Although the production and sale of cannabis has been legalized in a growing number of states throughout the USA, it is still technically illegal on the federal level which complicates how cannabis businesses are structured. That means when it comes to cannabis business deductions, according to the IRC Sec. 280E tax code, all cannabis businesses have to pay taxes on all income without writing off business expenses. This forces cannabis businesses to pay much higher tax rates, but knowing the 280E loophole can lessen the blow.

What is IRS 280e?

The IRC Sec. 280E tax code is a federal statute that opposes illegal business, preventing businesses from deducting expenses from their overall gross income or applying tax credits when based on the trafficking of schedule I and II controlled substances according to the controlled substances act. And because marijuana is still classified as a schedule I drug by the federal government, this applies to cannabis even when it is legal at the state level.

If you are involved in a cannabis business, this effectively prohibits you from writing off most business expenses, forcing you to pay taxes on all of your business’s income leading to a much larger tax bill.

What’s the History of 280E?

IRC Sec. 280E goes back to 1981 during the Reagan era when congress created this statute in reaction to an interesting and famous court case. The Jeffrey Edmonson vs Commissioner case involved a convicted cocaine, amphetamine, and cannabis trafficker asserting his rights to not just pay taxes relating to the income generated by his illegal business, but that he also had the right to deduct business expenses such as rent, cost of goods sold (COGS) and employee salaries from his taxable income. 

The court ruled in his favor allowing him to do so, however the following year in 1982 this decision was overturned and the 280E tax code was enacted, preventing businesses trading in schedule I and II substances from deducting business expenses from their illegal operations. Today, even though drug reform is changing state law, IRC 280E is still punishing cannabis businesses.

How Does It Impact Cannabis Businesses?

The way your business is taxed has a direct effect on its specific structure and how you prioritize aspects of your business in an attempt to limit the effects of taxation. Because any sale of cannabis, be it retail or wholesale, is viewed as “trafficking” and therefore subject to IRC 280E, vertical integration of your cannabis business is a must. It is important to consider how you can effectively integrate cultivation, processing, extracting, infusing, and retail into a single business structure as much as possible in order to limit the amount of taxation exacted per product. 

Cannabis business vs normal business

When you take a look at the average tax rate for non-cannabis businesses and compare that with what cannabis companies have to pay, the difference is stark. If each of these business types generated $350,000 in gross income, the non-cannabis business would be able to claim around $200,000 in expenses, reducing their taxable income to $150,000 while the cannabis business would not be able to do the same, leaving them with $350,000 in taxable income. 

If both of these businesses then apply a tax rate of 30% to their taxable income, the non-cannabis business would only pay $45,000 in taxes while the cannabis business pays a total of $105,000. This is the effect of IRC 280E, increasing the effective tax rate applied to cannabis businesses by over double that of non-cannabis businesses, even though at face value they are both paying 30% of their taxable income. 

What’s Not Deductible Under 280E?

According to I.R.C. 280E, “taxpayers cannot deduct any amount for a trade or business where the trade or business consists of trafficking in controlled substances…which is prohibited by Federal law. Cannabis, including medical cannabis, is a controlled substance.” This may appear to be a small detail, but anyone involved in the cannabis business knows that this means a lot more than what it looks like.

Non-Deductible items under IRC 280E include:

• Employee salaries
• Electricity, telephone, internet, and other utility costs
• Health insurance and other insurance types including premiums
• Advertising and marketing
• Site maintenance and repairs
• Facility rental costs
• Payments made to contractors
• Amortization
• Banking fees
• Meeting expenses
• Travel expenses
• Vehicle expenses
• Equipment such as computers and tech
• Freight and shipping costs
• Legal fees
• Licenses and permits
• Pension and retirement plans

Regardless of what state your business is based in, as long as 280E remains part of the federal tax code, you will not be able to deduct these expenses from your taxable income.

What’s Deductible Under 280E?

Fortunately, you can still deduct your COGS, or cost of goods sold, from your taxable income for some reprieve, and this presents you with an opportunity that should be taken advantage of to its fullest extent. The COGS section was added to the 280E tax code so that it may remain constitutional and avoid any challenges which have been tested and upheld in court. Utilizing this loophole gives cannabis producers an opportunity to minimize the damage caused by high taxes.

COGS refers to the direct cost relating to producing goods sold by any company, such as the raw materials and labor directly relating to production.

Types of COGS

For the marijuana industry, COGS refers to:

• Inventory costs
• Cost of the product
• Trimming
• Packaging (including rolling)
• Curing
• Cleaning
• Infusing
• Extracting

Cannabis cultivators may also claim raw materials and supplies such as seeds, fertilizers, and clones, along with a few more indirect costs such as equipment maintenance, utilities related to growing, and quality control and inspection costs.

If a single company is able to vertically integrate the entire cannabis production and retail process, then they not only reduce the amount of instances that 280E is applied when product changes hands, they also maximize the amount of COGS that they can deduct from their taxable income.

How Accelerant’s PaaS Model Can Be Deducted as COGS

At Accelerant Manufacturing, we have specifically designed our Product as a Service (PaaS) business model so that cannabis businesses can easily connect the steps in between cultivation and retail with our PaaS pre-roll machine, the PRO. As mentioned above, whenever a product is sold, even through wholesale to another business, it is liable for additional taxes under 280E. Instead, you can manage the entire grinding and rolling process in-house by using our state-of-the-art automatic rolling equipment that you pay for based on use. This way, you can take care of the rolling and packaging process in-house, avoid unnecessary taxation, and maximize your efficiency without needing to invest large amounts of capital in the purchase of machinery. 

And because this is directly related to the production of your goods, our services may be included under your business’s COGS and are therefore tax deductible.

‍

‍