Rhode Island Gov. Dan McKee (D) has proposed decoupling state and federal taxes for cannabis industry operators as a partial workaround for IRS code 280E, Marijuana Moment reports.
The cannabis industry pays an exorbitant amount of taxes as a result of 280E, which prohibits companies from taking normal business tax deductions if their work is tied to a federally prohibited substance (cannabis is still declared Schedule I under the federal Controlled Substances Act).
The governor included the tax relief language as part of his budget proposal for the fiscal year 2025, stating that “Rhode Island would join Massachusetts and Connecticut, and at least 10 other states, in decoupling from this federal policy,” and estimating that the move would save cannabis operators $824,642 in the fiscal year 2025 and $1.7 million in the fiscal year 2026.
The tax relief language is supported by Cannabis Control Commission (CCC) Chair Kim Ahern, who attended the House Finance Committee meeting last week addressing the governor’s budget proposal, the report said. Lawmakers have not yet voted on the budget proposal.
It’s possible the cannabis industry could soon find tax relief at the federal level if the Biden Administration were to either reschedule cannabis from Schedule I to Schedule III — as was recommended last year by the U.S. Department of Health and Human Services — or remove cannabis from the federal drug schedule entirely, a move that was recently suggested by a group of Senate Democrats.
Rhode Island passed its cannabis legalization law in 2022 and the state’s licensed cannabis dispensaries earned more than $100 million in combined medical and adult-use sales during their first full year of adult-use operations.
Illinois’ budget bill includes provisions that eliminate the state’s conformity with Internal Revenue Service (IRS) Code 280E which will allow state-licensed cannabis businesses to take some normal business deductions, according to a report from Tenth Amendment Center. Section 280E prohibits businesses from deducting otherwise ordinary business expenses from gross income associated with the “trafficking” of Schedule I or II substances, as defined by the federal Controlled Substances Act, and applies to cannabusinesses in states that have legalized cannabis.
The bill also includes language to direct funding to a cannabis development fund and extend the deadline for conditional cannabis business licensees to find a storefront.
The budget bill was approved this week by both chambers of the Illinois legislature and Gov. J.B. Pritzker (D) is expected to sign it into law.
Earlier this month, New Jersey Gov. Phil Murphy (D) signed a standalone bill to allow the state’s cannabis companies to deduct normal, management-related business expenses from their taxes.
Minnesota’s newly-signed adult-use cannabis law also decouples the state’s tax regime from IRS Code 280E.
In a National Cannabis Industry Association policy paper, Henry Wykowski, a California attorney who works with cannabis clients on tax issues, said that “Section 280E de-incentivizes people from filing tax returns” and “penalizes people who are trying to be transparent and operate within the law.”
House Rep. Earl Blumenauer (D-OR) reintroduced a bipartisan proposal yesterday that seeks to let state-licensed cannabis companies throughout the country take the standard tax deductions afforded to any normal U.S. business. Originally co-sponsored by Reps. Blumenauer, Nancy Mace (R-SC), and Barbara Lee (D-CA), the Small Business Tax Equity Act addresses IRS Code Section 280E, a 1982 provision that prohibits the standard business tax deductions for operations associated with illegal drug trafficking and which — because the plant remains a federally scheduled substance — has vexed modern, state-legal cannabis operators for years.
If approved, the bill would exempt state-legal cannabis companies from the restrictions of 280E. The proposal has been introduced in previous sessions but never advanced.
“State-legal cannabis businesses are denied equal treatment under 280E. They cannot fully deduct the cost of doing business which means they pay two or three times as much as a similar non-cannabis business. This grotesquely unfair treatment incentivizes people to cut corners. If Congress wants to get serious about supporting small businesses and ending the illicit cannabis market, it is common sense that we allow legal cannabis operations to deduct business expenses, just like any other industry.” — Congressman Blumenauer, in a statement
In a press release following the latest unveiling of the bill, NORML Political Director Morgan Fox said the cannabis advocacy group “commends the sponsors of this legislation for their efforts to end the unjust federal overtaxation of licensed, state-regulated cannabis businesses.”
“Allowing [cannabis companies] to take the same federal tax deductions that most other businesses enjoy will facilitate new opportunities in the legal cannabis industry and make it more competitive with the unregulated market, which will directly benefit consumer health and public safety,” Fox said.
“The unfair application of the outdated 280E provision on state-licensed cannabis businesses is preventing our industry from reaching its full economic potential and our ability to successfully replace criminal markets in accordance with the will of the voters and state legislators that have implemented modern state marijuana programs across the country,” said National Cannabis Industry Association CEO Aaron Smith in a statement. “We commend Congressman Blumenauer and the bill’s original co-sponsors for leading this narrowly-crafted, sensible legislation that would resolve this unforeseen consequence and bring our tax code into the 21st century.”
Adult-use cannabis has been legalized in 21 U.S. states and a recent Pew Research Center report found that 48% of Americans have local, legal access to cannabis products.
Editor’s note: This editorial was contributed by Faith Bygd, advisor for Breakaway Bookkeeping & Advising.
Being a legal cannabis company, you are likely familiar with the IRS Tax Code 280E. This tax code sets forth financial hurdles directly related to the amount of tax liability you owe the government at the end of the year.
From cultivators to retail shop owners, medical, or adult-use, 280E places financial struggles on legal businesses. The limitations around what the IRS will allow you to recognize as legitimate business write-offs are unclear and present significant problems to those owning companies in the cannabis industry.
While non-cannabis businesses can write off any expense that goes into the cost of running the company, this is not the case for cannabis businesses. We need to get used to it: this will remain in effect until cannabis is no longer federally classified as a Schedule 1 Illegal Substance. Brass tacks: The federal government still views cannabis as “illegal” and any business that sells it as trafficking — even though individual states have voted to legalize it. The federal government is not in the business of helping to sell illegal substances… but they are in the business of taxation. Cannabis businesses can stay in business — if they play along.
Why is 280E so confusing? For historical context, the reason 280E exists is due to the monumental case of Edmondson v. Commissioner. In 1981, a convicted drug dealer, Jeffery Edmondson, was fined and held liable for back taxes owed on the money he made from illegally selling cocaine, amphetamines, and marijuana. He brilliantly filed returns for the years he was being held accountable for and applied write-offs, including the costs of the drugs themselves, to reduce the amount of tax liability he had, which in turn reduced his interest and fines due. The court determined he was allowed to do so because, as the law was written, that was a legal approach to the tax burden. The IRS quickly reacted with the enactment of Tax Code 280E, passed into law in 1982. The new law would disallow write-offs to be applied to the total revenue if the revenue was created through federally illegal activity.
Currently, cannabis still sits on the list of Schedule 1 Illegal Substances, which is in the same category as harmful substances such as meth, heroin, and ecstasy. Marijuana is the only substance on the list that is legal in 39 states. But until it is recognized as legal by the federal government, 280E’s frustration will remain a daunting reality.
Have no fear! There is a way to work with the 280E instead of against it!
280E allows cannabis companies to deduct expenses that it has to produce the product for sale, just not any cost related to the sale itself. Expenses that are 100% direct in the production of your product are considered COGS, meaning cost-of-goods-sold. COGS are deductible.
How can you put this into practice? Scrutinize your bookkeeping and accounting workflows by creating a tight cannabis-friendly chart of accounts. Be sure to include all acceptable COGS above the gross revenue line. Anything below the gross revenue line will be taxed federally, but your state may allow you to deduct these expenses from your state income tax.
Let’s dive a little deeper into how this breaks down:
Grow equipment/supplies/materials. These expenses are direct and 100% used for the process of creating your product and are considered tax deductible from your total revenue.
Repairs and maintenance directly related to the grow buildings. Contractors that perform services directly related to the grow or production space will count towards the COGS amount.
Wages for cultivation and production. Keep meticulous records of employee hour breakdowns and record payroll on your books by these breakdowns. Make sure your books match the payroll records in case of an audit. Talk to your tax CPA about filing as a S-Corp to include the owner’s wages in the payroll. In most non-cannabis businesses, the owners’ wages are considered admin (below the gross revenue line). However, cannabis owners working directly with the cultivation can possibly apply some of their wages to the allocations of COGS. Discuss this with your tax preparer and bookkeeper to devise a good plan.
Utilities directly related to the grow or production areas. Utilities used in retail or office space are not deductible. Ask your tax CPA about the best workflow to separate out your utility bill. Your monthly bookkeeper should be tracking the bill splits to ensure a constant clear picture of where your financials stand from month to month.
The biggest secret weapon to working with 280E is finding a financial partner who can help you track these expenses as they are incurred. This does not mean scraping together a handful of receipts at the end of the year. A stellar bookkeeper is imperative to your cannabis’s business success. A bookkeeper who knows the importance of breaking down COGS is a necessity.
Currently, the IRS has been lenient about auditing cannabis companies, but that will not be the case for long. If your company is audited, they can go back 3-6 years. Do you have those books in order? Let it be your 2023 New Year’s Resolution to organize your accounting. This will aid in the success and longevity of all of your hard work and efforts and help you work with 280E.
How social equity applicants can use tax and cash planning to prepare for 280e, improve cash flow, and become more profitable
It is extremely difficult to run a profitable cannabis company. In large part, this is because of 280E, which is a section in the Internal Revenue Tax Code that has been the thorn in the side of the cannabis industry since states legalized (as I’ll further explain below). But 280E alone is not the issue.
