While medical and even recreational marijuana is legal in many states across the U.S., it is still federally illegal and considered a Schedule I drug. Since federal law supersedes state law, marijuana businesses are still at the behest of the government when it comes to their business decisions. For instance, the vast majority of marijuana businesses cannot use banks since it would be a violation of federal law.
Marijuana businesses also have to deal with federal law when it comes to the tax code, which can be difficult – if not impossible – to navigate on your own. All marijuana businesses are required to operate under the 280E tax code, which 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.” Simply put, since marijuana is a Schedule I drug, you are unable to deduct most normal business expenses. This can be a challenge for companies, as it puts you at a far higher tax rate than usual.
Let’s discuss how the tax code works, and what you can do to avoid losing money.
How do deductions work?
Businesses that fall under the 280E tax code are actively disallowed from taking any tax deductions or credits. Businesses can usually deduct expenses like employee salaries, utilities, marketing, rent and more, but 280E businesses do not qualify for these exemptions. Instead, you will be taxed on the full amount, which can sometimes be up to 3.5 times higher than the tax rate of businesses around you.
With that being said, there are some ways to get around the ruling about deductions. The most common deduction used by medical marijuana businesses is the cost of goods sold, or COGS. COGS includes anything that is directly related to the cost of creating or manufacturing the product you sell. For instance, if you are a cultivation facility, you may deduct the cost of fertilizer and the cost to water your plants, but you cannot deduct the salaries of your growers and the cost of transporting the plants to a dispensary. We suggest working with someone who has experience in the 280E tax code to determine what you can deduct under COGS. Listing your COGS incorrectly could lead to an audit, or worse, prosecution for tax fraud.
Some make it possible to deduct more of their earnings by housing two businesses under the same roof. For instance, a dispensary may also use the building as the home for a drug counseling center or a patient advocacy business. The dispensary would still be required to use the 280E tax code, but the other business could file separately and use the normal business deductions available to them. Sometimes, the second business will own the building, which allows you to deduct that cost. In total, you often pay fewer taxes than if you were a combined company. It’s important to note that these two separate businesses must have a real purpose and real expenses. You cannot fake a business, as this would be a crime.
What should I do to avoid trouble?
As we said earlier, figuring out the 280E tax code by yourself with no background in tax law is incredibly difficult. You can reduce your burden by:
- Hiring an accountant. It’s in your best interests to have someone on your team who has a complex understanding of the current tax code. They may be able to help you find deductions that you didn’t know about, and they can help you when it comes time to prepare your taxes. An accountant can also give you an estimate of the taxes you will have to pay, allowing you to put money aside to prepare.
- Documenting everything. No matter how small the transaction is, you absolutely must document anything and everything. It’s likely that your business will be audited by the IRS since you will probably operate only in cash and will have to pay in a high amount in taxes, and when that time comes, you don’t want to be digging around for the receipts you need. Make sure to have a designated spot where all of your receipts and invoices go so you can find them at any time.
- Paying attention to local, state and federal law. The current law surrounding marijuana is a bit of a patchwork system. Certain states have legalized medical and/or recreational marijuana, while it is still illegal federally. Cities may create legislation that documents where businesses can operate or how long they can be open. In order to keep your business operating at its most successful, staying out of legal troubles is key. Always be aware of any changes to the law at any level and never ignore the latest legal updates.
Do you need help getting your dispensary or cultivation facility started?
Contact Reynolds & Gold. We’re here to help navigate you through the application process and reduce the burden and stress of starting a medical marijuana business.