Section 280E is a provision in the United States tax code that has significant implications for businesses operating in the cannabis industry. This provision disallows deductions and credits for any business that traffics in controlled substances, including marijuana, which remains illegal at the federal level. In this article, we’ll explore what Section 280E is, how it affects the cannabis industry, and what businesses can do to minimize their tax liability.
What is Section 280E?
Section 280E was added to the tax code in 1982 in response to a court case involving a drug dealer who tried to claim business deductions on his tax return. The provision states that no deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business involving trafficking in controlled substances.
While the provision was intended to target drug dealers, it also applies to businesses operating legally under state law that traffic controlled substances at the federal level, such as cannabis. This means that cannabis businesses cannot deduct normal expenses, such as rent, utilities, and wages, when calculating their taxable income.
How Does Section 280E Affect the Cannabis Industry?
Section 280E has significant implications for the cannabis industry, as it increases the effective tax rate for cannabis businesses and makes it more difficult for them to be profitable. Because cannabis businesses are not allowed to deduct normal business expenses, they are effectively taxed on their gross revenue rather than their net income.
This can result in a much higher effective tax rate for cannabis businesses, as they are paying taxes on revenue that the cost of goods sold has already reduced.
Section 280E makes it difficult for cannabis businesses to raise capital and access traditional banking services. Because cannabis is still illegal at the federal level, most banks are unwilling to work with cannabis businesses, which makes it difficult for them to obtain loans or open bank accounts.
What Can Cannabis Businesses Do to Minimize Their Tax Liability?
While Section 280E presents significant challenges for cannabis businesses, there are steps that they can take to minimize their tax liability. One strategy is to minimize the cost of goods sold, as this is the only deduction allowed under Section 280E.
Cannabis businesses can manage their supply chain carefully and negotiate favorable terms with suppliers. They can also invest in automation and other efficiency measures to reduce labor costs.
Another strategy is to structure the business in a way that separates the sale of cannabis from other business activities that are not subject to Section 280E. For example, a cannabis business could also sell accessories like pipes and vaporizers, which would not be subject to Section 280E.
Additionally, cannabis businesses can work with tax professionals experienced in dealing with Section 280E and help them navigate the complexities of the tax code. Tax professionals can help cannabis businesses maximize their deductions under Section 280E while ensuring they comply with all relevant laws and regulations.