Work in the cannabis industry long enough and you can expect to come up against “the weed tax”. Tax code § 280E with its profound effects can often make or break a business operating in the cannabis space. 280E highlights the importance of diligent accounting and legal representation especially in the ‘flower touching’ section of the cannabis industry, as farmers, processors and dispensaries look to best navigate cannabis law.
Prebirth of 280E
The federal income tax law determines that individuals should report all income whether or not the income was gained from legal or illegal activities. This is shown where IRC § 61(a) does not differentiate between income derived from legal sources and the income derived from illegal sources. Congress has a right and collects taxes on income as shown under the “ Sixteenth Amendment ”. This stance was supported in the court case James v. United States, 366 U.S. 213, 218 (1961). To provide further clarity, income was defined as the gross income of a reseller or producer and NOT the gross receipts. Both § 61(a) and the Sixteenth Amendment consistently support that gross income is the taxpayer’s gross receipts minus the cost of goods sold. This precedent was set in the following court cases: Stratton’s Independence v. Howbert(1913) and Doyle v Mitchell Bros. Co., 247 U.S. 179, 185 (1918).
Taxpayers involved in business ventures also have the ability to deduct any ordinary and necessary business expenses from their gross income to derive their net income, which is supported by § 162(a). This is a very common practice as tax preparers routinely apply the deduction of their client’s applicable business expenses on the relevant schedules in computing taxable income. The New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934) and Reading v. Commissioner, 70 T.C. 730, 733 (1978) cases are two main examples where the deduction of ordinary expenses related to businesses was applied.
The Birth of 280E
In 1981, Jeffrey Edmondson, a drug dealer, decided to use the §162(a) provision to deduct business expenses related to his trafficking of controlled substances. Jeffrey Edmondson v. Commissioner, T.C. Memo. 1981-623 shows he was able to deduct the following.
The cost of the controlled substances (amphetamines; cocaine; marijuana) obtained on consignment
A portion of the rent he paid on his apartment which was his sole place of business
- Packaging expenses
- Telephone expenses
- The cost of a small scale
- Automobile expenses
Edmondson’s use of §162(a) to deduct ordinary and necessary business expenses from his drug trafficking business was initially upheld by the US Tax Court and that revealed a loophole in the tax code that was not anticipated. To address this, Congress reversed Edmondson’s ability to deduct these expenses claimed by enacting IRC § 280E in 1982. The § 280E code states the following:
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 in 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.
Businesses in the Cannabis industry are faced with extremely high taxes especially because of their federally illegal status. Learn how this all started and how companies may be able to navigate through it.
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