Navigating Cannabis Tax Law: Minimizing Risk & Maximizing Deductions
Legal marijuana has gone mainstream, and the cannabis industry is experiencing a boom that shows no signs of slowing down anytime soon. In 2020, global cannabis sales reached $19.7 billion. In the U.S. alone, sales hit a record $17.5 billion last year, according to cannabis market research leader BDSA.
Despite those huge numbers — and the fact that 36 states plus the District of Columbia have decriminalized cannabis sales in some form — the industry is still not legal on a federal level. That’s one reason the IRS is much more likely to audit cannabis businesses compared to other sectors. Additionally, cannabis is largely a cash business and industry regulations are highly technical and constantly evolving. All that adds up to a tricky legal and financial landscape.
At CJBS, we have the expertise to help cultivators, processors and dispensaries navigate the complicated tax and financial issues that come with working in the fast-paced cannabis industry. With a deep understanding of the history and application of cannabis tax law, we help ensure that your business is not only complying with the law but that you’re also taking advantage of any tax savings and planning for future success.
Internal Revenue Code Section 280E
The main complication is that even when it is legal at state level, federally, cannabis is considered a Schedule 1 Controlled Substance, alongside heroin, LSD, and ecstasy. This means it is subject to Section 280E of the Internal Revenue Code, a statute enacted in 1982 to prevent illicit drug dealers from deducting “business expenses” for tax purposes. This, in turn, means that even legitimate cannabusinesses that comply with all the relevant laws are nevertheless burdened with federal taxes on expenses that no ordinary business would have to pay. In 2020, the IRS established a dedicated marijuana industry website to answer business owners’ frequently asked questions and explain their tax obligations.
How Cannabis Businesses Can Minimize IRS Audit Risk
As tax management and cannabis accounting specialists for over 6 years, CJBS partners with cultivators and dispensaries to help you manage the risk of audits and properly maintain your financial records as a top priority.
We work to ensure you’re keeping your cost of goods sold (COGS) as precise as possible and are mirroring those costs on your tax return preparation, as inconsistencies between books and tax reporting can be a big red flag to the IRS and will decrease your chances of being successful if you’re audited. And our experience is that, for most cannabusinesses, an audit will come sooner rather than later.
How Cannabis Businesses Can Maximize Deductions
Because 280E prevents legal marijuana businesses from writing off most “normal” expenses, it creates a very high effective tax rate. However, the code does allow cannabis businesses to deduct the portion of expenses that can be allocated to (COGS) — one key way to reduce taxable gross income. So determining which items are classified as COGS is extremely important. At CJBS, our team helps our cannabusiness clients boost their tax savings — and increase cash flow. One way we do this is by carefully analyzing your fixed assets. We make sure your fixed assets are classified properly for COGS purposes and, if applicable, we assist with recommendations to properly utilize accelerated depreciation when it’s best to do so.
In one case, we were able to save one of our clients, a cultivator, significant tax dollars by moving up a purchase date of an asset to take advantage of accelerated depreciation on those assets placed in services for that time period. Like many cannabis operators, they were concerned with paying the lowest amount of taxes possible in the early years to conserve cash for expansion purposes. This is one of the multiple strategies we’ve used with many of our clients to help them not only expand their operations, but continue to utilize additional accelerated/bonus depreciation on new purchases year after year.
In the exciting but volatile cannabis business, it’s essential to work with a tax industry expert with a thorough understanding of accounting and financial practices, not only to ensure you’re operating within the law but to position your company for future growth.
We’d love to discuss your cannabis business with you today. Please contact us with any questions you might have!
Matthew S. Bergman, CPA
Senior Partner, CJBS