Federal Cloud And The IRS
If you follow Washington and Colorado’s march to mainstream, recreational use cannabis law implementation you read all about how big business is moving in, or the fears from the established medical marijuana, MMJ, community that big business might move in. No matter who moves in, or what happens to the existing Washington MMJ business, businesses of all sizes are planning to “move in.” But when they do they move in with limited business tools.
Possession of non-hemp cannabis is illegal under Federal law. And because it is illegal under Federal law all types of support businesses and the primary business itself have learned to live in a cloudy world. Most business expenses for growing, processing, and selling cannabis are not deductible from the income of the business thanks to section 280E of the IRS Code. A business operator can split some hairs, and collect a ton of paper work to justify vaguely related business expenses, but generally, expenses are not allowable write-offs.
280E: Read It And Weep
26 USC Section 280E-Expeditures in connection with the illegal sale of drugs:
No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business consists of trafficking controlled substances (within the meaning of schedule I and II of the Controlled Substances Act) which is prohibited by Federal Law or the law of any State in which such trade or business is conducted.
Cannabis is a schedule I drug under Federal law and thus, illegal. In English, a cannabis business owner can deduct very little from income from the business. However, there are two Federal cases that allow a deduction of cost of goods sold (COGS). COGS are carefully detailed in IRS Form 1125-A Cost of Goods Sold document. But since cannabis is illegal, the form hardly covers allowable COGS for a cannabis business. One ruling from a California MMJ operation allowed the counseling and evaluation work for the authorization to be an allowable COGS. But, the dispensary side COGS were denied. A COGS is not actually a “deduction” from income but a subtraction from the gross receipts. It is the material and labor that goes into producing the final gross sales amount. Hair splitting yes, but still a complex pathway for cannabis enterprises.
And so you think bartering will be the way to go? The IRS considers bartering to be a business transaction and treats the fair market value of the property and services received through barter as taxable income. There is even a line on an IRS business form, Schedule C, P/L report.
Three tiers of 25% tax (I-502) can produce a compounded 75% gross receipts tax. Will this be a liability, or a deduction? There are many unanswered questions about the tax side of MMJ and soon recreational use business. Rob Braach, Montana CPA advises clients and attendees of his seminar presentations to move slowly, carefully, conservatively and be ready to watch an entire body of tax law develop. http://www.braachcpa.com/about.html
Next Series of Posts:
Banking and Federally Chartered Banks, Credit Unions, Insurance, other support services including, yes, lobbying. Washington has at least one cannabis friendly credit union. And, are insurance brokers, and other support businesses engaging in Federally defined illegal activity when they provide services to cannabis business? Stay tuned.