IRC Tax Code 280E Explained

Cannabis industry banking comes with a host of challenges, especially when it comes to tax regulations. The businesses in this industry need to pay special attention to the 280E tax code and to know exactly why it’s important and how to deal with it. This piece of legislation, a mere sentence long, has profound implications for cannabis businesses across the United States. Let’s take a deep dive into everything you need to know about this code.

What is the tax code for cannabis in the IRS?

If you plan on opening a dispensary or already own one, you’ll have to be familiar with this law. IRC section 280E was enacted in 1982. It was initially designed to prevent drug traffickers from claiming business expenses on their federal tax returns. However, with the legalization of the plant for medical and recreational use in various states, this has become a significant hurdle for legitimate cannabis businesses.

The code reads as follows: “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.”

In simpler terms, if your business deals with cannabis (a Schedule I substance under federal law), you’re barred from deducting typical business expenses from your gross income. All businesses involved in the industry, from growers and processors to dispensaries, are subject to this restriction. 

Why does 280E exist?

The law was introduced after a court case where a convicted cocaine, amphetamine and cannabis trafficker successfully claimed his business expenses and got tax deductions. To close this loophole, Congress established this law, which was supposed to bar businesses dealing with Schedule I or II substances from writing off common business costs. 

Although it originally targeted illegal drug operations, 280E accounting now significantly impacts legal businesses due to the federal classification of the plant.

How does Section 280E have an effect on the cannabis business?

Unlike other industries, where businesses can deduct a wide array of expenses, marijuana accounting is significantly restricted. They can only deduct the cost of goods sold (COGS), which directly affects their taxable income and, ultimately, their profitability.

This is why these businesses need to clearly determine what falls under COGS if they want to minimize their financial burdens. Generally, COGS includes the direct costs associated with producing or purchasing your inventory. For cultivators, this might include seeds, soil, and water, while dispensaries can include the cost of purchasing products for resale.

However, the IRS has been tightening the definitions of what can be included in COGS. For this reason, it’s extremely important to keep meticulous records and stay informed about the latest guidelines.

How to avoid 280E?

You can’t avoid this regulation if you want your business to stay legitimate and compliant. But how do dispensaries pay federal taxes and make a profit with this restriction in place? They may not be able to avoid the regulation, but they can make the best of it with a strategic approach. Here’s what you can do to navigate this obstacle more effectively:

1. Adjusting your business structure

Separating business activities can sometimes help. For example, a cannabis retailer might create a separate legal entity for merchandise that’s not directly related to the plant. For this separate entity, they can apply standard business deductions, without the limitations that their primary business has.

2. Maximizing COGS

It’s important to understand all the nuances of what you can include in COGS. A business solution professional who specializes in this industry could provide more insight on how to maximize these deductions legally. 

3. Impeccable record-keeping

Keeping your records detailed and organized is non-negotiable. In the event of an audit, clear documentation of your COGS calculations and business expenses will be your best defense.

4. Staying informed

Laws and their interpretations can evolve, especially as the legal landscape around the plant changes. You’ll need to stay updated on the latest IRS guidelines and court rulings to stay compliant and optimize your strategy.

Is 280E still in effect?

This regulation affects more than just tax filings. It affects the overall financial health of a business, influencing everything from pricing strategies to profit margins and the ability to attract investment. The way you handle it can make a significant difference in the viability and success of your business operations.

There’s a growing movement advocating for reform or repeal of IRC section 280E, especially as more states legalize the plant and recognize its medical and economic benefits. Several states, including California, Virginia, Minnesota, Maryland, and many more, have taken measures to decouple from this code, fully or partially. 

However, it’s important to note that this decoupling applies only to state filings. At the federal level, deductions other than COGS are still prohibited. This reflects the ongoing conflict between state and federal laws in this industry. While there has been discussion at the federal level about reforming the law, no legislative changes have been made yet.

How do I find dependable banking for the cannabis industry?

Stay ahead in the complex regulatory landscape with Green Business Solutions. Specializing in cannabis-specific regulations and compliance, we offer expert guidance to ensure your business meets all legally required obligations.

Our seasoned professionals are well-versed in the unique challenges that businesses like yours have to face. Partner with us and focus on growth while we handle the rest. Contact us today to see what we can do for you.