Will we see tax reform in 2023 for cannabis sellers? Specifically, will Congress finally get something done about the pain inflicted on industry by the Internal Revenue Code at 26 USC § 280E? (“IRC 28oE”.) It feels like a long shot, but you never know.
After many attempts to get the SAFE Banking Act through Congress, I can say that the industry feels a little defeated on the federal front. Dems had two years of control to get the SAFE Banking Act passed and politics basically kept it from going through. I’ve been on panels with many experts who rightly take the position that the way to get to federal legalization is through a piecemeal legislative process; chipping away at prohibition one legal reform at a time. Hence, SAFE Banking made a lot of sense.
Now that it’s dead and gone (for now), the industry may take some tiny hope in the fact that Republican House Representative Nancy Mace is back again with some cannabis legislation. She started with the States Reform Act (which has gone nowhere), but is now looking at the biggest issue for the industry next to banking: federal cannabis income taxes. Specifically, the application of IRC 280E. Even if Rep. Mace’s bill never passes, I’m glad to see her continue the fight, and now against IRC 280E.
IRC 280E is devastating for the cannabis industry
Banking headaches combined with the effect of IRC 280E makes for an industry killer. Arguably, IRC 280E is worse than the banking problem because cannabis businesses can at least rely on the 2014 FinCEN guidelines and the financial institutions that follow them to establish basic merchant accounts in most jurisdictions.
IRC 280E provides:
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.
IRC 280E was passed by Congress in 1982 in response to a case where the Tax Court ruled that a taxpayer could deduct expenses relating to his sales of cocaine, amphetamine, and cannabis. Deductible expenses included the costs of packaging, travel, and even scales used to weigh the illegal substances. Since cannabis is a Schedule I controlled substance, the IRS has used IRC 280E to disallow cannabis businesses from deducting their ordinary and necessary business expenses. The result is that cannabis companies face much higher federal tax rates than similar companies in other industries. There are differing opinions on the level of tax rates imposed on marijuana companies – from 40% to 70% to as high as 90% – all of which are higher than the standard corporate tax rate paid by most other businesses in the United States.
The impact of IRC 280E
The result of IRC 280E is that normal business expenses such as rent, advertising, and employee salaries don’t reduce taxable cannabis income unless they can be allocated to Costs of Goods Sold (COGS). For cannabis growers, COGS typically includes expenses directly related to production of the plants, such as the seeds, electricity, and labor that went into growing and preparing the flowers for sale. For cannabis dispensaries and distributors, COGS is much more restrictive, and generally includes only the amount they paid for the cannabis products they sell plus a few additional allocations.
In recent years, the IRS has increased its outreach to the industry to try to ensure compliance with IRC 280E. It even has a “Cannabis Industry” page on its website with industry FAQs. It’s good that the IRS is generally willing to educate cannabis businesses, but it doesn’t change the overall negative impact of IRC 280E. And federal courts have shown again and again that they have no appetite to change IRC 280E and that it’s Congress’s job to do so.
Mace’s IRC 280E bill
On December 30, 2022, Rep. Mace filed her IRC 280E bill right before the end of the 2022 Congressional session. It won’t go forward as written as a result, so she’ll have to re-file it accordingly for 2023. I wasn’t able to find the entire text of the proposed bill, but its summary text states that it serves ” To amend the Internal Revenue Code of 1986 to allow deductions and credits relating to expenditures in connection with marijuana sales conducted in compliance with State law”.
Will this be the one?
Sounds simple enough, right? Well, there’s a reason why IRC 280E has never been amended to accommodate the cannabis industry. And that’s because such an amendment could have significant collateral damage for taxes related to illegal activities around Schedule I and II drugs. Plus, I doubt that the IRS and federal government are so keen to give up the massive windfall provided by IRC 280E without full federal legalization taking place first.
Of course, with the correctly tailored language and so long as enforcement can do its job with the IRS, miracles can happen. Public sentiment likely supports such a measure to ensure that the state democratic experiments persist without bankrupting cannabis companies. But it’s unlikely in my opinion. Still, if and when Rep. Mace re-files this bill, I will be sure to analyze it and blog about it accordingly.