Federally legal hemp companies and non-plant touching companies struggle with profitability. The problem is the lack of short- and long-term financial planning.
So what is 280E? How do you create a financial plan when you do not have a finance background? What do these things have to do with each other?
In short, 280E is a section of the IRS tax code that says companies involved with the trade of federally scheduled I & II drugs cannot receive tax deductions and tax credits. If you are running a federally illegal company, you must pay taxes on total gross sales and not total profit. Check out more info on 280E and how to navigate it here
Lack of planning downfalls
If the country shuts down again, how long will the cash you have now last?
Do you know how much cash on hand you expect to have next month?
Do you have the budget to add a new employee? Will you still be profitable each month if you hire them?
Financial planning gives you clarity into these answers. Without it, you risk the following downfalls, which are experienced by many businesses and often lead to closed doors:
You are always in crisis mode because you are not prepared for when things go south, and unforeseen mishaps occur. Obstacles are inevitable.
You cannot reach a goal that your company hasn’t set.
Expenses are not covered timely, from payroll to taxes.
Adjusting to the market and external business environment becomes a significantly harder challenge.
It is harder to take advantage of free cash flow (the cash you have available after all operating and financing responsibilities are paid for).
You miss out on the ability to compare your performance against predetermined measurements to identify areas of strengths or areas that need improvement.
The solution is cash flow forecasting, setting taxes aside, and a proper accounting setup
A weekly or monthly cash flow forecast will drastically increase your ability to foresee negative cash balances before they happen, allowing you to make the necessary adjustments to prevent them. The idea of a weekly cash flow forecast sounds good, but there are important factors to consider in order to make a useful forecast.
The keys to a useful cash flow forecast are:
Accurate accounting records
Understanding of current market and business environment
Analysis of how long it takes for customers to pay invoices (less important for retail dispensaries)
Accurate recording and consideration of due dates for bills and expenses
Create weekly, monthly, and annual forecasts
Benefits of a weekly cash flow forecast
We’ve discussed how a cash flow can help prevent negative cash balances, but another major benefit of cash flow forecasting is using it to understand the growth potential for your company. Do you have excess cash each week? Are you making enough profits each month that will allow for another dispensary location, another employee, another grow facility?
A cash flow forecast can save your business and keep it afloat during downtimes. It can also help you thrive and grow. In cannabis, it can help you operate correctly and make sure taxes and all compliance-related expenses always taken care of. It is a key to cash management.
Strategize and set aside taxes daily, weekly at minimum
From setting aside the taxes from each sale to following a year-round strategy, taxes should be a part of cash flow planning. One method to assure taxes are thoughtfully planned for is to obtain a separate vault or bank account strictly for taxes. The goal is to quickly put it away and not touch it to avoid the temptation to spend and rob Peter to pay Paul. You get the idea.
A strategic tax plan can guide you as a roadmap throughout the year. It is best to regularly review your plan throughout the year because situations change. Consider these strategies to draw up ideas:
Consider setting up a non-cannabis entity
Consider setting up a cannabis IP entity
Deduct real estate depreciation & utility expenses
Understand what COGS are (& deduct them)
The foundation of it all begins with good accounting setup
Accounting is the foundation for cash flow planning as well as tax planning (280e included). A proper setup greatly improves the accuracy and organization of all these different types of information.
Bonus: Pricing and Cost
Improving prices and costs directly impact profitability and ultimately increase the cash in your pocket. Prices shouldn’t change too frequently but should be routinely compared to the cost of each item or service sold. I recommend performing a cost assessment for multiple reasons:
To understand the profit margins for each product or service
To keep costs within a specific range. If costs surpass this range, it should draw a red flag causing prices to be reviewed.
To create and stay under budget
To get rid of unnecessary and unproductive costs
Cash flow forecasting and planning can be the key to not only keeping your doors open but also reaching every goal you’ve imagined for your company.
Learn more ways to better manage your cash and create a foolproof plan at our blog here.
The U.S. Supreme Court has declined to hear a case challenging whether the Internal Revenue Service (IRS) can determine whether state-approved cannabis sales are prohibited by the federal Controlled Substances Act, Law360 reports.
The Green Solution LLC owner Eric Speidell and other cannabis companies petitioned the high court to hear their case following a previous decision by the Tenth Circuit Court that ruled the IRS could use 280E to determine whether a business or individual was in violation of criminal drug laws.
James D. Thorburn, an attorney for Speidell, in an interview with Law360 said the Supreme Court’s decision was “disappointing.”
“Our founders fought and died to keep revenue agents from having the unchecked power to rummage through our homes in search of contraband. Unfortunately, we have to accept that we just lost one of our most basic freedoms.”—Thorburn to Law360
Acting Solicitor General Elizabeth Prelogar, the fourth-highest-ranking official in the U.S. Department of Justice, has twice filed briefs with the Supreme Court asking them to support the government’s positions in cannabis-related 280E cases and the previous decisions of lower courts.
The Tenth Circuit in October determined that a lower court correctly upheld the IRS summonses on the Green Solution and other companies owned by Speidell, as well as on Medicinal Wellness Center LLC, which joined Speidell in his legal challenge. The appeals court applied an April 2020 precedent in the Standing Akimbo LLC case which found that the IRS was justified in requesting information from the Colorado Department of Revenue during an audit.
In May, the Supreme Court also declined to hear an appeal case by California cannabis companies that sought to challenge their tax bills; however, that denial was based on the companies filing their petitions with the U.S. Tax Court one day after the deadline.
The court did not elaborate on its decision to turn down the Green Solution case.
The U.S. Supreme Court has declined to hear an appeal case by California cannabis companies that sought to challenge their tax bills after filing their petitions with the U.S. Tax Court one day after the deadline, Law360 reports. Organic Cannabis Foundation LLC and Northern California Small Business Assistants Inc are fighting a $1.9 million tax bill — the result of filing under Section 280E, which prohibits tax deductions for companies trafficking in a controlled substance.
Cannabis companies throughout the U.S. must file under 280E because cannabis remains federally illegal.
The companies – both owned by Dona Ruth Frank – argued that under the precedent set by a Supreme Court decision in 2015, statutory deadlines are presumptively non-jurisdictional and therefore subject to equitable tolling. The companies’ case challenged the constitutionality of the 280E provisions, the report says.
The Ninth Circuit had ruled in June that the Tax Court was correct in dismissing the case based on the lack of jurisdiction.
In a separate case, the Tax Court ruled in February that San Jose Wellness, a subsidiary of Harborside, was liable for $4.2 million in taxes because federal law prohibits it from claiming depreciation and charitable contribution deductions due to 280E. In that case, Judge Emin Toro said that the “requirements of Section 280E are clear.”
Last month, the U.S. Circuit Court of Appeals rejected the 280E appeal from Oakland-based Patients Mutual Assistance Collective Corp – or Harborside Health Center – ruling that federal cannabis prohibition prevents legal cannabusiness from excluding or deducting taxable income as business expenses.
Last year, the Supreme Court declined to hear the case challenging the constitutionality of federal cannabis prohibition and the Drug Enforcement Agency’s Schedule I classification.
Editor’s note: This article was contributed by Cannabis Tax Solutions.
Just when you think you have 280E figured out – BAM! Here comes another curveball. Recent court cases (Alterman and Alpenglow, among them) have empowered the IRS even more, and have seemingly weakened landmark cases like CHAMP.
Attorneys representing clients in audits have told Cannabis Tax Solutions the IRS has now taken the position that if you do not have “enough” non-cannabis revenue from products such as glassware and T-shirts, you will not be able to take related deductions. What is enough? Good question, and one we are still trying to figure out. Another adverse position the IRS is taking: advertising. If you have your brand name or logo on T-shirts, hats, or any non–cannabis item you sell, it can be construed as advertising, which falls directly under 280E. Disallowed deduction.
So, what can you do to protect yourself? In the past, the belief was as long as you accounted for the non–cannabis activities separately — such as different classes in QuickBooks — you would be ok. It doesn’t appear this will fly anymore. The single biggest step you can take now is to set up your non–cannabis activity as a totally separate entity. Completely segregating the businesses will give you a much better path to justifying the revenues and fully legitimate deductible expenses for the non–cannabis activity.
Another crucial factor in determining the success or failure of your cannabis business is choosing which professionals to work with. Cannabis Tax Solutions have had several new clients come to us with tax returns and financials prepared by non-cannabis accountants that bordered on criminal — they were that bad. No 280E recognition, balance sheets not tied out, incorrect codes, no disclosures. If you hire professionals that don’t know 280E (accounting and legal) then you are digging a huge hole for yourself. This industry is filled with very complex accounting, tax, and legal issues; not having the proper people in place will kill your business.
One of the biggest things you can do to help yourself is simply taking time to review your own books and tax returns. Don’t put your complete faith and trust in your accountant/tax preparer — it’s YOUR business, after all. Make sure you know what’s going on inside. Look at the tax return to make sure the proper 280E adjustments are being recorded. Does it pass the common sense test? You would be surprised. You may also want to engage in a 280E analysis by a qualified professional who knows what to look for.
