Understanding the tax issues and problems posed by Section 280E
As highlighted in many prior posts, students in my marijuana law school seminar are in the midst of assembling readings and leading discussions concerning the research topic(s) that are the focal point for class project(s). This week, besides the prior topics noted here and here that still on the agenda, is for review of the impact of a federal tax code provision that creates unique problems for state-legal marijuana businesses. Cribbing from this on-point commentary, my student provides this introduction to this issue:
In 1982, Congress enacted Section 280E of the Tax Code as a way to punish drug traffickers . . . This provision of the Tax Code disallows all deductions and credits for business expenses related to the trafficking of illegal drugs. Since the federal government classifies marijuana as a schedule I narcotic, marijuana falls under this regulation. In 2007, in Californians Helping to Alleviate Medical Problems Inc. (CHAMP) v. Commissioner of Internal Revenue, the U.S. Tax Court ruled that IRC 280E applies to cannabis businesses operating legally pursuant to state law.
Despite the foregoing, marijuana operators are able to mitigate some of the impact of 280E in two ways, costs of goods sold (COGS) and deductions for non-trafficking services and expenses. Per the CHAMP case, marijuana businesses can still take COGS. Namely, COGS should amount to those costs that go into the production and/or manufacturing of the cannabis. But it has never been clear what the IRS will actually accept as cannabis COGS.
On January 23, 2015, the IRS released an internal legal memorandum outlining how Section 280E should be applied in the cannabis industry. Though this memorandum may not be used or cited by taxpayers as precedent, it outlines how some IRS officials analyze Section 280E and how to determine COGS. In the IRS memorandum, marijuana retailers and producers are required to compute COGS under inventory rules that predate the enactment of Section 280E . . .
Ultimately, the memorandum outlines a very narrow reading of the costs that can be included in COGS by suggesting that the IRS will not allow cannabis businesses to allocate purchasing, handling, storage, and administrative costs to COGS.
In addition to COGS, CHAMP also dictates that a marijuana business that provides other non-cannabis related services, like yoga, massage, or education, can deduct expenses related to those other lawful services . . . For example, a cannabis business can maximize the physical floor space it devotes to other services and minimize the floor space it devotes to cannabis sales. It could give employees not directly involved in cannabis distribution job tasks that do not involve cannabis. This way, the marijuana business can place the greatest amount of expenses in the “deductible” column, resulting in a smaller tax hit.
Cannabis businesses will only attain full relief from Section 280E when Congress amends the Tax Code or when Congress re-schedules or decriminalizes marijuana. (See also: Olive v. Commissioner).
My student also provided links to these stories highlighting the practical impact of Section 280E: