Top Cannabis Business Considerations for Filing Taxes in 2022

April 4, 2022

The cannabis industry is treated differently than other sectors regarding taxes and banking due to its legal status, and cannabis businesses of all sizes must prioritize tax planning to be successful. Cannabis businesses are highly recommended to consult a cannabis accountant because of the specialized considerations and layered ramifications within the realm of cannabis business taxes. With that said, here are some general tips for cannabis businesses to ensure Tax Day is a success.

What Is Section 280E and How Does it Affect Cannabiz Taxes?

Cannabis is classified as a Schedule I drug under federal law, and therefore the production, distribution, and possession of cannabis remain illegal on the federal level. Section 280E of the Internal Revenue Code prohibits cannabis businesses from deducting ordinary business expenses, even if they operate legally under state law.

IRS Section 280E States, “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.”

Which Kinds of Cannabis Businesses Are Subject to 280E?

Section 280E affects all state-legal businesses that cultivate, sell, or process the cannabis plant, such as cannabis cultivators, processors, manufacturers, and dispensaries.

Which Business Expenses Are Deductible Under Section 280E?

Cannabis business owners can deduct the cost of goods sold (COGS) on federal taxes, which is the total amount a business paid as a cost directly related to the sale of products. COGS includes the cost of products or raw materials, including freight, storage, direct labor costs for workers involved in the production, and factory overhead.

Which Business Expenses Are Not Deductible Under Section 280E?

Ordinary overhead business expenses that cannabis businesses cannot deduct under Section 280E include (but are not limited to):

  • Marketing and advertising expenses
  • Wages and salaries
  • Payments to contractors
  • Health insurance premiums
  • Travel expenses
  • Utility costs such as electricity, internet, and telephone service
  • Repairs and maintenance
  • Rental fees for facilities

State and Local Tax Considerations for Cannabis Businesses

Medical and adult-use cannabis is taxed differently in different states, according to the product's price, weight, and/or potency. Many states levy more than one of these types of taxes on cannabis, and some jurisdictions also levy a general sales tax on cannabis purchases in addition to excise taxes.

How a Cannabis Consultant Can Help Optimize Taxes for Cannabis Businesses

For cannabis businesses, seeking expert tax advice from a cannabis accountant is imperative. An IRS report found that 59% of cannabis businesses had 280E adjustments in 2016 filings, resulting in underpayment of taxes. The IRS stated it is preparing to increase cannabis industry audits nationwide.

Federal laws and regulations strongly discourage banks and other financial institutions from partnering with licensed cannabis companies because cannabis is classified as a Schedule I controlled substance. However, more banks are gaining confidence with cannabis. Cash-intensive business issues unique to the cannabis industry highlight the need for expert cannabis accounting.

At Terradigm, our cannabis accounting services support cannabis businesses at every stage, including:

  • Merger and acquisition structuring
  • Investment due diligence
  • Financial audits
  • Independent inventory observation and analytics
  • 280E strategic planning
  • Cash flow and capital allocations
  • Risk assessments
  • Licensing agreements
  • Business plans