Legal deductions are lost by failing to track and document employees whose work involves production-related activities that qualify as cost of goods sold (COGS) deductions, as well as non-production activities disallowed under 280E. Using technology such as Würk’s cannabis time-tracking and attendance software system to track employee activities can also help produce records that can satisfy the IRS. This is as bulletproof a way as anything to show where employees are working to back up employee-related expenses that may be deductible.
Of course, bookkeeping is always an ongoing issue. And truly, having great bookkeeping practices will help you both in the long and short run. If the books are in order, chances are those deductions in question will have a greater chance of being accepted under audit. If you can’t get banked, don’t worry — creating cash logs and having the proper backup in the way of receipts will go a long way for providing a complete accounting environment.
Speaking of environment, another important consideration is how you are structured as an entity. Should you be taxed as a C corp? S corp? Something else? How do other shareholders and investors fit into this equation? Are there outside states to consider? How will this decision affect exit strategy? There is the potential for tons of moving pieces, so make sure they are all covered.
If you want to keep your doors open, having a perpetual tax planning and projection initiative is imperative. You should always be looking at actual versus budgeted numbers, forecasts, and anything else that will ultimately tilt the (tax) bottom line. Don’t let a million dollar tax bill sneak up on you — be aware! And don’t wait until December to perform this most critical task. Federal and State income, payroll, marijuana-related taxes — including excise and sales tax — all need to be accounted and planned for. Staying current with all tax liabilities is crucial for long term success. If you fall behind, seek immediate help for formulating a plan to catch up. Once you get on the IRS radar, in conjunction with being a federally illegal business, it can be a quick recipe for disaster.
Until Marijuana is removed as a Schedule 1 drug, it will still be the Wild West when it comes to figuring out what you can and can’t do for maximizing your deductions and minimize taxes. Seek out the best representation and you will be on your way to providing your business with the best chance to survive and succeed.
If you would like more information on 280E or other cannabis tax policies please reach out to us at info@cannabistaxsolutions.com or visit our website at CannabisTaxSolutions.com.
In a recent Federal District Court decision, Alpenglow Botanicals, LLC — a Colorado cannabis dispensary — protested the IRS’ disallowance of their business expenses under the oppressive Section 280E, which denies ordinary and necessary business expenses for operators in the cannabis industry.
The IRS had asserted that Alpenglow Botanicals owed additional taxes. The dispensary paid the taxes in question and then sued for a refund in federal court. In a motion for summary judgment, the taxpayer stated that the IRS did not have the authority to investigate whether the taxpayer violated the Controlled Substance Act (CSA), that Section 280E violated the Sixteenth Amendment, that the taxpayer had properly deducted their expenses, and that the IRS did not produce evidence that Section 280E applied to the taxpayer. The dispensary also stated that the application of 280E violated the taxpayer’s Fifth Amendment rights, as well as its Eighth Amendment rights — which should protect against excessive fines and fees.
The Court denied all requests.
In another recent case, a different Colorado company — also alleged by the IRS to be a cannabis dispensary — attempted to make the same arguments while filing a similar lawsuit.
In this case, the District Court ruled that:
the IRS’ application of Section 280E to a business it determined was selling marijuana was within its authority to apply the Internal Revenue Code;
the IRS’ application of Section 280E was a “purely tax-based determination” that did not violate the taxpayer’s Fifth Amendment rights;
the taxpayer did not allege that the IRS disallowed costs other than cost of goods sold and therefore the court could not determine that the Sixteenth Amendment was not violated;
the taxpayer did not allege enough facts for the court to determine whether Section 280E is an excessive fine and penalty in violation of the Eighth Amendment; and
the taxpayer did not allege any facts to show that the IRS lacked evidence to show that the taxpayer was violating the CSA.
The taxpayer has filed a motion for reconsideration and an amended complaint to add allegations necessary to support their claims, so the case may move forward based on those new allegations. However, the taxpayer’s attempt to stop the IRS from enforcing Section 280E was ultimately unsuccessful under the facts of this case.
Interestingly, as this case moves forward, a slew of cannabis-related bills are making their way through Congress, including:
Better Drive Act
Small Business Tax Equity Act (bicameral)
Marijuana Revenue and Regulation Act (bicameral)
The Veterans Equal Access Act
Regulate Marijuana Like Alcohol Act
Ending Federal Marijuana Prohibition Act of 2017
Respect State Marijuana Laws Act of 2017
LUMMA (Legitimate Use of Medicinal Marijuana Act)
Compassionate Access Act
States’ Medical Marijuana Property Rights Act
Hopefully, Section 280E will soon become a thing of the past.
Recent legislation introduced in the Senate and House of Representatives would end the federal prohibition of cannabis and replace it with a system that would regulate and tax marijuana in a manner similar to alcohol or tobacco.
According to a press release dated March 30, 2017,
Bills filed by Sen. Ron Wyden (D-OR) and Rep. Jared Polis (D-CO) would remove marijuana from the Controlled Substances Act, leaving states to determine their own marijuana policies, and impose federal regulations on marijuana businesses in states that choose to regulate marijuana for adult use. Wyden’s bill would also enact a federal excise tax on marijuana products. In the House, the tax is being proposed in a separate bill introduced by Rep. Earl Blumenauer (D-OR).
Wyden and Blumenauer also filed marijuana policy “gap” bills that would eliminate many of the collateral consequences associated with federal marijuana convictions without removing marijuana from the Controlled Substances Act.
That legislation has been introduced in the House and Senate, where it will be argued by the various chambers. The House and Senate must come to an agreement in order for an Act to be contrived for the president to sign. The president could either sign or veto the bill; if vetoed, it would return to Congress and they would need a three-fourths majority vote to override the veto.
Who knows what will happen with this legislation — but if it becomes a law, it would end Section 280E. Dispensaries and growers would be able to deduct salaries, rent, and all other necessary and ordinary expenses, just like any legal business. This would be huge for the legal cannabis industry.
Section 280E says:
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.
Tax Court has left the door open for tax accountants like me that look for ways around a stupid and oppressive law. What is typically done in states that allow it is the dispensary does some other business in addition to being a dispensary as a way to write off the expenses other than Cost of Goods Sold (COGS), which is basically the cost of the cannabis for dispensaries. If the state doesn’t allow it, then a creative way of calculating COGS is done.
This legislation would also open banking opportunities up to dispensaries and growers; the only thing they would still have to fight is the stigma following the cannabis industry.
A big reason behind this bill’s introduction is Congress having seen what a cash cow cannabis could be. Every state with legal cannabis has imposed taxes on it, some as high as 15%. If you reread the excerpt of the press release, it mentions an excise tax similar to alcohol.
One thing is certain — I will be watching this closely and updating you as news arises.
Editor’s note: This is the second installment of a three-part series about cannabis taxes and the tax hurdles faced by marijuana business owners. This article contains hypotheses that haven’t yet been proven by case law; we highly recommend consulting your accountant before adapting any of these theoretical strategies.
If you haven’t yet, check out Part 1 before reading further. Stay tuned for Part 3, coming next week!
In the first part of this series, I introduced Section 280E and various Tax Court Cases that have left the door open for mitigating your tax liability as a cannabis business owner.
One way to alleviate federal taxation is through cost of goods sold (COGS). According to the Tax Court:
“Taxpayer trafficking in controlled substance determines COGS by using applicable inventory-costing regulations under Code Section 471 as they existed when Section 280E was enacted. And IRS Examination or Appeals may change to inventory method for that controlled substance when the taxpayer currently deducts otherwise inventoriable costs from gross income.”
What that means is that instead of using the favorable way to calculate COGS in Section 471, we must go back to 1982, when Section 280E was enacted. Van Pickerill & Sons Inc. v. United States stated that when the use of inventories is necessary to determine the income of a taxpayer, the taxpayer must use the best accounting practice to determine the amount of income (Section 471(a)).
Despite the use of the word “best,” multiple accounting methods may satisfy the best accounting practice requirement for any given business. The court and the IRS are caught between what is legal under state law, when the exact same thing is illegal under federal law.
In Jason R. Beck v. Commissioner, the Tax Court ruled that although the COGS were deductible to marijuana businesses, the cost of marijuana seized by federal authorities could not go into the calculation of COGS. Even though marijuana is legal in a state, federal government law enforcement agencies can raid legal state marijuana facilities, and, in the Beck case, the court said these amounts are not deductible.
Right now, many CPAs and EAs are loathe to sign a tax return that respects a non-trafficking trade or business. There was a famous paper written for accountants which concluded that the tax law makes it difficult to establish a second trade or business and therefore creates a challenge in treating that business as non-trafficking for purposes of IRC § 280E.
Appearing to follow the Tax Court’s lead in Olive, the paper used a multi-factor analysis from the Trupp case applying the rules of IRC § 183 (relating to hobby losses) to the question. The paper did not, however, consider accounting method cases under IRC § 446, which also address the issue and are likely in some instances to be more favorable to the taxpayer.
Added to that is the misinformation spread a few years ago that people like me, when helping those in the cannabis industry, are in danger of losing their license for aiding and abetting a drug dealer.
Common Section 280 strategies
As I mentioned in my first article, the first approach derived from Californians Helping to Alleviate Medical Problems, Inc. (CHAMP) v. Commissioner. In this Tax Court Case, the California-based marijuana dispensary provided marijuana to its patients, but also provided non-cannabis services, including counseling and caregiving services for its patients. This allowed the company to fully deduct the expenses associated with those practices.
