Avoid unnecessary risks and update your accounting practices. Follow these best practices for IRC Section 280E tax compliance and long-term growth.
Internal Revenue Code (IRC) Section 280E remains one of the most challenging and frustrating issues for the cannabis industry. The decades-old federal statute continues to significantly limit cannabis profits by prohibiting companies from deducting typical business expenses from their federal taxes. In response, cannabis company decision-makers need to analyze exceptionally technical tax laws and regulations to help them manage their tax liability, from the determination of cost of goods sold (COGS) to entity structuring.
To compound the dilemma, tax guidance on Section 280E is a moving target. Recent U.S. Tax Court decisions have prompted questions regarding the application of tax principles. Cannabis companies that cannot quickly adjust and that do not frequently reevaluate their Section 280E positions risk serious consequences that could hamper their cash flow and long-term growth. Consequences include potential tax filing errors that bring harsh penalties as well as making a business less attractive to future investors.
What does a sound approach to Section 280E look like in today’s environment? Crowe specialists offer three best practices to consider.
1. Stay current on what deductions are allowable for different business types
Cannabis businesses should analyze their inventory rules and how costs are allocated across the business and then apply consistent methodology for their COGS calculations. Allowable deductions can vary greatly depending on the type of business license a company holds (for example, retail, manufacturing, distribution, or integrated licenses). As a general matter, tax inventory rules are less punitive to manufacturers and growers than to retailers because more costs of manufacturers are production related and therefore included in COGS. Retail operations, on the other hand, generally are more restrictive in what is included in COGS. For an integrated company, distribution company, or delivery company, the rules fall in between. Thinking through what rules apply, to what kind of operation, and consistently applying inventory methodologies can either create significant value or significant tax risk to companies.
Businesses should periodically review how the most recent federal court decisions and IRS guidance affect their 280E positions.