The Internal Revenue Code Section 280E, established in 1982, has been a significant financial hurdle for the cannabis industry. This tax code provision specifically targets businesses that traffic controlled substances, including cannabis, which is classified as a Schedule I drug under the federal Controlled Substances Act. As a result, these businesses are unable to deduct most ordinary business expenses from their gross income or receive tax credits, leading to increased taxable income, far exceeding that of what traditional business owners and operators are accustomed to.
State-Level Changes to Tax Code 280E
In 2023, the implications of this tax code on the regulated cannabis industry remain substantial. Despite the fact cannabis is legal for medicinal use in 40 states and for recreational use in 23 (as of August 2023), cannabis businesses are still considered drug traffickers under federal law and are therefore subject to Section 280E. This results in these businesses facing higher federal tax rates, often between 40% and 80%, compared to the standard 21% corporate tax rate. However, there have been some changes and updates to tax code 280E that will impact the regulated cannabis industry in 2023. For instance, New York State’s 2023 budget includes an exemption from IRC Section 280E for licensed cannabis businesses, allowing them to take tax deductions for business expenses and claim credits at the state level. Similarly, in California, Governor Newsom signed Assembly Bill 37 into law in October 2019, eliminating the state’s conformity with IRC Section 280E for licensed Personal Income Tax (PIT) cannabis businesses.
Persistent Challenges Posed by Section 280E
Despite these state-level changes, the burden of Section 280E remains a significant challenge for the cannabis industry. The inability to deduct normal business expenses such as rent, advertising, and employee salaries from taxable income unless they can be allocated to Costs of Goods Sold (COGS) continues to financially strain these businesses. Furthermore, the Employee Retention Credit (ERC), a payroll tax credit, is available to cannabis businesses that meet the program’s requirements, potentially delivering significant recovered costs to businesses with W-2 employees. In conclusion, while some states have taken steps to alleviate the tax burden imposed by Section 280E on the cannabis industry, the federal tax liabilities associated with this provision continue to pose significant challenges for these businesses in 2023.
The Effect of 280E on the Evolving Landscape of Cannabis Legalization
Additionally, the evolving landscape of cannabis legalization and regulation further complicates the implications of Section 280E on the regulated cannabis industry in 2023. As more states embrace the legalization of cannabis for medical and recreational purposes, the industry experiences rapid growth and increased competition. However, the federal tax restrictions imposed by Section 280E hinder the ability of cannabis businesses to thrive and reinvest in their operations.
One major consequence of Section 280E is the limited access to traditional banking services for cannabis businesses. Due to the federal classification of cannabis as a Schedule I drug, financial institutions are often reluctant to work with cannabis companies in fear of potential legal repercussions. This lack of access to banking services restricts cannabis businesses from obtaining loans, accepting credit card payments, and even opening basic checking accounts. As a result, many cannabis businesses operate on a cash-only basis, which poses security risks and makes financial management more challenging.
Disadvantages Faced by the Regulated Cannabis Industry
Moreover, the inability to claim deductions for ordinary business expenses puts the regulated cannabis industry at a significant disadvantage compared to other sectors. While businesses in most industries can deduct expenses such as marketing, research and development, and employee benefits, cannabis businesses are forced to allocate as many expenses as possible to the COGS category to minimize their taxable income. This creates a distorted financial picture and limits the ability of cannabis businesses to invest in crucial areas like research, innovation, and expansion.
Furthermore, the unequal tax treatment resulting from Section 280E discourages compliance and encourages illicit activities. Some cannabis businesses may resort to underreporting their income or engaging in questionable accounting practices to mitigate the impact of this tax provision. These actions not only undermine the integrity of the industry but also continue to perpetuate cannabis stigmatization.
The Push for Comprehensive Federal Reform
In light of these challenges, there is growing momentum for comprehensive federal reform of cannabis laws, including a reconsideration of Section 280E. Advocates argue that treating cannabis businesses like any other legitimate industry will promote transparency, economic growth, and job creation. The potential tax revenue generated from a regulated cannabis market could also contribute to funding public services and initiatives.
In conclusion, while there have been some positive developments at the state level to address the implications of Section 280E on the regulated cannabis industry, the federal tax restrictions remain a significant obstacle for owners and operators in 2023. The ongoing efforts to reform cannabis laws and promote equitable treatment for cannabis businesses highlight the need for comprehensive changes at the federal level to ensure the long-term viability and success of the regulated cannabis industry. For more information on how to manage the implications of Section 280E on your cannabis business, reach out to a qualified tax advisor.
Author
Emily Wells, Membership Manager, Cannabis Marketing Association
What started as a perhaps juvenile enthusiasm for cannabis sparked an intense career interest when my time at CU Boulder approached its end, and my professors insisted that the most fulfilling careers combined your innate talents with your truest passions. Through classwork and internship opportunities, my intuitive communication skills and love for cannabis were seamlessly integrated, and my passion for the plant grew tenfold.
In my time at Cannabis Marketing Association, I’ve been given incredible opportunity to grow in my personal role and help scale the organization, all while navigating the intricacies of the cannabis industry and remote work. Now fortunate enough to be part of an industry still in its infancy, I’m eager to amplify my communicative adroitness and ability to establish meaningful relationships, while speaking truthfully and authentically about a plant hidden in the shadows of stigmatization and empowering others to do the same.
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