A common and basic strategy for a dispensary is to offer another service alongside its dispensary. You then allocate expenses between the dispensary and the other activity. However, what was learned in the Olive v. Commissioner case is that you simply cannot throw two things together and say that they are separate businesses under one roof.
I have heard of a strategy whereby a dispensary would sell cannabis and also sell hats and t-shirts. The allocation of the expenses were 80 percent t-shirts and hats, to 20 percent dispensary. But, unlike that sort of arrangement, you need a business that compliments a dispensary. For instance, medical cannabis and caregiving go together. Recreational marijuana and food go together. Then you have to make sure you are not allocating so much more on the non-cannabis side of the business that it ceases to make sense — then the question would arise: why do you have a dispensary at all?
Before going further, I want to mention that this idea does need some work and should not be considered bulletproof.
If you are in the medical cannabis industry, why not charge a monthly fee for caregiving services commensurate with the patient’s diagnosis? You could offer different packages like Silver, Gold, and Platinum. If the patient is prescribed a potent and more expensive strain of cannabis, you simply charge them more for the caregiving. The cannabis you just give away alongside the caregiving services.
Before you think that I’ve lost my mind, stay with me. You are providing caregiving services as a way to deduct your business expenses. What does the patient want most of the time? They just want the cannabis. So, you enter into a contract with the patient that says you will provide these caregiving services, charge them a fee, and give them the cannabis for no charge.
Will the patients take part in the caregiving services? Some will, but for this to work, you would have to make a requirement that the patient attend so many appointments to get their cannabis. They can simply do a certain thing every month when they come to pick up their supply and that would fulfill the contract.
What do you need to employ this method? A good accountant that understands the strategy, an attorney that can write the caregiving contracts, and an attorney/accountant team that can offer ongoing consulting services.
If we go back to the successful CHAMP Tax Court Case, this was their basic concept, but I tweaked it a little bit. They were charging for both the cannabis and the caregiving expenses. You are charging more for caregiving expenses than what would cover the price of the cannabis, but you are effectively giving away the cannabis. Conceivably, you are no longer stymied by Section 280E because you aren’t selling an illegal Schedule I drug; you are selling caregiving expenses and just giving away the cannabis.
You would still have to have a license as a dispensary. That wouldn’t change. However, depending on how your state has written the cannabis laws, this strategy may get you out of the oppressive state taxes on cannabis. Remember that you aren’t selling it. You are offering a caregiving service that may or may not include free cannabis.
NOTE: there is NO case law that supports this. This is simply one person looking at caregiving, cannabis, and other therapies from a holistic medicine approach.
Will you be audited?
Any strategy you employ to avoid Section 280E will open you up to scrutiny by the IRS. You need good professional help in employing the strategies listed in this article.
Following the 2016 elections, cannabis is now legal in some capacity in 28 states. However, even though it’s legal in certain states, the federal government considers the plant an illegal Class I narcotic, and as a result business owners in the marijuana industry have hit a wall with IRC §280E, which 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.”
IRC §280E will only cease to apply to cannabis businesses if and when cannabis is no longer classified as a Schedule I or Schedule II controlled substance.
When IRC §280E was enacted in 1982 to overturn the result in the Tax Court case Jeffrey Edmondson v. Commissioner, it held that the taxpayer, who was engaged in an illegal drug dealing business, was entitled to deductions for “telephone, auto, and rental expenses” that he incurred in his business. The Senate report makes clear that IRC §280E was intended to overturn the decision in Edmondson and deny deductions to illegal drug dealing businesses. However, for Constitutional reasons, Congress did not attempt to prevent taxpayers from using cost of goods sold (COGS) to compute gross income. Thus, IRC §280E denies all deductions from gross income in computing taxable income, but illegal drug dealing businesses are permitted to take COGS into account in computing gross income.
IRC §61 defines “gross income” as “all income from whatever source derived.” One category of income listed in IRC §61 is “gross income derived from business.” Reg. §1.61-3 states that “gross income” for manufacturing and merchandising businesses, “means total sales, less the cost of goods sold.” As the Tax Court has observed, “cost of goods sold is an item taken into account in computing gross income and is not an item of deduction.”
Coping strategies for cannabis companies
There are various strategies that those in the marijuana industry have employed. The first approach derived from Californians Helping to Alleviate Medical Problems, Inc. (CHAMP) v. Commissioner. In this Tax Court Case, the California-based marijuana dispensary provided marijuana to its patients, but also provided non-cannabis services, including counseling and caregiving services for its patients. This allowed the company to fully deduct the expenses associated with those practices.
It is perfectly okay to run two separate businesses under one roof. If the business is a medical marijuana dispensary, it could certainly provide other caregiving services under another company. It can also then share employees with the dispensary, paying the employees minimum wage under the dispensary company, and making up the difference with the caregiving company. The dispensary is only allowed to deduct COGS, whereas the caregiving business isn’t held to the same restrictions.
However, not all cannabis businesses have been successful in separating their businesses between dispensary and non-dispensary activities. In the Tax Court Case Olive v. Commissioner, the Court found that the taxpayer’s activities of providing free yoga classes, chess and other board games, movies with popcorn and drinks, chair massages, use of vaporizers, education on medical marijuana and its responsible use, and snacks, did not constitute a business separate from the taxpayer’s dispensary business.
Cannabis companies face some taxing issues that are entirely unique from other industries. Photo Credit: Rory Savatgy
The second approach to minimizing the impact of IRC §280E is to characterize as many costs as possible as COGS rather than operating expenses.
As the Tax Court has observed, “[the concept of COGS] embraces expenditures necessary to acquire, construct or extract a physical product which is to be sold; the seller can have no gain until he recovers the economic investment that he has made directly in the actual item sold.” In other words, the total costs incurred to create a product or service that has been sold. Generally, a taxpayer first determines gross income by subtracting COGS from gross receipts, and then determines taxable income by subtracting expenses from gross income.
The IRS and cannabis
IRC §471 gives broad authority to the Internal Revenue Service (IRS) to force taxpayers to account for inventory in a way that most clearly reflects income. IRS regulations under IRC §471 provide that a producer of property generally is required to treat indirect costs as COGS if they are “incident to and necessary for production” or manufacturing operations. In 1986, Congress enacted IRC §263A, which requires purchasing, handling, and storage expenses, as well as a portion of third party service costs such as accounting or legal fees, to be included in COGS, in addition to the costs covered by the IRC §471 regulations.
Absent an inclusion in COGS, indirect costs for cannabis businesses are subject to IRC §280E, which denies deductions from gross income. It does not impact costs for determining gross income. Increasing COGS decreases gross income and decreases the amount of denied deductions from gross income as a result of IRC § 280E. This creates an incentive for cannabis businesses to maximize their costs included in COGS.
Normally, taxpayers with inventories prefer to treat costs as deductible expenses rather than including them in COGS because expenses are currently deductible, while COGS does not reduce income until the taxpayer sells the inventory items to which the COGS relates. However, because IRC §280E prevents the deduction of many cannabis-related costs as current expenses, taxpayers in the cannabis industry have reversed the normal tax planning objective and prefer to maximize the costs treated as COGS.
A recent IRS pronouncement attempts to limit reliance on IRC §263A to maximize COGS and minimize expenses subject to IRC §280E. Chief Counsel Advice memorandum 201504011 (CCA) takes the position that a taxpayer who traffics a Schedule I or Schedule II controlled substance must determine COGS using the applicable inventory-costing regulations under IRC §471 as that IRC § existed when IRC §280E was enacted. Thus, the IRS is taking the position that IRC §263A does not require — indeed, does not allow — taxpayers to include in COGS cannabis-related costs that would be nondeductible under IRC §280E if they were not capitalized.
The CCA interprets two tax provisions in making its conclusion. First, the CCA interprets language in IRC §263A(a) (2) to limit indirect costs included in COGS to those that are deductible from gross income when calculating taxable income. Stated differently, an indirect cost cannot be included in COGS by reason of IRC §263A for determining gross income if that cost could not be deducted from gross income if it were not included in COGS.
Second, the CCA points to legislative history to interpret IRC §280E. The Senate report notes the adjustment to gross receipts for COGS was not affected to preclude Constitutional challenge. Congress feared that denying COGS to determine gross income might be held unconstitutional.
Interestingly, the CCA concludes that a business trafficking in cannabis “is entitled to determine [COGS] using the applicable [COGS] regulations under IRC §471 as they existed when IRC §280E was enacted.” The CCA does not explain its basis for making this assertion. It is unclear why changes to the IRC §471 regulations subsequent to the enactment of IRC §280E should not apply to businesses trafficking in cannabis.
It appears the IRS is asserting that COGS, as defined by the IRC §471 regulations at the time IRC §280E was enacted, represents COGS that are Constitutionally protected when determining costs for gross income. Further, the IRS interpretation permits costs generally included in COGS to be denied as a cost for determining gross income whenever COGS includes incremental costs from when IRC §280E was enacted. Presumably, the IRS does not find these incremental costs to be Constitutionally protected.
The analysis by the CCA is flawed because:
(1) it provides no support for the position that COGS may be defined differently for certain classes of taxpayers, and;
(2) the fact that IRC § 263A does not apply to indirect costs of a cannabis business does not mean that those costs cannot be capitalized.
