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Tax Challenges for Cannabis-Related Businesses in 2024

18 July 2024 / Category: Blog
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Cannabis-related businesses face significant tax challenges due to the complex legal landscape in the United States. Despite state-level legalization, cannabis remains illegal under federal law, creating unfavorable tax conditions for these businesses.

When Did Cannabis Become Subject to Unfavorable Federal Tax Rules?

Cannabis businesses have been subject to challenging tax rules since the federal government classified cannabis as a Schedule I controlled substance under the Controlled Substances Act. This classification means that cannabis is considered illegal at the federal level, despite being legal for medical or recreational use in many states.

Where Do These Tax Challenges Originate?

The primary source of tax challenges for cannabis businesses is Section 280E of the Internal Revenue Code. This section specifically targets businesses that are involved in the trafficking of controlled substances, including cannabis.

Why Is Section 280E Significant for Cannabis Businesses?

Section 280E of the Internal Revenue Code 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.”

This means that cannabis businesses cannot deduct ordinary business expenses such as advertising, rent, employee salaries, and insurance, which significantly impacts their profitability compared to other businesses.

Who Faces These Tax Challenges?

All cannabis-related businesses, including dispensaries, delivery services, and producers, are affected by Section 280E. This section does not distinguish between legal state-level operations and illegal activities, thus applying to any business involved in the commercial activities of cannabis.

How Can Cannabis Businesses Navigate These Challenges?

Cannabis businesses have attempted to challenge the application of Section 280E in court, but success has been limited. However, there are some strategies to mitigate the impact:

Legal Challenges:

  • Distinct Business Operations: Some businesses have succeeded in distinguishing their cannabis-related activities from other services. For example, a community center that also provides caregiving services may separate these activities from cannabis dispensing to claim deductions on the non-cannabis-related expenses.

Offsets for Cost of Goods Sold (COGS):

  • COGS Deductions: Despite Section 280E, cannabis businesses can still deduct the Cost of Goods Sold (COGS) from their gross receipts. COGS includes expenses directly related to the production or purchase of goods sold, which can help reduce taxable income. This is crucial because Congress can only tax income, not revenue, allowing for some financial relief.

Conclusion

Navigating the tax challenges posed by Section 280E is a complex but essential task for cannabis businesses. Understanding the limitations on deductions and leveraging COGS offsets are critical strategies. Business owners must stay informed about legal developments and consider structuring their operations to separate cannabis-related activities from other services to potentially reduce tax burdens.

For specialized insurance services tailored to the unique needs of cannabis, marijuana, and hemp companies, consult Cover Cannabis Insurance Services. Their expertise can help manage risks and ensure compliance with the complex regulatory environment. For more information, visit Cover Cannabis Insurance Services.

References

  1. NORML – Federal Tax Law
  2. Forbes – Cannabis Tax Challenges
  3. Internal Revenue Code Section 280E
  4. Cover Cannabis Insurance Services