This article was originally published on Hoban Law Group, and appears here with permission.
As of right now, sixteen states and Washington, D.C. have legalized cannabis for recreational adult use. A whopping 36 states have laws on the books regulating medical cannabis usage. The green economy is no longer budding – it’s in full bloom.
But cannabis entrepreneurs are in a tricky situation. Though legal to produce or sell in their respective domiciled states, at the federal level cannabis is still considered a Schedule I substance. This classification presents complicated hurdles for cannabis accounting and compliance.
Additionally, cannabis companies are lightning rods for audits. We expect most cannabis businesses will be audited by local governments on revenues on an annual basis. Therefore, impeccable financial and compliance record-keeping is a must.
Bottom line: the rules are different for cannabis companies. Here’s what you should know.
Tax deduction limits under 280E
According to the U.S. government, cannabis is still a narcotic. Therefore, it is still enmeshed in federal legislation targeted toward “harder” substances. 26 U.S. Code Section 280E stipulates that businesses engaging in a Schedule I or II controlled substance (cannabis!) are barred from taking tax deductions or credits.
This means cannabis businesses must pay taxes on the entirety of their revenue. Owners are unable to claim business expenses to reduce their taxable income. 280E restrictions also extend to plant-touching subsidiary companies or those holding cannabis licenses, as demonstrated in a recent ruling against California’s Harborside, Inc. by U.S. Tax Court.
In short, cannabis entrepreneurs are locked out of valuable tax credits available to other businesses and should proceed with caution when it comes to business expense deductions.
Exclusion for Cost of Goods Sold (COGS)
According to the IRS, COGS includes the cost of the product itself, costs to ship the product, and expenses directly related to the product – it’s essentially equivalent to inventory costs. The federal tax code contains an exclusion enabling businesses to claim a deduction for the cost of goods sold, even if the goods themselves are illegal under federal law.
COGS is a valid deduction. However, the IRS definition narrows when applied to cannabis companies and right …