Filing taxes in the cannabis industry can be a real headache without a proper plan and lots of preparation. Photo Credit: 401(K) 2012
Cannabis businesses should be entitled to include in COGS all costs that may be included in COGS under all capitalization rules other than IRC §263A. The fact that IRC §263A requires the capitalization of particular costs does not preclude such costs from capitalization under other rules. Capitalization must be decided based on the IRC §471 regulations as currently written, and IRC §280E has no impact on capitalization requirements.
Looking to the future
Under the 16th Amendment, Congress has the ability to tax only gross income, not gross receipts. The determination of what is included in COGS determines gross income. Both IRC §471 and IRC §263A determine whether a cost is included in COGS. The U.S. Supreme Court in New Colonial Ice Co. v. Helvering held that deductions from gross income depend “upon legislative grace,” and a particular deduction can be allowed only if it is clearly provided by the statute.
By enacting IRC § 280E, Congress has denied its legislative grace to deductions from gross income for businesses trafficking in Schedule I or Schedule II controlled substances. However, the IRS provides no evidence that a court has applied the concept of “legislative grace” to the inclusion of costs in COGS. It is therefore unclear whether Congress has the authority to create a separate and narrower definition of COGS for these businesses. If it does not, the Constitution requires that IRC §263A be taken into account in determining COGS for cannabis businesses in the same manner as it is taken into account for other businesses — that is, without regard to IRC §280E.
One case, Alpenglow Botanicals, LLC, Et Al. v. U.S., is challenging the very concept of IRC §280E. On February 3, 2016, plaintiffs Alpenglow Botanicals, LLC, filed a Complaint against defendant The United States of America seeking declaratory, injunctive, and monetary relief so as to overturn the IRS’ decision to deny deductions to income obtained during the course of plaintiffs’ business for the tax years 2010, 2011, and 2012. More specifically, plaintiffs raised the following claims:
The IRS went beyond its jurisdiction in administratively determining that plaintiffs were not entitled to certain deductions pursuant to 26 U.S.C. §280E;
Congress exceeded its power under the Sixteenth Amendment in passing §280E;
The IRS violated the Fifth Amendment in taking evidence from plaintiffs without informing them that they were under investigation for violating the Controlled Substances Act (CSA); and
§280E violates the Eighth Amendment’s prohibition on excessive fines and penalties.
The appellate court ruled in favor of the government, setting up a showdown that could soon take place in the Supreme Court.
One thing is for sure: with marijuana now legal in over half the states in America, §280E may soon be a thing of the past.
This is Part 3 of our three-part series covering the Internal Revenue Code Section 280E. If you haven’t already, you may want to read parts one and two before moving forward.
Previously, we learned that Section 280E was originally designed to prevent illegal drug traffickers from claiming business deductions. However, with the state-legal cannabis businesses now operating in many states across the U.S., Section 280E is creating a lot of problems for the industry.
Here, we discuss 280E’s wide-reaching impact on state economies.
Section 280E is Reducing Tax Revenues
State-legal cannabis businesses want to pay federal and state taxes. However, the high tax rates (up to 70% of the business’s income, in some cases) has made some businesses ignore 280E on their tax filings or avoid paying taxes altogether. Many cannabis industry businesses want reform before they pay taxes. While they wait for these changes, Section 280E is effectively reducing the tax revenues for both states and the federal government.
In addition, the risk of being targeted by the IRS has led some state-legal cannabis businesses to hoard cash rather than reinvesting it in their communities and their businesses. The risks that Section 280E has created for legal businesses means that these businesses will continue to be less profitable, making their long-term survival unlikely.
How Can This Problem Be Resolved?
The National Cannabis Industry Association has suggested that the best fix for the problem would be to remove marijuana from the list of substances included in the Controlled Substances Act. Most members of the industry agree, though progress on that front has been bleak.
In addition, The Small Business Tax Equity Act of 2015 — companion Senate and House legislation introduced in the 114th Congress by Sen. Ron Wyden (D-OR) and Rep. Earl Blumenauer (D-OR) — is a proposal that would exempt state-legal cannabis businesses from Section 280E as long as the business remains in compliance with state law.
This is the second installment of our series investigating Section 280E of the Internal Revenue Code (IRC).
In Part 1, we explained how this overreach has made it nearly impossible for state-legal cannabis businesses to thrive in the long run — the interpretation of Section 280E by the IRS means that businesses in this industry are not allowed to claim the deductions to which most other businesses are entitled.
Here is how Section 280E affects federal tax liability for state-legal cannabis businesses.
State-legal Cannabis Businesses Pay More in Taxes
While state-legal cannabis businesses are permitted to deduct Cost of Goods Sold (COGS) and capitalize indirect costs, such as inventory, state excise taxes, and administrative costs, most deductions receive extra scrutiny from the IRS.
These deductions include:
Utilities
Health insurance
Maintenance
Advertising and marketing
Rent
Repairs
Contractor payments
Employee salaries
State-legal Cannabis Businesses Face IRS Challenges to Deductions Claimed
In addition, deductions that were previously claimed by state-legal cannabis businesses for state excise taxes, administrative costs, and the storage, purchase, and depreciation of cannabis are now likely to be challenged. In 2015, the IRS Office of Chief Counsel issued Chief Counsel Advice (CCA) 201504011. The IRS Office of Chief Counsel determined that these businesses were not allowed to use more recent provisions from IRC Section 263A, which expanded the types of expenses that could be included in COGS.
As a result, cannabis-related business owners are left to worry about the IRS challenging their deductions each time they file their taxes. The IRC is open to interpretation, which means that most businesses are unable to definitively prevent a challenge from the IRS, even after preparing their tax filings under the guidance of a qualified tax professional.
In the third and final part of this series, we will discuss the impact of 280E on the cannabis industry and the state economies that have been impacted by this legislation.
As of the writing of this piece, certain marijuana-related activities have been legalized in 25 states and the District of Columbia. However, outdated sections of the tax code — namely Section 280E — continue to threaten the viability of state-legal cannabis businesses.
This is the first installment of a three-part series that will delve into and explain the intricacies of Section 280E, so stay tuned throughout the week for Parts 2 and 3!
What is Section 280E?
Section 280E of the Internal Revenue Code (IRC) restricts businesses from taking deductions for ordinary business expenses if the business has earned income from trafficking Schedule I or Schedule II substances per the Controlled Substances Act (CSA). This section was originally added to the IRC in 1982. However, it has now also been applied to cannabis businesses that operate legally under state law because cannabis is still listed as a Schedule I substance under the CSA.
Section 280E was created by Congress after a 1981 court case in which a convicted cocaine trafficker was disallowed from claiming deductions for ordinary business expenses under federal tax law. However, Section 280E is still being applied to legal cannabis businesses in these states despite the fact the law was mostly intended to target illegal drug dealers.
How Does Section 280E Affect State-Legal Cannabis Businesses?
For businesses in other industries, the ability to deduct ordinary business expenses provides important tax savings. In fact, many business owners actually increase the profitability of their businesses as a result of these business deductions.
However, for state-legal businesses in the cannabis industry, Section 280E means that these businesses often have tax liabilities that are up to 70% of their income. Without the ability to claim the deductions that other businesses can claim, Section 280E has created a bleak environment for cannabis companies in the United States.
In the next part, we will discuss how 280E affects cannabis businesses that are legal according to state law when it comes to the computation of federal income taxes.
For more information, continue reading Part 2 of our three-part series about this important tax issue.
As the 2024 election approaches, BGM recognizes the pivotal role it could play in shaping the future of cannabis legalization across the United States. Matthew Schweich, the Executive Director of the Marijuana Policy Project and a prominent cannabis reform advocate, offered insightful commentary on the potential impacts of the election on cannabis policy. Schweich’s observations reveal that no matter the outcome of the election on November 5, significant developments for the cannabis industry are likely, but challenges remain. In this blog, we’ll delve into Schweich’s key points and explore the election scenarios that could reshape the future of cannabis legalization in the United States.
In this blog, we explore Schweich’s perspective on the possible election outcomes and what they could mean for cannabis businesses nationwide. We share our perspectives and provide insight into the ever-changing cannabis industry landscape that BGM helps clients navigate every day.
Bipartisan Support for Legalization: A Milestone in 2024
One of the most striking aspects of the 2024 election, according to Schweich, is that both major presidential candidates from the Democratic and Republican parties support cannabis legalization. This bipartisan backing marks a significant shift in U.S. political dynamics. As Schweich remarked, “That’s something that I think would have shocked a lot of people 20 years ago, probably even ten years ago, to have the Democrat and the Republican both supporting this policy.”
This widespread support, he noted, reflects a dramatic change in public opinion and political establishment views over the past decade. Just three elections ago, in 2012, no states had legalized cannabis for adult use. Fast forward to 2024, and 24 states have fully legalized cannabis, a clear indication of the cannabis reform movement’s influence and persistence.
Former President Donald Trump’s residency in Florida also played a pivotal role in eliciting his stance on cannabis legalization, as the issue was placed directly in front of him via a statewide initiative. This direct interaction between local politics and federal influence demonstrates the growing importance of cannabis as a national issue, rather than just a state-by-state battle.
