Marijuana Companies’ Struggle with the IRS
The Internal Revenue Service has written specific rules for every profession and activity, legal and illegal. For political bribes, see tax code 162(c) and for trafficking illegal drugs see tax code 280e. Legal marijuana businesses have to pay taxes under the same category of illegal drug traffickers because cannabis is still a federally illegal drug and is categorized as a Schedule I substance under the Controlled Substances Act.
But there are tax attorneys and accountants waging battle against these rules, and they may just be the industry’s biggest allies as marijuana companies’ struggle with the IRS.
If you’re unfamiliar with tax code 280e, you probably are not in the marijuana industry. Marijuana businesses that are operating legally under state licenses across 25 states and Washington, D.C., pay effective tax rates of 70 percent under the tax code. Under 280e, entrepreneurs can deduct costs associated with growing the plant, but nothing related to the retail business. While the marijuana industry has accomplished a lot by reforming state laws, the road to profitability and sustainability is still far away and requires changing federal law, which has been resilient to the legalization movement.
One of the biggest wins in the marijuana companies’ struggle with the IRS, was the tax court case of Californians Helping to Alleviate Medical Problems Inc. v. The Commissioner in 2007. CHAMP, a medical marijuana dispensary, was on the hook for a tax deficit, but successfully convinced the court to allow medical marijuana companies to deduct expenses that could reasonably be separated from the trafficking of marijuana (CHAMPS offered caregiving services, education, and support for patients in addition to selling marijuana). This win set an important precedent: Marijuana businesses can now differentiate the cannabis retail, production, and manufacturing aspects of their business from the (federally) lawful business aspects of the company and claim deductions attributable to the taxpayer’s separate and lawful trade or business.
Tax code 280e was created in 1982 after Jeffrey Edmondson, a Minneapolis-based man who dealt amphetamines, cocaine, and marijuana, won a lawsuit against the IRS to claim business expenses.
During the taxable year of 1974, Edmondson received 1.1 million amphetamine pills, 100 pounds of marijuana, and 13 ounces of cocaine from a supplier on consignment. Edmondson reported on his 1974 return that his cost of goods sold for these products was $105,300, itemizing deductions, which included a couple thousand miles he put on his automobile, the cost of a scale to weigh his product, packaging costs, a couple hundred dollars in long-distance and local business calls, and a portion of his rent for his home office.
The court decided that he was entitled to “both ordinary and necessary” business expenses in 1981. The next year, however, Congress passed tax code 280e, banning businesses that trafficked Schedule I or Schedule II substances from taking business expenses besides the cost of goods sold.
State-legal cannabis businesses are only allowed to deduct the cost of goods sold on their taxes and after the CHAMP case in 2007, cannabis businesses have been able to make deductions on their noncannabis business activities. Cannabis companies are also allowed to use section 263A of the Internal Revenue Code, which allows businesses to capitalize on indirect costs like inventory and administrative costs, and state excise taxes to be deducted under cost of goods sold.
As marijuana companies’ struggle with the IRS, there are answers and solutions.
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