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280E Cannabis Tax Code: What Is It and Who Should Care?

Section 280E refers to a provision in the Internal Revenue Code (IRC) of the United States. 280E has significant implications for businesses involved in the sale of controlled substances, including marijuana (or “cannabis” under Minnesota law).

The key points related to Section 280E are:

1. Disallowance of Deductions: Section 280E prohibits cannabis retailers from taking deductions incurred in carrying on their trade or business. It applies to cocaine, heroin, and cannabis, among other Schedule I substances. 
2. Impact on Marijuana Businesses: While most states have legalized cannabis for medical or recreational use, it remains illegal at the federal level. As a result, these businesses cannot deduct ordinary business expenses for federal income tax purposes and may only deduct cost of goods sold (COGS). This results in the effective tax rate for cannabis businesses in the range of 70 to 110 percent, despite a federally legal business having an effective rate of more like 20 to 30 percent. 
3. Scope of Controlled Substances: While it may make sense to prohibit deductions for those in the illegal markets for heroin and similar Schedule I drugs (although even that is subject to debate), the fact that cannabis is legal in most states and still subject to the same tax restrictions is – frankly – absurd. 
4. Challenges for Cannabis Businesses: In light of 280E, cannabis businesses cannot deduct things like employee payroll, health care, lease expenses, repairs, utilities, and capital expenses. 
5. Tax Planning Strategies: Despite the limitations imposed by Section 280E, cannabis businesses still have the ability to strategize when it comes to tax planning. This kind of strategizing is best done with an accountant (although it may also be a good idea to bring your lawyer into the discussion because some of these issues have been litigated with the IRS). 

More on Section 280E Deductions for Cannabis Retailers

Section 280E is going to make business difficult for cannabis businesses (and dispensaries in particular). While deductions for COGS are permitted, that is the only deduction available. There is case law on the issue but even these cases do not provide much clarity. 

Olive v. Commissioner

The issue in Olive v. Commissioner was whether a medical marijuana business could deduct expenses for non-marijuana touching activities. For example, the business also offered free services like snacks, movies, board games, yoga classes, massages, and other amenities. The taxpayer deducted expenses associated with the free services but the Commissioner disallowed the deductions. The court agreed with the IRS, reasoning that the additional services were only incidental to the sale of marijuana. For example, the free services were only provided to those who bought marijuana and the same employees performed both marijuana sales services and complimentary services. 

CHAMP v. Commissioner

In this case, the court held that expenses related to a “separate trade or business” may be deducted when such expenses are not related to the cannabis side of the business. The taxpayer in this case mainly offered caregiving services to people with AIDS, and while it also sold marijuana, it provided mainly caregiving services. The court decided that the caregiving portion of the business was sufficiently separate from the sale of marijuana because marijuana sales were made to a relatively small percentage of customers, and employees selling marijuana were exclusively involved in that side of the business, while 18 other employees strictly offered caregiving services.

Patients Mutual Assistance v. Commissioner

In Patients Mutual Assistance Collective v. Commissioner, the court rejected the plaintiff’s argument that its expenses were deductible, but it also provided some useful guidance:

“Even separate entities’ activities can be a single trade or business if they’re part of a ‘unified business enterprise’ with a single profit motive. Whether two activities are two trades or businesses or only one is a question of fact. To answer it, we primarily consider the ‘degree of organizational and economic interrelationship of various undertakings, the business purpose which is (or might be) served by carrying on the various undertakings separately or together, and the similarity of the various undertakings.”

As noted above, the issues presented by Internal Revenue Code Section 280E for cannabis retailers are substantial and could easily mean the difference between generating a profit versus generating a loss.

Don’t Go it Alone

Check out our blog for more helpful information about Minnesota cannabis law and how it impacts business. Garner, Ginsburg & Johnsen, P.A. has wide legal expertise and can help your business sort through the industry’s myriad legal concerns. Contact us for a consultation.