The Impact of Rescheduling: Step Forward, But Not Far Enough
In recent months, the Biden administration initiated the process ofrescheduling cannabis to Schedule III. This move is significant, but Schweich is quick to point out that it falls short of what the cannabis industry needs. “I think it should be descheduled entirely,” he commented. “Even as a Schedule III drug, it’s going to be considered more dangerous than Xanax.” Schweich emphasized that this classification remains problematic because, in his view, cannabis poses far less danger and addiction risk compared to certain other Schedule III substances.
However, he acknowledged that rescheduling would offer some relief for cannabis businesses, particularly about the burdensome 280E tax regulation. If cannabis is reclassified under Schedule III, businesses could potentially start deducting standard operating expenses, significantly easing financial strains in the industry. Schweich noted, “That’s a huge potential impact, but the cannabis industry knows that more \work needs to be done at the federal level.”
The Role of Federal Legislation: The Next Major Milestone
While rescheduling cannabis is a positive step, Schweich is adamant that the next significant development for the cannabis movement must come in the form of comprehensive federal legislation. Such a law would address lingering issues related to federal policy, mainly banking restrictions and tax regulations that have hampered the cannabis industry for years. The cannabis sector remains largely cash-based due to the lack of access to traditional financial services, which Schweich described as a significant obstacle to growth and safety.
Looking ahead to the potential election outcomes, Schweich mapped out four possible scenarios, ranking them in order of the likelihood for advancing cannabis legislation:
Democrats Control the White House and Congress: According to Schweich, this scenario offers the most promising path forward for federal cannabis reform. Suppose Vice President Kamala Harris wins the election, and the Democrats retain the House and Senate control. In that case, there’s a strong chance of passing a comprehensive federal bill that could legalize cannabis nationwide. Schweich believes this would be the most favorable outcome for the cannabis industry, as it would provide the political alignment needed to push through significant reform.
Republicans Control the White House and Congress: Schweich ranked this as the second most likely scenario for achieving federal reform. He noted that a Republican-controlled Congress and White House under former President Trump could create a more functional system of government, allowing for more streamlined policymaking. However, Trump’s views on cannabis differ significantly from those of many Republican members of Congress, which could complicate the passage of federal cannabis legislation.
Split Government with Trump as President: Schweich expressed cautious optimism in this case. He explained that a Trump presidency with a split Congress could still result in some federal cannabis reform, mainly if Republicans see political advantage in supporting the issue. However, Schweich believes that partisan politics might get in the way, limiting the likelihood of significant progress.
Split Government with Harris as President: Schweich ranked this scenario as the least likely to result in federal cannabis reform. If Harris wins the presidency, but faces a Republican-controlled Congress, Schweich predicts widespread gridlock. “I think if Vice President Harris wins the Presidential election and Republicans control Congress, they’re going to wage a war against her that has nothing to do with cannabis,” he warned. The deeply entrenched partisanship could prevent any meaningful cannabis legislation from passing.
The Filibuster: A Key Obstacle
One of the significant barriers to federal cannabis reform, according to Schweich, is the filibuster in the Senate. With the filibuster requiring 60 votes to pass most legislation, many policy efforts die before they even have a chance to gain momentum. “The filibuster is the enemy of policymaking,” Schweich stated. “It is a mutation of the legislative process in Congress and kills everything.”
Schweich argued that the filibuster prevents thoughtful, well-crafted laws from being passed and hinders progress on issues like cannabis legalization, which enjoys broad public support but faces institutional roadblocks.
State-Level Initiatives: An Optimistic Outlook
Beyond the federal landscape, Schweich is optimistic about the success of state-level cannabis initiatives. In the 2024 election, Florida, North Dakota, and South Dakota are all expected to vote on cannabis legalization. Schweich is cautiously optimistic about all three states, particularly noting that turnout will be crucial. Florida, however, presents a unique challenge due to its 60% threshold for passing ballot initiatives, which Schweich described as “difficult in any state on any issue.”
Nevertheless, Schweich predicted that all three states have a strong chance of passing legalization measures, which would mark yet another milestone in the steady march toward national cannabis legalization.
The Future of the Cannabis Industry Hangs in the Balance
As the 2024 election looms, the future of cannabis policy in the United States remains uncertain but full of potential. Schweich’s insights highlight both the progress made and the obstacles that still remain and stand in the way. While rescheduling cannabis is a step in the right direction, comprehensive federal legislation remains the ultimate goal. Whether that goal is achieved will depend on the outcome of this election and the ability of lawmakers to overcome partisan gridlock.
As Schweich put it, “The cannabis industry knows that work needs to be done at the federal level,” and this election could be a turning point for the entire movement.
If your cannabis business is navigating the evolving regulatory landscape or preparing for the potential changes, BGM is here to help. Our team of experts stays ahead of industry trends to provide guidance on compliance, tax strategies, and long-term planning. Don’t wait for the 2024 election results to take action—reach out to BGM today for tailored advice to keep your business on track. Contact us to schedule a consultation and explore how we can support your cannabis business goals.
The American Institute of CPAs (AICPA) on Tuesday sent a letter to the Department of Treasury and Internal Revenue Service (IRS) requesting guidance for cannabis businesses as the federal government moves to reschedule cannabis from a Schedule I drug under the Controlled Substances Act to a Schedule III. Under the reforms, state-approved cannabis businesses would no longer be subject to section 280E of the tax code.
In a statement, Melanie Lauridsen, vice president of tax policy and advocacy for the AICPA, said that “Since the beginning of the decriminalization and legalization of marijuana across a growing number of states, cannabis businesses and their CPAs have struggled to walk the tightrope of an industry that is locally legal, but federally illegal.”
“It’s imperative that the federal government’s tax administration bodies provide guidance to these profitable businesses and their advisors in advance of the rescheduling of marijuana to help ensure a clear understanding of their federal tax obligations and mitigate non-compliance.” — Lauridsen in a press release
In the letter, the organization makes several recommendations to officials, including retroactive treatment for expenses previously subject to section 280E, clarifying issues stemming from prior section 280E disallowance, uniform tax treatment among cannabis businesses, and that the Treasury Department and IRS offer a voluntary disclosure program for cannabis businesses that would no longer be subject to section 280E as a result of the rescheduling of cannabis.
Although many cannabis experts and industry insiders were hoping to see a change in cannabis’ federal classification before the upcoming Presidential election in November, the Drug Enforcement Administration (DEA) has scheduled a hearing for December 2 to consider expert opinions on the Department of Justice’s proposal to reschedule marijuana from a Schedule I to a Schedule III drug under the Controlled Substances Act (CSA). This follows a public comment period that received over 40,000 submissions, leading to the decision to hold an administrative hearing after the November elections.
The hearing introduces some uncertainty into the timeline for the potential rescheduling, raising concerns that the rulemaking process may not be completed before January, potentially complicating the transition under a new administration. Despite hopes from some advocates for a quicker resolution, the DEA regularly schedules hearings for major public interest regulatory proposals, and this case is no exception.
If the rescheduling is finalized, cannabis would be subject to the same regulatory controls as other Schedule III substances, while still maintaining specific restrictions under federal law. While some advocates have argued that this development would set the stage for state-legal cannabis markets to be taken over by large pharmaceutical companies, many industry stakeholders believe that Schedule III will enable access to much-needed financial services and remove the burden of IRS Tax Code 280E, which prevents cannabis businesses from deducting any normal business expenses on their tax returns.
The itinerary for the DEA’s upcoming hearing has not yet been laid out, though in all likelihood it will feature presenters from both sides of the debate. Interested parties who may be affected by the policy change must submit a notice of intent to participate in the hearing within 30 days of the notice’s publication.
For cannabis retailers, 2023 was a year of busy stores and flat revenue. According to a Dutchie Report, the increase in visits was offset by a decrease in average basket value as retailers responded to heavy competition with heavy discounts: the average discount was 28.5 percent per order, and about 65 percent of total orders processed were discounted.
As more markets come online and mature, competition will only increase. So how can retailers get to profitability and stay there?
Certainly, once Section 280E goes away with the upcoming reschedule, retailers will get to keep more of their hard earned cash. But that’s no reason not to try to optimize the things you can control. One example, suggested by Dutchie, is to use digital payment systems like theirs, as consumers using DutchiePay had a 27% increase in average basket value.
Another way to systematically improve profitability is by tracking retail metrics. This approach, part of what we call “profit-focused accounting,” boils down to accomplishing financial goals by breaking down revenue into non-financial drivers: essentially the behaviors you can control to improve profitability.
A few criteria for choosing non-financial drivers: they need to be consistently controlled and monitored through very clear metrics; and they need to be limited to a few metrics, so that the amount of data is manageable.
Basket size is an obvious choice: it’s the most important metric for a retailer. We’ll look at how to measure and increase basket size below.
Calculating and monitoring basket-size
A calculation of basket size starts with total sales per month: If you sell $100 (according to your income statement) and make ten transactions (according to your point of sale data), the basket size would be $10.
Basket size should be measured monthly – at least – and benchmarked across your industry. (Legacy markets like Oregon and Washington have basket sizes in the mid-to-high 30s, while emerging markets like Missouri and Maryland are at the upper range of $80-$90). By following this number regularly, you can look for seasonal trends.
Since basket size times the number of transactions per month equals revenue, if basket size comes down, there are high chances revenue is coming down with it.
