Section 280e of the Internal Revenue Code (IRC) is a provision that prohibits businesses from deducting “ordinary and necessary” expenses related to the sale of controlled substances. This provision includes operations that deal in cannabis, even when legal under state law.
The effect of section 280e is that cannabis businesses get taxed on their gross income rather than their net income. As you might already understand, this can result in significantly higher tax liability for cannabis businesses.
Other ways 280e could harm cannabis operations
As mentioned, cannabis businesses subject to section 280e must pay taxes on their gross income. Essentially, this means that all income from a cannabis operation is subject to tax, whether the expenses related to that income are deductible or not. A higher tax liability (compared to other businesses) can harm a cannabis business owner’s bottom line.
3 more ways the section can damage operations:
- It may impact marketing efforts. When a cannabis business cannot deduct marketing and advertising costs, it could lose money and fail to attract more customers.
- It may increase audit risks. The IRS has a lot of discretion in interpreting section 280e and may challenge the deductions claimed by cannabis businesses during an audit.
- It may complicate accounting practices. Cannabis businesses bound by section 280e must be extra diligent with their accounting to justify their deductions to the IRS.
California cannabis operations stand to lose millions in income due to section 280e. You might not realize this, but it may be possible to defend your business if challenged or audited by the IRS, keeping your income safe from undue taxation.
Consulting with someone who understands the ins and outs of tax and cannabis laws can make a huge difference in your bottom line.