The 280E tax code in the United States prohibits businesses that traffic in controlled substances, such as marijuana, from taking deductions or credits for ordinary business expenses. White Rabbit urges all franchisees secure a CPA familiar with 280e and its ramifications.
Tax code 280E is a crucial yet often frustrating piece of legislation for cannabis retailers in the United States. Its history and ongoing impact reveal the complexities of federal cannabis policy and the financial challenges that legitimate cannabis businesses face today.
The History of 280e
The story of Section 280E begins in the early 1980s. In 1981, a convicted drug trafficker named Jeffrey Edmondson took an unusual step: he claimed ordinary business expenses on his federal tax return. Edmondson argued that, like any other business, he should be allowed to deduct the costs associated with selling illegal drugs, such as packaging, transportation, and even a portion of his rent. Surprisingly, the U.S. Tax Court agreed with him in a 1981 case, Edmondson v. Commissioner. The court allowed Edmondson to claim these deductions, which prompted outrage in Congress.
In response, Congress acted swiftly to close what it saw as a loophole. In 1982, it passed Section 280E of the Internal Revenue Code as part of the Tax Equity and Fiscal Responsibility Act. This provision states that no deductions or credits are allowed for any amount incurred in the trade or business of trafficking in controlled substances prohibited by federal law. While the language was originally aimed at illegal drug dealers, its consequences have profoundly affected the state-LEGAL cannabis industry.
State vs Federal
Even though cannabis is legal for medical and recreational use in many states, it remains classified as a Schedule I controlled substance under federal law. As a result, cannabis businesses are subject to 280E, meaning they cannot deduct ordinary business expenses such as rent, employee salaries, marketing, and utilities. The only deduction they are permitted to take is for the cost of goods sold (COGS) — essentially, the direct costs associated with producing or purchasing the cannabis products they sell.
The financial impact of 280E on cannabis retailers is significant. Most businesses in other industries can reduce their taxable income by subtracting a wide range of operating expenses. But for cannabis retailers, the inability to claim these deductions often results in effective tax rates that can reach 60% to 80%, compared to the 21% corporate tax rate paid by most other businesses. This puts cannabis retailers at a major disadvantage, forcing them to operate with tighter margins and higher prices, which can drive consumers to the illicit market.
The Challenges of 280e
The challenges of 280E compliance also extend beyond taxation. Cannabis businesses must meticulously track COGS to ensure they maximize their limited deductions, often requiring sophisticated accounting practices and legal guidance. Smaller cannabis retailers, in particular, may struggle to afford this level of financial oversight, further exacerbating their operational difficulties.
Despite its burdens, 280E has not gone unchallenged. Over the years, there have been multiple legal battles and legislative efforts aimed at either reforming or repealing this tax provision. The most notable among these is the STATES Act, which sought to exempt state-legal cannabis businesses from 280E, but it has yet to pass through Congress. The continued federal prohibition of cannabis remains the primary barrier to resolving this issue.
Looking to the Future, Hope on the Horizon
Looking forward, the future of 280E is closely tied to the broader movement for federal cannabis legalization. As public opinion increasingly favors legalization and more states adopt legal cannabis markets, pressure is mounting on Congress to address the inequities faced by cannabis businesses. Until then, retailers must continue to navigate the harsh realities of operating under a tax code that treats them as illicit enterprises, despite their compliance with state laws.
Section 280E is a relic of the War on Drugs that now serves as a significant financial obstacle for legal cannabis retailers. Its history is a testament to the unintended consequences of federal drug policy, and its impact is felt daily by businesses striving to provide safe, legal cannabis products to their communities. The eventual reform or repeal of 280E would not only level the playing field for cannabis retailers but also reflect the evolving attitudes toward cannabis in America today.
How 280e Tax Code Impacts White Rabbit Cannabis Franchises
This means that marijuana businesses are typically subject to much higher effective tax rates than other businesses, which can make it more difficult for them to be profitable. Additionally, 280E can make it harder for marijuana businesses to access traditional banking services, as many banks are hesitant to work with companies that are not able to take deductions on their taxes. Overall, 280E can make it more challenging for marijuana businesses to operate and be successful.
What Deductions Are Permitted For Legal Cannabis Retailers?
Under IRC 280E, cannabis dispensaries are not able to take the usual business tax deductions because marijuana is still a controlled substance under federal law. However, dispensaries can still take deductions for the cost of goods sold (COGS), which includes expenses directly related to producing and distributing the product, such as the cost of the marijuana plants and labor to cultivate them. However, those deductions would only apply to those that are “vertically integrated”, meaning the retailer is also growing and processing the products. .
Additionally, dispensaries can take deductions for expenses that are not considered to be “trafficking” in controlled substances, such as rent, utilities, and wages for employees who are not directly involved in the production or sale of marijuana. There are also some deductible expenses for some materials and goods sold, like cleaning supplies and paraphernalia.
The Good News
White Rabbit Cannabis franchisees benefit from years of experience dealing with the burden of 280e. While it is challenging, smart management and record keeping, plus knowing the intricacies of the 280e tax code allow us to flourish despite those tax burdens. If you are considering franchising with White Rabbit Cannabis, then we will work with you to address every issue associated with 280e. Toward that goal, we also vet your potential CPAs on their knowledge as well.
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