As a retailer, you need to come up with a strategy around basket size. Ask yourself: “Is my basket size in line with my market” and, if it’s lower, “am I using a high volume strategy to be able to come up with the right profitability and revenue that I’m looking for?” Ultimately, you don’t want to sacrifice market share, but you don’t want to sacrifice profitability either – and that’s what retailers are inadvertently doing with their discounting.
Increasing basket size: Cross-selling and upselling
When monitoring basket size, the next questions to ask yourself are: “Where’s the right basket size that you’re comfortable with?” and “How do I build that without heavy discounting?”
When looking at how you’re going to increase your basket size, you want to look at two things: the number of items per basket, and the price per item. If we’re seeing that price per item come down, then we’re obviously seeing the size of those baskets come down.
Two ways to increase the basket size are cross-selling or upselling.
Cross selling is suggesting additional products from a different category. The Dutchie report suggests that pre-rolls, flour and edibles are growing categories, so you could train budtenders to interest customers in those products.
Upselling is suggesting a larger or more premium item in the customer’s original choice category, which also increases basket size.
Here’s a concrete example of how non-financial drivers can add to your bottom line: Simply train your sales staff to ask every customer if they want to add a pre-roll to their transaction – a $4 increase. If that question has just a 10% conversion rate, let’s look at what that does to your profit:
Let’s just say baskets for this particular retailer were 16,667 with an average basket size before we do this upselling strategy is $61.
If our budtenders manage to convert a sale on a $4 item, 10% of the time, the average basket size goes up to $61.60 – a minimal change, but over a month period, that adds $10,000 per month, $120,000 per year, and $600,000 over a five-year period – all without increasing number of transactions.
That $.60 increase seems miniscule, but it increases gross margin, so as long as you’re doing these things and doing them consistently, there’s huge potential.
Basket size and profitability
What’s the basket size you need to hit to be profitable? In cannabis, every penny matters. Forecasting revenue comes from looking at basket size along with customer retention, but you’re also going to want to forecast your overhead: people, marketing, your facility expenses.
Let’s look at two examples, using a retailer with healthy numbers.
Revenue
Basket size: $71
Daily transactions: 463
$1000 sales per square foot
Revenue: $12 million
Once taxes are subtracted (under 280E), that retailer is operating at a loss.
Boosting basket size and daily transactions
If we increase basket size from 71 to 81 and increase our average daily transactions from 463 to 507, now we’re at $15 million in revenue. Overhead might come up a little bit, but this is the required basket size to make a profit after 280E.
Once 280E goes away, the retailer in the first scenario would be slightly profitable, while in the second example the retailer would be making around 10-15% profit as a percentage of revenue.
These KPIs help you with visibility into the future because they help you build your forecast and set realistic financial targets. They may not tell the full story on their own, but they generate conversations to identify the right actions to take to increase sustainable profitability.
The Minority Cannabis Business Association (MCBA) has issued a report detailing that the sector stands to create more than 50,000 new jobs by 2030 if the federal government were to follow through on the Biden Administration’s plans to reschedule cannabis. The group submitted the report on Monday to meet this week’s deadline for public comments related to the rescheduling plan.
The proposed rescheduling move — which would shift cannabis from Schedule I to Schedule III under the Controlled Substances Act — would not federally legalize cannabis but it would relax some of the harshest restrictions on the industry. Primarily, cannabis licensees would be finally spared from the federal Section 280E tax code, which prohibits tax deductions for companies that deal in Schedule I substances — and the potential tax relief is the primary factory behind those 50,000+ potential new jobs, the report said.
The report — signed by MCBA’s President Tahir Johnson and Vice President Frederika McClary Easley — consults survey data from 206 cannabis licensees across 32 states, including 171 businesses that directly cultivate, process, manufacture, distribute, test, or sell cannabis products.
“Our comprehensive survey and detailed economic analysis projects that rescheduling and the resulting [tax] reform would result in the creation of 55,500 jobs by 2030, generating as much as $2.7 billion in wages and $5.6 billion in new economic activity. We therefore encourage DEA to act with deliberate speed in publishing a final rule moving marijuana to schedule III.” — Statement signed by Johnson and McClary Easley, in the report
The survey also found that 80% of cannabis companies in the U.S. cite tax and finance issues as significant problems.
The pre-roll industry has exploded in recent years, becoming one of the most lucrative avenues for cannabis operators to take, even in declining markets.
Moving cannabis to Schedule III will only increase the opportunities in this category. Pre-roll manufacturers can expect new money, new consumers, and new products. Leveraging these new opportunities will determine who flourishes after Schedule III and who gets burned by the competition.
New Money
When cannabis is rescheduled to Schedule III, the 280E tax code currently burdening all plant-touching cannabis businesses will be removed from the industry, creating new opportunities by way of tax savings.
Pre-roll brands should expect competition to heat up. With the lift of 280E, new operators may feel more inclined to enter the cannabis market, and existing brands will have more revenue to back marketing efforts and new product lines.
The removal of 280E also makes purchasing new equipment more feasible as operators will now be able to depreciate their equipment for tax purposes. Upgrading to an automatic pre-roll rolling machine and ditching the cone-stuffer will be within reach for brands looking to improve their products.
New Consumers
Markets could also potentially see a surge in revenue from new customers who may be willing to try cannabis once its federal status is updated. Using the savings from the removal of 280E to increase marketing budgets and focus on this potential new audience could lead to a boost in sales. Even if the bump in cannabis consumers is minimal, increasing marketing budgets to prioritize building a loyal following will be the key to success after the rescheduling spikes competition.
Although the reschedule doesn’t open interstate commerce, it puts the industry one step closer to it. Once those doors open, competition will no longer be siloed by state. Consumers will be free to explore products from around the country.
Establishing your loyal audience now will be crucial to staying alive once interstate trade becomes legal. It may be years down the road, but the reschedule demonstrates the federal government’s willingness to participate in the cannabis industry, so it could happen sooner than we think. Start nurturing your audience now.
New Products
New money and new customers will innately lead to new products on the market, but there’s another reason Schedule III could open the door to new products—new research.
As it stands, getting approval to do any type of cannabis research is incredibly difficult. Moving cannabis to Schedule III will make it easier for scientists to explore the plant and learn more about how it interacts with the body. This new research could eventually inform new products, especially if there’s fresh data on how specific strains work and impact humans.
Consistency Will Reign Supreme
Above all, the move to Schedule III will reinforce what we already know—a consistent product is key to a successful brand. On the medical side, the FDA will now be involved in operations, and their demand for consistency may be even greater than your customers’. For both med and rec markets, manufacturers can anticipate new products and brands on the scene, increasing the need to create a consistent pre-roll experience in order to build and maintain a loyal customer base.
Using a cone-stuffing machine to create pre-rolls could leave your brand in the lurch once the plant is rescheduled. While those machines may create a consistent experience, having a pre-roll that consistently canoes and/or consistently burns hot is not the consistency customers are looking for.
Customers want a consistent pre-roll experience that burns evenly, pulls easily, and provides the same effects each time. To achieve this, manufacturers should consider rolling their joints with the BlackBird. This machine rolls pre-rolls; it doesn’t stuff cones. The joint it produces does not canoe or require a hard pull because the flower isn’t compacted on one end. Plus, the machine requires moist, fluffy flower, as opposed to the dry flower cone-stuffing machines need, so it can deliver a more intentional high while using less product.
Prepare for Schedule III
As with anything in government, moving cannabis from Schedule I to Schedule III will take time. However, there is precedent for a fast turnaround, so it could come sooner than we think. Either way, the time to prepare is now.
If you’re ready to upgrade your pre-roll so you’re prepared for the new customers and competition headed your way, get in touch with RollPros. We’ll walk you through the BlackBird’s rolling process so you can enter this next phase of the cannabis industry ahead of the pack.
On Thursday, the Justice Department initiated the formal process to reclassify marijuana from Schedule I to Schedule III, a less stringent classification acknowledging its medical benefits. This historic move, announced by President Joe Biden, aims to address long-standing inequities caused by the previous classification, which placed marijuana in the same category as heroin, fentanyl, and methamphetamine.
“This is monumental,” Biden declared in a video posted on X, emphasizing his commitment to reversing the failed approach to marijuana that has upended many lives. The Drug Enforcement Administration (DEA) submitted a notice of proposed rulemaking, opening a 60-day public comment period.
Too many lives have been upended because of our failed approach to marijuana.
So today, the @TheJusticeDept is taking the next step to reclassify marijuana from a Schedule I to a Schedule III drug under federal law.
While the rescheduling marks a significant shift at the federal level, it does nothing to specifically help those incarcerated due to cannabis criminalization, whom Biden referenced in his announcement when he said he’s committed to “righting those wrongs.” Schedule III still maintains federal control over cannabis and does not make it legal to possess, consume, or grow without a doctor’s prescription. The many legal discrepancies between state and federal laws will remain unresolved.
However, the reclassification could benefit the cannabis industry by reducing tax burdens, particularly by removing marijuana from the IRS code’s Section 280E. This would allow legal cannabis businesses to deduct ordinary expenses, fostering growth in states where the plant is legal. It could also make it easier for scientific research to be conducted around the medicinal benefits of cannabis.
