3 fundamental truths about IRC Section 280E

Marc A. Claybon, Tiffany Richardson
5/26/2021
3 fundamental truths about IRC Section 280E

Review the facts of Section 280E to reset your tax planning as needed and make sure your approach is sound

In an unpredictable regulatory environment that is also ripe with opportunities, cannabis businesses have little room for mistakes. To avoid risks and remain sustainable, they must be in good standing with the IRS, including compliance with Internal Revenue Code (IRC) Section 280E. 

Section 280E excludes typical business expense deductions from federal taxes for cannabis companies. Not only can this exclusion limit profits, but it also complicates cannabis companies’ approach to taxes. Understanding and managing Section 280E as part of tax planning is not impossible, however. Acknowledging these three facts is a good start.

1. Section 280E workarounds or loopholes do not generally exist

Without deductions and credits, some cannabis companies face an effective tax rate of up to 80%. It’s no wonder that business owners unwisely have sought ways to circumvent Section 280E. But too many have learned the hard way that aggressive and risky Section 280E strategies do not succeed.

Some companies have incurred penalties for incorrectly allocating expenses into cost of goods sold and improperly allocating costs to nonplant-touching lines of business. Many cannabis companies are currently in litigation, and ones that have pursued litigation have been regularly defeated by the government.

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2. Rigorous accounting is essential to managing tax liability and attracting investment

Cannabis businesses that seek to optimize their tax positions diligently work to fully understand the tax laws and improve inventory accounting and finance operations. They establish consistent methodologies, detailed documentation, and reports that can stand up to an audit. In essence, they follow current cannabis accounting practices to the letter.

This approach addresses Section 280E tax compliance, and it lays the foundation for long-term growth. Conversely, companies with disorganized or inadequate accounting practices often struggle to attract investment.

3. Cannabis businesses should expect IRS scrutiny

Here’s another reason to improve accounting practices: The IRS continues to signal that it will aggressively audit cannabis companies and penalize violators. In September 2020, the IRS released a brief FAQ on cannabis taxation that reiterated its long-time stance. As long as marijuana remains a Schedule 1 or 2 substance under the federal Controlled Substances Act, the agency will strictly enforce Section 280E.

All cannabis businesses should expect an IRS examination sooner or later. But they should not expect the IRS to significantly negotiate or forgive any tax filing missteps or improper deductions. A well-documented defense will be required.

As regulations for the cannabis industry evolve and shift, stay up to date regarding changes to Section 280E and revisit the implications to tax planning, as necessary. 

 

Qualified organizations only. Independence and regulatory restrictions may apply. Some firm services may not be available to all clients. Given the continued evolution and inconsistency of various state and federal cannabis-related laws, any company should seek competent legal advice relating to its involvement in the cannabis industry, including when considering a potential public offering as a cannabis-related company.

3 best practices for IRC Section 280E tax compliance 

Now that you understand these fundamental facts about cannabis taxation, review three best practices to improve your compliance with Section 280E.

Contact us

Turn to cannabis tax specialists who understand the industry and can leverage the experience and resources of a top 10 accounting firm. Since 2014, Crowe tax professionals have helped cannabis industry clients with entity planning, inventory optimization, IRS audit defense, and federal, state, and international tax compliance. Contact us to discuss your needs. 
Marc Claybon
Marc A. Claybon
Principal, Tax
Tiffany Richardson
Tiffany Richardson
Partner