The old adage “Nothing is certain but death and taxes,” is accredited to the American wise man, Benjamin Franklin. Used in a letter penned over 225 years ago, this is still true today. Death has already been considered, briefly, but today’s post will focus on the other of life’s certainties – taxes. Although there is a current trend of legalization that is quickly becoming a national consensus regarding the way marijuana should be treated legally, a key point of contention between marijuana industry entrepreneurs and government officials are the tax codes on state and federal levels that impose harsh penalties and disincentives toward investment into cannabis capitalism.
Federal Taxes and Business Expenses.
American business is assisted greatly by one key piece of U.S. Tax Law – Internal Revenue Code Section 162. This provision allows for ordinary and necessary expenses for operating a business to be counted as a deduction against a business’ gross taxable income that is. This allows businesses to write off all the small purchases used to carry out normal operations. For an office, this would include paper, ink, pens, paper clips, and water for the water cooler. This significantly reduces the amount paid in taxes when they become due.
Edmondson and IRC 280E.
Consider the Marijuana dispensary. The ordinary and necessary costs for the production of marijuana would include dirt, nutrients, and water; business expenses for the retail side would be much like any other store. However, although all these costs would generally fall under the business and trade expenses deduction allowed under IRC Sec. 162(A), Congress stepped in following a rather embarrassing court case to change this. In Edmondson v. Comm’r, decided by the U.S. Tax Court in 1981, a business-savvy drug dealer in Minnesota kept very precise records of his costs and expenses, and claimed deductions under IRC 162 for his drug enterprise expenses. The Tax Commissioner disagreed and issued a tax deficiency, but the tax court agreed with Mr. Edmondson and allowed the deductions. Following that decision, Congress enacted IRC Sec. 280E, which barred any deductions or credit for business engaged in the trafficking of controlled substances, which the code defines as Schedule I and II. This again makes the DEA scheduling of Marijuana so important, because under this law a decrease to Schedule III or lower would make this law inapplicable to marijuana businesses.
Cannabis Corporate Construction.
As a result of this law, all marijuana stores legally operating within permissive states are barred from using one of the best tax benefits offered to American businesses. However, since the law was enacted, there have been two cases that have addressed this law in Court, and both decisions offered hope to cannabis company’s tax problems. The more recent case, Olive v. Commissioner, decided in 2015 by the 9th Circuit out of California, held that a business limited to the sale of marijuana was controlled by IRC 280E, and those expenses could not be deducted. However, the court noted the insufficiency of record keeping. Another case from California, Californians Helping to Alleviate Med. Problems, Inc. v Comm'r, decided in 2007, shows the hope competent corporate structuring can provide to marijuana marketers. The corporation had properly separated its caregiving services from marijuana sales, and as a result allowed the deduction for costs of caregiving not associated with marijuana. This shows that cannabis companies must be sure to keep precise records to show separate, distinct costs not associated with marijuana cultivation. Additionally, separating corporations into multiple business entities will allow the majority of costs to be deducted under IRC 162 as part of a retail sale business separate and distinct from a small, less capitalized business that grows and distributes the marijuana.
Current Congressional Efforts.
In 2015, there were bills introduced in the U.S. Senate and House of Representatives to repeal the effects of IRC Sec. 280E on marijuana sales in legalized states (114 H.R. 1855, 114 S. 987). Interestingly, representatives from both political parties have co-signed the bill. However, according to multiple legislative outlooks, there are very low chances of passages, but you can change that by writing your congressional representative and urging them to support these bills!