With the rules around cannabis changing on an almost constant basis, it’s hard to stay on top of things. It’s illegal in one state but legal in another. It might be medically legal but illegal recreationally in another state. Trying to understand how to comply with taxes on top of everything else is an annual headache. The 280e tax code is confusing, for sure. But we can help. Read on.
How cannabis business taxes work on the federal level
Income reporting: no matter the industry, you have to comply with paying Uncle Sam your fair share of what’s owed. This includes income from any and all sources. Taxpayers must file a tax return, reporting income to the IRS. I get it; banking access makes things more difficult for cannabis businesses, and most transactions are cash. That said, from a 40,000-foot view, the IRS requires all companies to meet their tax responsibilities. For cash-centric companies like ours, you must report all cash transactions and pay taxes accordingly. The IRS refers to this as ‘enforcing the law with integrity and fairness to all.’
Estimating payments: Not all businesses (or individuals) can afford to pay their entire tax bill in one swoop. That’s where estimated payments can help. Small businesses can make quarterly tax payments — estimated to cover their annual tax obligation. Form 1040-ES can help you figure out what your taxes should be every year and what the quarterly tax payments would look like.
Download IRS Form 1040-ES for guidance on estimated tax here.
Advice: Keep good records. This is critical; you want to back up the items reported on your tax returns. It’s easier to do this in real-time rather than rely on notes or memory. Get a solid recordkeeping system in place. Record daily transactions. Track deductible expenses. Talk to your accountant or tax preparer if you have questions or need additional help specific to your situation.
Find an accountant who can help you with cannabis-specific accounts and reporting here.
IRS 280e tax code/challenges
Think back to olden times, specifically 1981. That’s when the IRS came out with tax code 280e. The war on drugs was in full swing.
Scene: a drug trafficker was fighting for his rights in tax court — he wanted to deduct ordinary business expenses from overall taxable income — and the court ruled in his favor. The advent of COGS (Cost of Goods Sold) was born and with it 280e.
After the tax court case, the drug trafficker was allowed to deduct things like packaging materials and phone, vehicle, and home expenses as the cost of goods sold. Boom. Unfortunately, that victory was short-lived; the following year, the decision was overturned.
The COGS phenomenon was no longer applicable if you were a business owner selling Schedule I and/or II controlled substances. What’s more, Section 280e prohibits cannabis businesses (and any others “trafficking” Schedule I and II controlled substances) from taking any tax credits that might apply to other industries. In other words, you don’t get to deduct regular business expenses, and you don’t get tax credits.
No wonder that 280e is a thorn in the side of the cannabis industry.
The fact that the feds consider weed illegal continues to plague state-legal cannabis businesses at tax time. The deductions offered to other businesses elude the industry. This is how the IRS effectively opposes what the feds consider illegal businesses while also demanding their fair share of tax. So while the feds and IRS lumps all cannabis businesses as part of the drug trafficking category, they still want their money. Every last cent. Hand it over.
There is one silver lining for cannabis businesses: COGS. While not much of a break, when Congress passed Section 280e, they decided to soothe their fear of potential constitutional challenges to the new law, and with that came a small exclusion; COGS. This allowance means COGS applies to products considered illegal federally. The provision isn’t much, but at least it’s something.
The cost of goods sold (COGS) applies primarily to inventory costs — including the actual product, the shipping costs to the retail location — and any other directly-related expenses. Expenses related to the distribution process, however, are not part of the COGS allowance.
At the core, COGS pretty much only applies to purchases involving seeds, soil, water, and nutrients. Again, talk to your accountant or tax preparer to ensure you’re compliant and keeping records on what is required to substantiate the COGS exclusion. For now, however, it’s best to remember that any expenses associated with the distribution process itself cannot be lumped under COGS. For now, anyhow.
If you’ve been involved in the cannabis industry, you know about the banking issues surrounding it. A quick summary goes like this: cannabis businesses might be considered legal in some states, but they’re one hundred percent illegal federally. Banks are insured by the feds. They do not want anything to impact their FDIC or NCUA protection, so banks are caught between the federal regulatory regime and the state.
Some banks or credit unions work with the cannabis industry, but these banking privileges are sparse, and they are expensive. For those that don’t have banking access, all business is done in cash. Tax payments are then paid with cash, and the IRS has acknowledged that this practice is not only risky but requires security and physical space to hold all-cash tax payments.
The IRS has provided some guidance on this topic.
Cash payment options
The IRS wants their taxes fair and square, no matter the industry. Congratulations. For cash-based businesses (like those in the cannabis world), cash payment options are available for all taxpayers classified as ‘unbanked.’ If you’re in this category and need to pay taxes, some IRS Taxpayer Assistance Centers take cash. Locations that accept cash typically require an appointment — Call 844-545-5640 to find a location near you.
View the IRS guidance on paying taxes in cash here.
Large cash amounts
The IRS handles any single or related cash transactions of $10,000 or more a little differently. The key words here are ‘single or related.’ If you’re not sure what ‘related’ means, please consult with your accountant for more clarification as it pertains to your specific situation. In this scenario, generally speaking, the IRS requires filing Form 8300 no later than 15 days after receiving this sort of payment.
Download IRS form 8300 for paying large sums of tax here.
Tax time is a headache for many, but it’s even more so for the cannabis industry. Thanks to section 280e, the cost of doing business in the cannabis arena is expensive, with taxes owed on gross profit rather than net income. The disparity is glaring: cannabis business owners typically pay tax rates of 70% or more — that’s at least three times the tax rates paid by non-cannabis business owners.
In the end, right now, marijuana is still very much considered a Schedule I controlled substance by the feds. In their eyes, all cannabis businesses, whether state-legal or not, are lumped into the drug trafficking category. Until that classification is gone, all cannabis entrepreneurs must pay tax on all business income and are pretty much prohibited from writing off actual business expenses to minimize taxable income. Crazy, right?