IRC 280E – Business Expense Tax Deductions

If you have been in the cannabis business for some time, then surely you have heard about the infamous Section 280E. If you are new to the industry or are considering entering the playing field, you might want to take some time to review this seemingly innocuous IRC provision that has apparently already caused many cannabis business owners grief. 

If the Internal Revenue Service has invoked IRC 280E to adjust the tax liability of your cannabis business, call attorney Jin Kim at (916) 299-9913 to explore your tax defense options.

What is IRC 280E?

As far as provisions go, IRC 280 is fairly brief, and states simply:

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.

IRC 280E

If we try to break this provision down, we come down to the following core concepts:

• Trade or business trafficking in controlled substances, in this case, encompassing cannabis businesses operating legally under their respective state law.
• Within the meaning of schedule I and II of the Controlled Substances Act, where marijuana is classified as a Schedule I substance under federal law, and Schedule I substances are deemed to have no accepted medical value, a high potential for abuse, treated as the most dangerous, and prescriptions for their use are not allowed to be written.
• Prohibited by Federal law or the law of any state, so that even if cannabis is considered legal for either medical or recreational use under state law, is still treated as a controlled and regulated substance under federal law, and therefore a cannabis business or trade is deemed to engage in the trafficking of controlled substances in violation of federal law, thus putting cannabis businesses directly within the ambit of 280E.
• No deduction or credit shall be allowed, so that any income of a cannabis business is still considered taxable income, except that those falling within IRC 280E are not allowed to avail of any tax deduction or credit.

280E was intended to penalize drug dealers

The IRS does not make any distinction between legal and illegal businesses or activities in so far as their responsibility to pay income tax. But when a cocaine trafficker, back in 1981, successfully claimed his right to deduct ordinary business expenses, IRC 280E was born. The rationale is, of course, that while any business, whether legal or illegal, is required to pay income tax, legitimate and illegitimate businesses should not be treated the same way in terms of the deductions they can claim. Legitimate businesses can validly deduct necessary and ordinary business expenses, thus effectively lowering their taxable income and the amount of tax they have to pay. But illegitimate businesses, who are not even legally operating under state or federal law, still have to pay income tax based on their gross income, without any deductions. The result is that illegal businesses have to pay a very hefty amount of tax compared to legitimate businesses. The ultimate intention, of course, was to effectively put illegal trades, or trades engaged in prohibited activities, out of business.

280E effectively penalizes legitimate cannabis businesses

The irony here is that 280E, while designed to apply to illicit trades or businesses which are, by their very nature, not really transparent or upfront about their operations, is now being applied to legitimate, state-approved, and legally operating cannabis businesses. And because cannabis businesses are duly registered and validly operating under state law, the IRS doesn’t really have to look very hard to find them. They are there, they fall under 280E, they are not entitled to claim any tax deduction or credit, and therefore should be taxed based on gross income.

The practical effect is that the punitive intention of 280E is now being widely applied to state-licensed and legally operating cannabis businesses, and treating such a business’s gross income as taxable income, is certainly not insignificant for a legitimate business with wages to pay, and other costs and expenses to cover.