How Taxes Are Handled in the Marijuana Industry
The IRS recently published updated guidance (via FAQs) regarding the deductibility of certain expenses for marijuana/cannabis businesses operating legally under state law, though these businesses are still illegal under federal law.
The FAQs reiterate that “income from illegal sources is taxable and is not exempt from taxation,” and therefore, marijuana businesses must report their income for tax purposes. The FAQs highlight Section 280E of the Internal Revenue Code, which disallows deductions for businesses engaged in “illegally trafficking in a Schedule I or II controlled substance within the meaning of the federal Controlled Substances Act.”
While many states have legalized marijuana businesses for both medicinal and recreational purposes, federal law still views those who engage in this activity as illegally trafficking a controlled substance since marijuana (cannabis) is listed as a Schedule I controlled substance.
The FAQs make clear, however, that such businesses may reduce their gross receipts by their costs of goods sold, thereby reducing their taxable income. While this has long been the conventional accounting method used by those in the cannabis industry mindful of 280E and its limitations, the FAQs are the Service’s first clear endorsement of this approach.
In an audit, the IRS is still likely to disallow many other operating expenses not tied to cost of goods sold, including payments for items like rent, utilities, payroll, advertising, and other big-ticket expenses. Dispensaries, who may have a harder time justifying treating expenses as part of their costs of goods sold versus manufacturers or cultivators, should still be particularly mindful of 280E’s ongoing limitations and its financial consequences.
Regardless of industry, small business owners should consider hiring professional tax and business lawyers who have the knowledge, planning, and counseling expertise to ensure any business is set up for long-term success, particularly when it comes to potential tax liabilities.
With so many questions and unknowns, it is important to hire a small business counsel who is the right fit for you.
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