280E Compliant Taxes
Due to the fact that Cannabis is classified as a Schedule I drug, all Cannabis touching companies must comply with 280E. So if you’re in the business of harvesting, producing, manufacturing, or selling Cannabis in any way, shape, or form, your business is not able to legally take deductions.
IRC 280E clearly states:
No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances (within the meaning of schedule I and II of the Controlled Substances Act) which is prohibited by Federal law or the law of any State in which such trade or business is conducted. Source: Cornell Law
Naturally, Cannabis investors, CEOs, and accounting professionals are going to try their hand at getting around 280E, but if you’ve been paying any attention at all, one would know that this is a terrible idea for the simple fact that the tax courts are winning cases against Cannabis companies left and right. But can you blame them? 280E is crippling. Having to pay state and federal taxes on 100% of income without any legal deductions cuts massively into profits, and in some cases it can make it hard to be competitive within the market if the product is too expensive.
How can Cannabis companies legally reduce their tax liability?
The answer lies in IRC 471. What makes reducing tax liability even more complex is that the rules vary from vertical to vertical, and can make things even more complicated for companies that have several verticals integrated within their business.
- IRC 471 gives an overview and applies to all Cannabis companies. It states that the method used for inventory must "clearly reflect the income". Also, it must conform to how the client accounts for inventory in the financials, which is usually going to be GAAP and Lower of Cost or Market (LCM).
- IRC 471-2 applies to all cannabis companies as well, and states how you must value inventory. It again says that the inventory must clearly reflect income and be consistent (usually going to be Lower Cost or Market, which is also GAAP).
- IRC 471-3 can be applied to retailers/dispensaries.
- IRC 471-11 is for cultivators, edible producers, and extract/processors. It requires GAAP if you want to maximize what is included in COGS. Also, 471-11 lists applicable ways to allocate costs via Burden Rate, Standard Cost, or Practical Capacity. We use a Practical Capacity approach in our firm.
So knowing the law when it comes to maximizing your taxes in the Cannabis industry is key. At the THC CPA's we understand the law, in and out, and work with our clients to ensure the proper Internal Revenue Codes (IRC's) are being adapted and used.