IRS Code 280E compliance is essential for those operating in the cannabis space. If you are not in compliance with Code 280E, you may be subject to an audit or investigation by the IRS.
Keep reading for insights into IRS Code 280E compliance, loophole availability, COGS, and more.
What is Code 280E?
Code 280E is a section of the Internal Revenue Code that disallows deductions for business expenses incurred in the trafficking of controlled substances. This includes marijuana, even though it may be legal at the state level.
How does Code 280E impact cannabis businesses?
Since cannabis is still illegal at the federal level, businesses involved in its cultivation, production, and sale are not able to take standard business deductions on their taxes. This leaves them paying a higher effective tax rate than most other businesses.
What deductions are allowed under Code 280E?
The only deductions allowed under Code 280E are those related to the cost of goods sold (COGS). This includes the direct costs associated with growing and selling cannabis, such as the cost of labor, materials, and overhead. All other business expenses, such as marketing, rent, and payroll, are not deductible.
Loving this post? Make sure to check out our other article about how 280E applies to growers before you go!
The 280E loophole ensures that state-legal cannabis businesses can deduct their business expenses, somewhat like any other business. However, 280E still has some limitations for those operating in this space.
For example, while cannabusinesses can deduct COGS, they’re not able to deduct other business expenses, such as marketing or rent.
In order to take advantage of this loophole, businesses must be sure to keep detailed records of their expenses and income. They must also file their taxes correctly, which can be complicated given the unique nature of the cannabis industry.
Cannabis businesses must also be aware of the risks associated with operating in a still-federally illegal industry. This includes the risk of audit or investigation by the IRS.
Despite these risks, many businesses feel that the benefits of operating in the cannabis industry outweigh the challenges. The industry is growing rapidly, and those who are able to navigate the complexities of complying with Code 280E will be well-positioned to succeed in this rapidly growing industry.
280E Cost of Goods Sold Explained
COGS includes direct costs associated with the production and sale of cannabis, such as labor, materials, and overhead. All other business expenses are not deductible. This leaves cannabusinesses with a higher effective tax rate than most other businesses.
Thus, while traditional businesses have write-offs they can take advantage of, like payroll, advertising, and marketing expenses; businesses in the cannabis industry are much more limited.
The reason for this is because of how COGS is defined. For a product to be considered a COGS item, it must be “tangible personal property” that’s “produced for sale.” This leaves out things like services, intangibles, and real property.
This leaves many common business expenses, like payroll and advertising, out of the COGS calculation. As a result, businesses in the cannabis industry have a higher effective tax rate than most other businesses.
FAQ About IRS Code 280E
Who does 280E apply to?
280E applies to businesses involved in the cultivation, production, and sale of cannabis. Among those impacted is medical dispensaries, cultivators, marijuana retail stores, and manufacturers of infused products. This legislation also applies to those producing concentrates and cannabis oil.
What can be deducted under 280E?
Cannabis business operators are allowed to deduct the cost of goods sold. This includes all of the expenses and costs that come about directly as a result of production. Standalone cannabis retail operations are allowed to claim deductions for the invoice price of cannabis minus any discounts.
Does 280E apply to growers?
Yes, 280E applies to growers, as well as any other business involved in the cultivation, production, and sale of cannabis. While challenging to make deductions as a cultivation operation, it’s not impossible!