By Jonpaul Taylor
Business Development Coordinator, Medbook Solutions
One of the questions we are asked consistently by cannabis clients or others wanting to enter this space is, “how can I push the limits on 280E?” Our recommendation is always a firm and resounding, “Don’t.”
Unfortunately, with the current state of the cannabis industry, the best course of action for a cannabusiness can take is to keep meticulous records to support tax-related filings and to know that you are technically in a federally illegal space which prevents you from being taxed like a normal for-profit business. A high-tax liability is just an unfortunate part of doing business in this space.
Still, 280E does leave space for minimizing your tax liability, and meticulous record keeping practices are the best way to do so. Our role at Medbook Solutions is to properly categorize, document and keep records of all expenses in your Cannabis business. This helps the CPA to properly tabulate the tax return and look at any tax strategies that could be available. Proper accounting is the door to proper taxation.
It is vital to have quality professionals providing guidance and management on tax positions taken. CPA firms and bookkeeping services that understand the actual operations of a cannabis business are priceless assets in this space and the safest way to mitigate tax liabilities. For example, Medbook performs the day-to-day accounting and bookkeeping functions, which gives us an in-depth knowledge of cannabis operations and compliance. We ensure that our client’s records are done meticulously, so that the CPA handling the tax filings is operating with a complete set of financial information on the cannabusiness. Working with a CPA that understands those specific processes is key to ensuring your business doesn’t face future injuries due to audits.
To further explain in detail 280E taxes and how this affects your company financials, see below for an illustration and explanation:
IRC Section 280E states in 26 U.S. Code § 280E – Expenditures in connection with the illegal sale of drugs:
“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 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.”
The 1982 Senate Report 97-494(I) explains that while ERC Section 280E disallows “ordinary and necessary business expenses,” adjustments to gross receipts for COGS are “not affected by this provision of” IRC Section 280E and therefore, are allowed as deductions for federal tax purposes. This is further confirmed by IRC Section 61 and the related regulations on the definition of gross income, which allow for the direct cost necessary to realize gross income.
It is imperative for the cannabis business to properly document expenses along with tracking employee time and functions being performed within the operations.
Figure 1.0: IRC Section 280E on a Cannabis Business with improper accounting:
|Standard Business||Cannabis Business Proper Accounting||Cannabis Business Improper Accounting|
|Cost of Goods Sold||($250,000.00)||($250,000.00)||($175,000.00)|
|350,000 (pre-tax income) x 35%||($122,500.00)|
|750,000 & 825,000 (gross profit) x 35%||($262,500) *||($288,750) **|
|Effective Income Tax Rate||35%||75%|
*Tax calculated at 35 percent of pre-tax income for the standard business and 35 percent of the gross profit for the cannabis business. The 35 percent tax rate is used for illustration purposes. C Corp income tax rates were set at 21 percent in the TCJA, while tax rates on pass-through entity income will vary depending on the owner’s income.
**Cannabis Business Improper Accounting is demonstrated by understating COGS provides overstated profits and ends with a higher tax liability.
Because of lack of clear guidance from the IRS, it is imperative for those operating in the cannabis space to keep comprehensive, clear and concise records. Working papers should be kept or a copy of how 471/280E were distinguished in any expenses. Until changes in federal law on cannabis, meticulous record keeping is the only way to safely ‘push the limits’ on 280E.Fully understanding and most importantly implementing these specific 280E rules and regulations is key for any cannabusiness. Unfortunately, these parameters must be managed and having the expertise of a place like Medbook Solutions will make your life so much easier! Interested in how we can help your cannabis shop? Schedule a FREE consultation today!