Pot-Friendly States Give Cannabis Sellers Tax Help Denied by IRS

When Anacostia Organics opened in Washington, DC, in 2019, owner and CEO Linda Greene was unaware of the US tax code provision that would prevent her business from deducting expenses, paving the way for what she says has been nearly six years of losses.

“280E is the biggest monster out there, and that is something we all agree on in this industry,” Greene said, referring to the part of the Internal Revenue Code that prohibits businesses involved in the trafficking of controlled substances, including cannabis, from deducting ordinary business expenses such as rent and payroll. Greene may finally see some relief soon, after the DC government enacted legislation last year to decouple the city’s tax code from the federal rule.

As states are increasingly adopting more lenient marijuana policies, many that follow the Internal Revenue Code are dropping their adherence to Section 280E, giving cannabis businesses some relief by allowing them to deduct expenses at the state level. More than 20 states allow some deductions for medical or recreational cannabis operations. The latest was Pennsylvania, where the budget Gov. Josh Shapiro (D) signed July 11allows medical cannabis growers and processors to start deducting expenses, though lawmakers accidentally excluded dispensaries.

For most businesses, the cost of goods sold can create a significant deduction on tax returns. But cannabis businesses are at a disadvantage. These have limitations on the cost of goods sold expenses they can deduct. Cost of goods sold typically account for between 75% and 95% of total expenses for marijuana growers and processors and between 40% and 70% for retailers, Marc Claybon, a principal at Crowe LLP who specializes in cannabis taxes, said in an interview.

At the federal level, marijuana businesses and pro-legalization lawmakers submitted comments last week to the Drug Enforcement Administration on proposed regulations reclassifying cannabis from Schedule I to Schedule III of the Controlled Substances Act. Such a move would shift the federal government’s view of cannabis away from having a high abuse potential to presenting a lower abuse potential, acceptable medical applications, and a moderate-to-low dependence risk.

In its comment, the Minority Cannabis Business Association referenced a study by the cannabis economic research firm Whitney Economics, which stated that marijuana businesses have paid over $2 billion more in federal taxes compared to businesses in other sectors as a result of 280E.

Without a policy change, the excess tax burden could increase to $5.2 billion by 2030, according to Whitney Economics.

“It’s almost hard to talk about rescheduling without talking about 280E, they essentially go hand in hand,” said Frederika Easley, vice president of the Minority Cannabis Business Association.

Rescheduling Changed the Strategy

Pro-marijuana advocates and lawmakers anticipate the rescheduling process wrapping up before President Joe Biden leaves the White House next January. If it doesn’t, Easley predicted more states will decouple their tax laws from Section 280E.

“He initiated rescheduling, this is part of Joe Biden’s legacy,” Rep. Earl Blumenauer (D-Ore.), told Bloomberg Tax in an interview. “This is something that the administration, both in terms of the people in the administration and the people running to be the next leadership, is on board with.”

Blumenauer, who is not running for re-election, introduced legislation (H.R. 2643) in 2023 to allow deductions and credits for expenditures related to marijuana sales, though the bill has been stalled in the House Ways and Means Committee .

“The biggest question I think that the industry is going to have to face if cannabis is moved down to Schedule III is when they can begin to take the business deductibility,” said David Culver, senior vice president of public affairs at the US Cannabis Council.

States ‘Need to Be Careful’

Pennsylvania’s accidental exclusion of dispensaries from its 280E decoupling represents the complications advocates hope to avoid if Biden’s rescheduling order goes through.

While more stateshave enacted legislation to detach themselves from the federal ban on marijuana business deductions, the state-level focus has been on legalization for so long that many “haven’t historically worried about the tax code,” said Crowe’s Claybon.

For states like Pennsylvania, where cannabis is only legal medically, Claybon does see language in the legislation that would trigger deductions for recreational and medical businesses alike if the state ever legalizes recreational use.

“States need to be very careful when they transition from medical to adult use, and differentiating between kinds of licenses and taxpayers to make sure that these decoupling rules will apply,” he said.

After focusing on Pennsylvania this year, the US Cannabis Council is now concentrated on states that still don’t allow business deductions, including Alaska, Arizona, Nevada, Washington, and Rhode Island. But even with the state-level changes, the most significant battle remains at the federal level.

“The amount that companies are paying on the state level is minimal. It pales in comparison to the federal tax that they’re paying,” Culver said.

Because some cannabis businesses can face a 52.5% effective tax rate, as reported by Whitney Economics, combined with strict regulatory rules and limited access to capital, about 75% of cannabis businesses operate without a profit.

Greene, of Anacostia Organics, said DC decoupling from 280E immediately allows companies like hers to provide their small staff with better benefits and maybe even turn a yearly profit.

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