Cannabis Faces Persistent Tax Issues But That Could Change

The continued classification of marijuana as a Schedule I managed substance has put hashish companies in a bind so far as federal taxes go, whilst extra states have moved to legalize leisure and medical use of marijuana.

The Division of Well being and Human Companies made an official advice in August to the Drug Enforcement Administration to maneuver hashish from its standing as a Schedule I managed substance to Schedule III. Such a transfer may result in the supply of federal tax deductions and credit and supply aid to authorized hashish companies which might be struggling to develop into worthwhile.

Lawmakers, regardless of Congress’s persistent dysfunction, have been attempting to treatment the issues. In April, Rep. Earl Blumenauer, D-Oregon, introduced the Small Enterprise Tax Fairness Act, which might create an exception to Part 280E of the Inside Income Code to permit marijuana companies working in compliance with state legislation to take deductions related to the sale of marijuana like every other authorized enterprise. Blumenauer introduced Monday he can be retiring from Congress, however different laws has been making some progress. The SAFE (Safe and Truthful Enforcement) Banking Act has been repeatedly launched by lawmakers since 2019 and handed six instances by the Home with out successful closing passage by means of the Senate. However earlier this month an up to date model, now dubbed the SAFER (Secure and Fair Enforcement Regulation) Banking Act, was passed by a Senate committee.

Such a invoice may assist hashish companies address their taxes. “Cannabis right now is a Schedule I controlled substance, so it’s on the same list as heroin and some other really unsavory illegal drugs, ones that you would normally think of as things people go to jail for,” stated Kristin Kowalski, a companion within the tax observe at The Bonadio Group in Syracuse, New York. “Schedule I means that the DEA considers it to have no possible useful medical benefit, it’s not useful for research, and there’s nothing about it that warrants it being out in the United States, so all of the states that have legalized it are obviously in direct conflict with that standing of it being on Schedule I.”

She sees potential significance within the DHS transfer to reclassify hashish, at the very least from a tax perspective. “It’s pretty monumental that the Department of Health and Human Services has proposed that it should be moved to Schedule III,” stated Kowalski. “If it’s on Schedule III, that doesn’t make it legal. It doesn’t make banking available. There’s a lot that it doesn’t do. But the one thing it does do is it takes away the burden of Code Section 280E, which is the Tax Code section that says no deductions are available for trades or businesses that are trafficking in Schedule I or II controlled substances. It’s a very important thing to note that 280E specifically references just Schedules I and II.”

The timeline is unsure not just for Congress to behave, but in addition the DEA. “The Department of Health and Human Services did a bunch of research and scientific studies on it, so they made a formal recommendation for the DEA to consider rescheduling it so the ultimate decision lies with the DEA,” stated Kowalski. “They can do some additional research on their own, and there’s really no way of knowing how long it will take to move through those administrative processes, and how they will ultimately decide. Of course, cannabis is always a political issue as well, so there might be some influence with the upcoming elections. It’s just hard to predict what will happen. As of now, it’s just a recommendation. Nothing’s changed. But it’s still noteworthy, especially for those who operate in the legalized states.”

As of Apr. 24, 2023, 38 states, three territories and the District of Columbia permit the medical use of hashish merchandise, according to the Nationwide Convention of State Legislatures.

Till the DEA acts, using tax deductions is severely restricted by hashish companies. “Right now all cannabis businesses are subject to 280E, which means that they can’t take any deductions,” stated Kowalski. “They are taxed based on their gross revenue. That’s their receipts, minus cost of goods sold. All they can subtract is cost of goods sold, but everything else — your marketing overhead, utilities, rent, especially if you’re a dispensary — none of that is deductible. Plus you can’t take any federal tax credits either. There are very high effective tax rates in the cannabis world.”

Till the SAFER Banking Act passes, hashish companies can even have bother accessing the banking system, so a lot of their transactions must be completed in money, making them weak to theft. Accountants can nonetheless assist purchasers within the hashish enterprise, nevertheless, even when a few of the conventional tax recommendation will not apply to them. 

“Because cost of goods sold is the only deduction, they are precluded from using 263A to capitalize indirect costs into inventory, so they have to only strictly follow 471, for example, for inventory accounting,” stated Kowalski. “There’s just not a lot of flexibility with things you can do in cannabis. And most of the planning people do circulates around trying to separate out trades or businesses that are subject to 280E that are plant touching from those that aren’t. And that’s where most of the court cases right now that you’ve seen move through the federal system, what they center around.”

Final yr, The Bonadio Group’s blog checked out 4 current Tax Courtroom instances involving hashish dispensaries, in three of which the taxpayer was denied the deductions they sought beneath Part 280E.

“The court cases that are out there, they’ve drawn a pretty hard line,” stated Kowalski. “It’s a high burden of proof to show that you have a separate trade or business that can stand on its own. Things that won’t work are setting up a management company and piling all of your expenses in there and then charging just a management fee over to the plant-touching entity, basically trying to pack deductions into this management company. That won’t work. It’s been shut down by the courts. Having a rack of T-shirts at your dispensary and saying that’s a separate trade or business and trying to put a bunch of expenses claiming that for retail, that doesn’t work. So it has to be a pretty clearly delineated separate business that can stand on its own if you took away the adult use.”

Even states like New York which have legalized hashish are nonetheless limiting the variety of dispensaries they’ll permit to open, with solely about 26 now listed by the state. The tax recommendation is pretty easy till adjustments are made on the federal degree.

“The most important thing that we see is because there’s nothing you can do about these tax obligations is to pay really close attention to your cash management,” stated Kowalski. “You run into these cases where if they’ve spent the cash, they don’t have it to make their tax payments, and that leads to many problems. Cash management becomes really front of mind for these businesses when they’re paying such a big percentage of their profits over to taxes. It’s also good to note that a lot of the states where they have legal adult use cannabis, New York included, they’ve decoupled from 280E. While you can’t get those deductions for federal, you can take them on your state return, it helps a little bit with the tax burden.”

Different states which have legalized hashish, together with California and Colorado, have equally “decoupled” from the federal tax legal guidelines. “It’s usually something that goes along with legalization, as the states are trying to encourage economic growth,” stated Kowalski. “But interestingly, New York City has not decoupled from 280E yet. It has been passed, but it has not yet been signed. That’s an interesting thing for the New York City dispensaries to have to deal with.”

On the federal degree, if hashish is moved off of Schedule I, that may convey many extra tax advantages to dispensaries throughout the nation.

“Rescheduling would look really similar to what happened when the Farm Bill of 2018 descheduled hemp,” stated Kowalski. “Hemp also used to be on Schedule I along with cannabis, and that was moved completely off. It’s not considered a controlled substance at all, so it’s completely legal. And all of a sudden, we had all these hemp growers who now were eligible for all these same tax benefits.”

That led to a profusion of hemp-related merchandise, similar to CBD gummies and oil. “It’s definitely something needed for an industry that, especially in New York, most of the cultivators have to grow outside, and so they face a lot of uncertainty as far as their crops,” stated Kowalski. “In the New York industry, where there’s not a lot of channels for retail right now, it would make a big difference economically for sure.”

Editor-in-chief, AccountingToday.com