Section 280E is a provision of the Code that has significant implications for businesses operating in the cannabis industry. In short, Section 280E prohibits businesses from deducting normal business expenses from their taxable income if they are involved in the production, sale, or distribution of controlled substances, including cannabis. In this article, we'll explore the history and impact of Section 280E and its implications for businesses in the cannabis industry.

Section 280E was first enacted as part of the Tax Equity and Fiscal Responsibility Act of 1982, in response to a court ruling that allowed drug dealers to deduct their business expenses from their taxable income. The provision was intended to prevent drug dealers from claiming tax deductions for expenses associated with their illegal activities.

The impact of Section 280E can be significant for cannabis businesses, particularly those operating in the retail sector. Because of the prohibition on deductions, businesses in the cannabis industry can face effective tax rates that are much higher than those faced by other businesses. This can make it difficult for cannabis businesses to compete with other retailers and to reinvest profits in their businesses. However, there are exceptions to this law that allow for the deduction of the cost of goods sold for certain types of cannabis businesses. Here are the categories and exceptions to Section 280E:

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Categories under Section 280E‍

1. Controlled Substance: Section 280E disallows deductions and credits for costs related to controlled substances, regardless of state or federal law and cannabis is listed as a Schedule I controlled substance under the Controlled Substances Act (CSA).

2. Trafficking: Act of buying and selling cannabis is considered trafficking under Section 280E, despite state legalization.

3. Trade or Business: Cannabis is considered an illegal business under federal law, but it is still expected from the related parties to pay income tax on the earnings acquired from the cannabis trade. Whether an activity related to cannabis is considered a business depends on case precedence, consistency, and extent of activities over a certain period of time.

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Exceptions to Section 280E‍

1. Cost of Goods Sold (COGS): Cannabis businesses are allowed to deduct the cost of goods sold from their federal tax returns, which includes the direct costs of producing or acquiring cannabis products. This means that businesses can deduct expenses related to cultivating, harvesting, and processing marijuana, as well as the cost of purchasing cannabis from suppliers.

‍2. Non-Trafficking Expenses: Businesses can deduct expenses that are not related to the trafficking of controlled substances, such as rent, utilities, and employee wages, as long as they can be clearly separated from the production or sale of marijuana. For example, a dispensary may be able to deduct the cost of its rent and utilities, but not the cost of advertising or marketing its products.

‍3. Research Expenses: Cannabis businesses can deduct expenses related to research on marijuana, as long as the research is conducted in compliance with state and federal laws. This includes expenses related to testing the potency and purity of cannabis products, as well as research on the medical benefits of marijuana.

4. Ancillary Businesses: Businesses that provide services to the cannabis industry, but do not actually produce or sell marijuana, may be able to deduct ordinary business expenses from their federal tax returns. For example, a law firm that specializes in cannabis law may be able to deduct its office expenses and employee wages, even though it is not directly involved in the production or sale of marijuana.

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Conclusion

Section 280E presents a significant challenge for businesses in the cannabis industry. As the production and sale of cannabis is still illegal under federal law, businesses cannot take advantage of the same tax deductions as other legal businesses. This can lead to high effective tax rates, making it challenging for these businesses to compete and reinvest profits. However, with exceptions such as the deduction of cost of goods sold and research expenses, there are still options available to reduce tax liability. It is crucial for businesses in the cannabis industry to navigate these exceptions and comply with federal tax laws to succeed in this rapidly growing market.‍