If you are in the cannabis industry, you should already know Section 280E of the Internal Revenue Code. It consists of only one sentence:
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.
In simple terms, 280E denies a cannabis business the ability to deduct its business expenses in computing its Federal income tax liability. How this actually works and how can you plan around it are topics beyond the scope of this post, so I suggest you familiarize yourself before continuing. I’ll wait…………..
Ok, are you back? Section 280E of the Internal Revenue Code has been on the books for close to 40 years, so, as the title of this post asks, why are we still having this discussion? We are having this discussion because too many people in the cannabis business, including accountants and lawyers, really don’t know about or understand 280E. Some of my clients ask me to review financial information for cannabis companies in which they are considering investments. In some cases, there is no analysis of the impact of 280E on cash flow. Spoiler alert #1, after considering 280E there may be no cash flow. In other cases, we are told the company’s accountant has good strategies for minimizing the effects of 280E. Spoiler alert # 2, the IRS has won every 280E case that went to court, and it plans on increasing its audits of cannabis businesses in the future. Last but not least, spoiler alert #3, the management company that doesn’t own any cannabis still can be subject to 280E.
So what’s a budding cannabis entrepreneur to do? First, hire an experienced cannabis accountant. This is not like other businesses. Second, hire an experienced cannabis lawyer. Third, get the accountant and lawyer talking to each other about structuring the business in a way that addresses 280E issues. It may be more expensive initially, but it will be much cheaper in the long run. If you are asked to make an investment in a cannabis business that does not fear and respect section 280E, be cautious of the cash flow numbers. The cash flows may not be accurate, and the company may have hidden tax liabilities of which it is not aware. Finally, don’t invest in cannabis or get into the business with the expectation that the 280E problem will go away any time soon.