Tax Issues Affecting Cannabis Companies
October 29, 2021
In this episode of CannaCast, Eric Altstadter, Partner and leader of our Cannabis and Hemp Group, speaks with fellow Partner Tom Cardinale, about the tax issues cannabis companies face.
EA: Tom, we're going to talk about cannabis and with cannabis, the 600-pound gorilla in the room is always Code Section 280E. Can you talk a little bit about what 280E is?
TC: Sure. It's definitely the biggest issue facing cannabis businesses today. Section 280E is a federal tax law provision that strictly prohibits all tax deductions and credits from gross income. I'm going to define gross income in a minute. This allows all deductions for a business that has a primary purpose of selling or distributing a schedule one or schedule two classified substance. Unfortunately, cannabis is still to this day listed as a schedule one drug, so the 280E provision applies. However, it is important to know what I said before is that it disallows deductions from gross income. Now in tax terms, gross income is defined as revenues, less Section 471 costs, which in layman's terms is inventory costs or product acquisition costs. So when you split up a cannabis business into two choices, you're either a cultivator or grower or you're a dispensary just selling it.
You would have a different answer of what those deductions would be. For a dispensary, pretty much your only acquisition cost is your purchase cost. You're buying it from a cultivator. So that would include the raw purchase cost plus maybe freight and taxes. That would be your only allowable tax deduction from a US income tax perspective. When you're a cultivator grower, you could include many more costs that are used to grow the product. You may have an allocation of indirect G and A costs that are vital to the growing activities of the cannabis plant. You would have in general, more costs of good sold deduction allocated could be utilities, plant seeds, of course, water, anything that is directly important to grow that product. You could also deduct. So that's 280E in a nutshell.
EA:How does 280E affect a company that sells other goods, such as t-shirts or novelty items?
TC: Great question, we get it often. There's case law precedent on this, namely the Harborside of Oakland case that brought this issue up, where if you're a cannabis business, but you also sell non-cannabis products. How does that all fit into 280E? And what it comes down to is it's an all or nothing rule for 280E. What case precedent has looked at is, "What is your primary purpose?" If you're in the business with a primary purpose of selling or growing cannabis, then if you're selling novelties or t-shirts on the side, all of those are going to be enveloped in the 280E provision. Unfortunately. So what we tell businesses to do, that plan to have different revenue streams between cannabis and non-cannabis products is to legally separate your businesses, keep them completely segregated. Don't keep it all under one roof or under one legal entity.
So, if you have it separated, then that, let's call it scenario company, where you're just selling t-shirts souvenirs, novelties. That would just be a general legitimate retail business, where you can get all your deductions. But if you just include that with a cannabis business and your dominant revenue stream or operation is the cannabis business, all of those deductions relating to the shirts and novelties would be also not deductible.
EA:Tom, are there any attempts or any move to lessen the sting of 280E?
TC: There's currently no intent by Congress to eliminate the 280E provision in its entirety, due to the vast and dangerous nature of say other non-cannabis drugs, such as fentanyl, which makes the news a lot, extremely dangerous. So I don't see 280E ever being eliminated. However, that being said in easier, off ramp for lawmakers and it's already in draft bill to take the sting out of 280E for cannabis businesses is to just deschedule the cannabis drug. Right now, it's listed as a schedule one drug, which goes back to the 1970 Controlled Substances Act. But if they deschedule it, then you're automatically taking it out of the grasp of 280E, because 280E is only on the schedule one and schedule two drugs.
So that, language is already in the MORE Act still sitting in Congress. I don't know if it's going to be up for vote again. It made an attempt during the 2020 elections, but it only passed one chamber, but because there was a change of control in 2020, unfortunately you have to reset the process. You have to get still both votes in both chambers of the Senate and House to pass that. If it that's going to deschedule cannabis as a list of schedule one. And so 280E would no longer apply.
EA:Now 280E effects drugs that are listed on schedule one and two, but there are two items that are coming from the same plant, hemp and CBD, among two of the most popular, there are many others that are coming from the plant, but those are the two that are most popular. How does 280E affect those entities or those items?
TC: Another great question. The good news for, and this is really to the maybe the farming industry, is that the 2018 Farm Bill, essentially across the board made it legal to grow hemp, which pretty much has no levels of THC, which is the psychoactive drug of cannabis. It could have traces of it but nothing that would do any harm. So hemp in itself is officially legal across the board. It's not considered part of cannabis. It is its own item. It's its own object. So the 280E provision on hemp, any hemp business or businesses that are just extracting the CBD oils out of hemp would be completely legitimate, and 280E would not affect those businesses.
EA:Are there any other tax issues that affect cannabis companies differently than other entities?
TC: Outside of 280E, which is really the biggest one, I would also urge cannabis owners to pay attention to state and local tax issues. Every state in the country almost has to be treated right now as its own country in a way in terms of its laws. They're coming up with crafty ways to come up with brand new taxes, who should pay for it? Different rates. Sometimes a sales tax may be imposed on the grower that they're selling to dispensaries. And it's usually the other way around. So state and local issues can get very tricky and many states that are just approving cannabis, to transact cannabis through referendums or just legislative law approval are right now, as we speak writing a very complex state and local tax issues that are specific to the cannabis industry. And we would recommend you get in touch with a state and local tax expert on your specific situation regarding your cannabis business
EA:Tom, you talked about state and local tax. There are many states out there that are moving forward to legalization at the state level. Is there any consistency with respect to the states as to what they're doing or are they all completely different?
TC: A state in general, when it comes to taxation of any federal provision has two choices, they could be a rolling conformity state, which means we roll in conformity with any federal act by default or any tax provision by default, or you could be static conformity, meaning we don't care what the federal government passes as a provision. We'll pass our own provision. If we agree with it, or if we'll write our own law pertaining to it, that's a static conformity state. So you only got those two choices among states.
So for the ones that are a static conformity, that have a choice, there are some states, namely California is probably the biggest, that have decoupled from the federal 280E provision for corporations. And this is a segue to entity choice in a way, because if you're a California cannabis business, only a California corporation could make you get away from the 280E grasp from a state level. And at the California rate, is over 10% now corporate rate, it could mean something to set it up that way. So states for the most part do follow 280E, the vast majority follow 280E, but it is state by state and always follow their efforts closely, because they may decouple from it or already decouple from it.
EA:Tom, in conclusion, what do you think about the prospects of future federal legalization of cannabis?
TC: I think the prospects are good. A few years ago, I would've said it's a long shot, but there's a lot more bipartisan support these days, especially when you consider the economics of it, the tax revenue, the job creation of it. So even some, in more conservative circles, they're embracing cannabis for their state and they're being good proponents of it. So I think the odds are very good. As I said, the MORE Act is already there waiting for a vote. I don't know what the delay is. Hopefully it does get taken up again soon. And if that gets passed, that would essentially remove cannabis from the Controlled Substances Act and it would be deemed legal at that point. So we'll have to wait and see.
EA:Thanks Tom. And thanks for listening to CannaCast as part of the EisnerAmper podcast series, visit Eisner Amper.com/cannabis for more information and podcasts and join us for our next CannaCast podcast where we'll discuss other budding issues.