Section 280E of the Internal Revenue Code forbids businesses from deducting ordinary business expenses from gross income associated with the sale of Schedule I or II substances, as defined by the Controlled Substances Act.
"Because cannabis is federally classified as a Schedule I substance the IRS has applied 280E tax rules to businesses in states where the sale of cannabis is legal. It’s hard to get excited about our best sales days when we know profits will be cut deeply as a result of 280E."
~ John Lord, CEO LivWell Enlightened Health
Weedia®Buzz recently had a conversation with John Lord, Owner and CEO of LivWell Enlightened Health in Colorado where he said, “This inequity is a huge burden on our industry and must be addressed if our business is going to succeed. Not fixing this problem challenges the very ingenuity and creativeness American commerce is built on.”
Section 280E states: 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. Click here for more.
While cannabis companies are forced to file taxes under §280E rules, they are also bound to comply with additional federal employment regulations. LivWell, for example, is required to pay payroll taxes, and provide health coverage for employees as required by the Affordable Care Act, yet, they are unable to deduct ordinary costs and other expenses related to their employees. LivWell employs 550 people.
Section 280E is creating an impossible position for cannabis company owners each year when they file their taxes. Ken Boiarsky, a tax attorney with the nation’s leading cannabis law firm Hoban & Feola, said, “This is just another example of paradoxical application of tax law by our federal government.” For instance, Boiarsky explains, “If the company doesn’t file taxes using 280E, they’re breaking the law and if they do file their taxes using 280E, they’re admitting to having broken the law,” this, in reference to “trafficking” cannabis material – a Schedule I Controlled Substance.
According to John Lord and his team at LivWell Enlightened Health, the sustainability of the cannabis industry depends on a change to IRS imposed policies. Other businesses are able to deduct normal costs to do business such as rent, utilities and employee related expenses. Since cannabis businesses are required to file its taxes using Code 280E, these deductions are disallowed.
While the IRS continues to trudge along, charging cannabis retailers differently than other retail businesses the cannabis industry continues to pour millions in tax revenue into local and state coffers.
For example, wholesale cannabis distributed to retail stores in Colorado is taxed at a rate of 15% before it ever hits retail shelves. Customers then pay a 12.9% state sales tax, plus an additional 7.15% city tax if located in Denver. The retailer is also required to pay income tax to the state each year.
Assuming a pound of cannabis sold for an average of $1,900 wholesale, which 2015 Colorado data indicates, at a 15% tax rate on wholesale material – before the product is ever sold remember – the state collects $285.
If the average gram sold for $7.00, (there are 454 grams in a pound) the retail value of that pound of cannabis would be $3,178 – $410 of it going to the State and the City receives $227.
Dispensaries in colorado sold nearly 150,000 pounds of cannabis to medical and recreational consumers in 2014 which provided nearly $140 million in tax revenue. This represents nearly $1,000 in taxes for every pound of cannabis sold.
As an American retailer can you imagine paying 53% of your revenues to state and local governments before you’ve even started paying all of the other expenses associated with running a business – and not being able to claim most of these expenses on your tax return?
This past 4/20 (April 20th) – the cannabis community’s annual holiday – LivWell Enlightened Health experienced the highest single-day sales in its history. But because LivWell is compliant with §280E rules, the majority of the profits from these record-breaking sales will be paid in federal and state income taxes.
LivWell’s John Lord said, “It’s hard to get excited about our best sales days when we know profits will be cut deeply as a result of 280E.”
So, with an overview of the problems facing cannabis retailers, what is the solution?
The solution to this inequity, according to both Lord and Boiarsky, is to remove cannabis from the Controlled Substances Act’s list of scheduled substances entirely.
Ken Boiarsky said, “There are legal remedies to this problem and there are several court cases at the federal level addressing this issue,” The first line of one of these pending complaints reads, “This case owes its genesis to the mixed messages the federal government is sending these days about the distribution of marijuana.” (Feinberg vs. the Commissioner of the IRS)
Cases such as the Feinberg’s are being heard in local tax courts and in federal courts across the country, but until the issue is addressed at the IRS and in Congress retail cannabis operations will continue to pay up to 90% of their profits in taxes.
John Lord does not have much confidence that the federal government is working towards a solution, “The government isn’t exactly losing the longer this [lingers] on. There is a vast disincentive for the government to fix this problem. I don’t hold a lot of faith that we’re going to fix this in a short time. Our best option is for cannabis to be descheduled from Schedule I” said Lord.
The tax payment issue is just the tip of the iceberg, as federal laws making the trafficking of cannabis material a crime cause a litany of other problems, business banking being just one.
Most financial institutions are unable to justify the risk in taking on cannabis industry clients making the industry a largely cash business. The industry, now exceeding $8 billion in annual commerce, is likely to double in size over the next few years and is in dire need of viable banking options. But this is another story for another day…