going to be any political pressure on the DEA to change marijuana’s scheduling from the current administration under President Trump or Attorney General Sessions. Fortunately, representatives from both political parties have co-signed bills to repeal IRC 280E and allow more financial and banking services for the regulated marijuana industry. This is a positive indicator that congress may enact changes within the next several years as more states shift their policies to allow medical marijuana.
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***This is for informational purposes only. The preceding blog post cannot and should not be taken as legal, tax, or business advice. Any reliance upon this information in that capacity is unreasonable.***