Vice President Kamala Harris highlighted the reclassification as a crucial step toward change, and Senate Majority Leader Chuck Schumer reiterated the need for Congress to end federal prohibition entirely. While many will see this advancement as a step in the right direction, achieving comprehensive reform will require continued efforts to align federal policies with state-level legalization and to ensure restorative justice for those affected by criminalization.
U.S. medical and adult-use cannabis companies have tallied up $3.8 billion in delinquent payments with total late payments on track to reach $4.2 billion in 2024, according to survey data and analysis from the Whitney Economics 2023 U.S. Cannabis Delinquent Payments Report.
The report found that the delinquent payments issue is universal to the cannabis industry but tends to hit cultivators harder than retailers; the delinquent payments also have a greater impact on smaller and minority operators. Additionally, 44% of respondents said that late payments by cannabis companies had impacted their ability to pay their own debts, while 34% said it had affected their ability to make tax payments.
Survey respondents were given the opportunity to provide written input — “I would love to pay my bills, if others would simply pay me first so I could do so,” said one respondent who had delinquent payments.
“The pressures created by current macroeconomic factors and regulatory policies have incentivized operators to stop paying their suppliers,” Beau Whitney of Whitney Economics said in a press release.
“This data further affirms the fact that the cannabis industry is struggling. Unless there is some form of federal and state regulatory intervention, the issues associated with the lack of payments will only get worse.” — Whitney, in a statement
More than half of survey respondents (57.3%) said that delinquent payments have a greater impact on their business than Section 280E of the Internal Revenue Code.
In this insightful Q&A, we sit down with George Jage, co-founder of Jage Media and one of the organizers behind the popular cannabis trade show event, MJ Unpacked, coming to Atlantic City, New Jersey, this April. Having been organizing cannabis industry events for nearly a decade, George is at the forefront of convening cannabis entrepreneurs and investors, and has been navigating the complex landscape long before the ink dried on today’s regulatory frameworks. George also has a seasoned background in fundraising and a knack for fostering environments ripe for growth and collaboration. In this interview, George joins us to discuss:
The evolution of the cannabis industry from its early, unregulated days to the current environment.
How MJ Unpacked provides unique value as an event exclusively attended by license holders, applicants, investors, and other qualified guests.
How license holders and applicants can maximize the value of their attendance if they’re seeking investor financing.
What prospects and challenges for the cannabis industry lie ahead going into 2024.
Read the full interview below!
You have been coordinating gatherings for cannabis entrepreneurs and investors since before most of the current regulations were even written, and in those days, everyone had a different vision for what the industry would become. Over the years, what are some of the ways in which the industry evolved that surprised you?
Probably the most surprising and disappointing is the lack of progress at a federal level for cannabis reform. At the onset, it was clear that the 280e taxation was punitive and unfair as well as discriminatory banking policies. Truly little has been done to change this in the past 10-12 years.
The rest is expected. Early stage markets are messy and confusing. You have good actors and bad actors. You have huge success stories and epic failures. Everything is new so there are always opportunities to win and plenty to lose.
Do you think cannabis reform will be a significant factor in the upcoming US presidential election?
I hope not as this is not a political football. Biden made promises and if he can live up to getting cannabis rescheduled (and not make it an issue to bait the younger voters), I think the industry should rally behind him if he commits to further descheduling. This is a tough question to answer given the presumption options we have on who can lead our country in the next 4 years and the risk of civil unrest or turmoil that could follow this upcoming election.
While many conferences are open to everyone, MJ Unpacked is unique in its focus and audience, limiting attendance to vetted license holders and applicants, accredited investors, and qualified media & research personnel. How does this change the experience for attendees?
Honestly, we just listened to people and understood what they disliked about most of the events they went to. And on the top of that list was how many unqualified people they need to sift through to have a meaningful conversation. Trade Shows are like family gatherings. You want to have a sense of belonging. Talk with the people you have shared experiences with. Sometimes get in arguments, but mostly feel you are among your people who care about you and support you. Your tribe.
But I think what sets our team apart is our compassion and empathy for the people we serve. We never approach this as selling a booth or selling a ticket. This is about partnering with our exhibitors and sponsors to invest in an event to get a return on their marketing spend. That can in turn help grow their business, hire more people, serve more customers.
We like to say we are focused on outcomes, not our income. The latter is a function of being of service and value.
The next MJ Unpacked event is coming up this April in Atlantic City, New Jersey. What aspect(s) of the New Jersey cannabis market are you most excited about?
This event is not a New Jersey event despite misconceptions in the market. Our focus is on the east coast because this is where all the new investment and market growth will come from in the next several years. But this is still national in scope. At the past 2 events we did in New York, California operators were among the top 4 states represented in our attendance.
What excites me is how well New Jersey is rolling out its market and licensees. And Atlantic City is on the up and reminds me a lot of Vegas 20 years ago. It was a tough decision to leave midtown Manhattan as we love the city, the energy, the opportunity there, but as the industry remains undercapitalized, the AC event offers a lot of savings to our delegates and provides a more concentrated event environment. We don’t want to see the event go the way of MJBiz where the trade show has become second billing to the action in Vegas.
How does MJ Unpacked proactively help facilitate connections between brands and investors?
This is the very basis of why we created MJ Unpacked. Cannabis will mature into a CPG (consumer packaged goods) industry. Brands will be where the true wealth creation will come. Retail will support local economies and create opportunities for local business success. Cultivation will bifurcate into craft and commodity. We started MJ Unpacked to meet the needs of the market at the moment, but to more importantly provide a better, fairer, and more open market for these brands to flourish. To compete on value and authenticity. And to support the small to midsize businesses people who have invested everything to make the industry not only what it is today but will be in the future. We truly want to support the personal and professional growth that happens when you have a brand new industry emerge.
That said, I think you were asking specifically at our events. Sorry for the soap box speech. I think the power of the connections comes from our event design. We know that walking a Home Depot style event that is endless aisles of sameness often leads to disengagement or overload. We intentionally design our event to create an experience that connects everyone in the room.
A simple tool is to create a lot of soft seating. Allowing people to sit down and have a conversation, establish trust and THEN be able to conduct business. On the tech side, our exhibitors and attendees can message each other leading into the event and schedule time to meet on the show floor or in one of the lounges. We designed our own lead gen tech so it is as easy as opening your camera and taking a pic of a QR code that can then be stored in your phone or accessed daily from your lead report. There is much more we put into our design that makes MJ Unpacked unique that would be too long to go into.
What advice would you give to founders who are attending MJ Unpacked specifically to meet potential investors?
Be prepared. The lack of capital in a growth market is the fundamental reason our industry is struggling. Period. Many early angel investors are tapped out or tired of losses. Many VCs have limited dry powder and are conserving it to support their existing portfolio companies. PE and institutional capital hasn’t overtly entered the game (yet). And if you’re raising money for a private venture, you’re competing against public companies that investors can buy at a 90% discount and exit whenever they want.
You need to be able to communicate your UVP effectively. How will you differentiate in the market? Gain customers? Scale with efficiency? Investors have seen and heard most before. You need to be able to demonstrate you have a solid plan and the team to execute. You need to show you can weather the storm. Turnover is rampant so your team better be bought into the vision (through equity).
There is money out there, but as noted, the competition is fierce. Grit, persistence, consistency are required, not unique.
If you were looking for an easy road to riches and picked cannabis, you might want to turn around and head back. It is bumpy and filled with pitfalls, but the reward is way beyond what any of us can imagine. Setting aside the opportunity to create wealth, equity, fame or fortune, we are collectively building a brand new industry and changing the world, for the better I believe. That needs to be the core source of your strength.
And after that doom and gloom, I am optimistic that if we achieve Schedule 3, this will have a radical impact on the available capital to the market. But you still need to be buttoned up and on top of your game to get it. The money that will come in next will be more cautious, more demanding, and have higher expectations (no pun intended).
Can you share a success story or two from past MJ Unpacked events where connections made at the conference led to significant outcomes for attendees?
This is what drives us and honestly, there have been too many to mention. But here’s a short list of my favorites. Mr. Moxey Mints exhibited in NY-22, signed a deal with Acreage to expand to 10 states. Matha Figaro participated through our social impact scholarship, met Azuca, got her NJ licensed and is launching her product right now. Seed Talent refused to break down early and 15 minutes before the end of the show had a buyer come in (who thanked him for not breaking down early) and closed the biggest deal of the event for his company. 40 Tons launched their brand at our inaugural event and we even designed their prison cell concept for them that now has become a signature part of their brand.
From your vantage point, what would you say investors and VC firms in the cannabis space are looking for right now? And how might sentiments change later this year if there is policy movement at the federal level, such as Schedule III status or SAFE banking?
I think they are starting to make moves into brands. Many are still playing the safe route to invest in ancillary, especially scalable tech due to the high margins of that business, but there are fewer and fewer new opportunities there. But if you really want to know, you can hear it directly from the horse’s mouth. We are having a Mega VC panel at MJ Unpacked titled Who’s Got Money and Where Are They Putting it.
Federal reform at this point is a requirement for our industry to move forward. 280e taxation was designed to bankrupt companies. The industry needs leadership and a united voice, not just that of the larger companies who can fund lobbyists, but truly the entire industry to unite behind the efforts of getting cannabis rescheduled.
Safe or Safer banking will follow. Then interstate commerce and eventually federal legalization.
