The Cannabis Industry and the Tax Treatment of Inventory
November 12, 2020
By Benjamin Aspir, CPA, MST
The recent release of IRS FAQs and a cannabis industry landing webpage has raised the following question amongst the cannabis industry: Are cannabis companies that are considered ‘small businesses’ eligible to make a tax election to immediately expense their inventory, thereby avoiding the effects of IRC Sec. 280E, which generally limits most tax deductions incurred by a cannabis business, other than cost of goods sold (COGS)?
The definition of a small business for tax purposes is critical as IRC Sec. 471(c) allows small businesses to elect to treat inventory as non-incidental materials and supplies. The Tax Cuts and Jobs Act of 2017 (TCJA) greatly expanded the gross receipts threshold criteria for a small business. Under TCJA, businesses with an average annual gross receipts for the prior three years of $25 million or less meet the small business criteria. As an industry in its early stages many cannabis business would meet the gross receipts requirement.
Can a cannabis small business elect to expense all of its inventory under IRC Sec. 471(c)?
The IRS has yet to comment on the interplay of IRC Sec. 471(c) and IRC Sec. 280E. The Treasury Inspector General for Tax Administration (TIGTA) recently recommended that guidance on this issue be released. If previous Tax Court rulings are any indication of their position, the IRS and the Tax Court would likely view an IRC Sec. 471(c) election as an attempt to circumvent IRC Sec. 280E. Additionally, an election under IRC Sec.471(c) may have an unintended effect under IRS examination. The IRS may attempt to completely disallow all deductions, which may have been previously deductible as cost of goods sold (had the IRC Sec. 471(c) election not been made). Until the IRS releases further guidance, this matter remains unresolved. A tax professional should be consulted to determine IRC Sec. 280E applicability.