26 US Code Section 280EHow the Tax Code Affects the Cannabis IndustrySection 280E of the Federal Tax Code prohibits any business connected to Schedule 1 or Schedule 2 drugs from deducting any business expenses, including payroll, marketing costs and rent. This creates financial disadvantages for cannabis businesses as compared to businesses that do not cultivate or sell cannabis products.When doing a side-by-side comparison between cannabis companies and non-cannabis companies with similar profits and losses, the typical business pays about $35,000 in annual taxes, while the cannabis company pays nearly $250,000.
During the height of the war on drugs in the early 1980’s, a drug dealer won a court case which allowed him to legally deduct expenses for car repairs and “business supplies”. The government did not like the precedent set by this case and Section 280E was added to the tax code to prevent other drug dealers from using the same deductions.
According to Forbes, when Congress passed Section 280E, it was feared that there would be constitutional challenges to the law. To prevent challenges, an exclusion was added that allowed a deduction for the cost of goods sold, even when those goods were illegal under Federal law. (No state had legalized cannabis at that time.) “Costs of goods sold” essentially means inventory costs – the cost of the product, shipping costs and directly related expenses.
Until cannabis is removed from the Federal list of Schedule 1 substances, cultivators and retailers will have to find other ways to reduce their tax burden. Creating a cannabis business in states like Massachusetts can be cost intensive. Long wait times, complicated points throughout the process, and the requirement for a large amount of capital on hand are all barriers to developing the industry. Removing the Schedule 1 classification would allow for a more cost-effective environment, reduce barriers to entry and open up banking options. Costs to the consumer could be reduced. On the downside, it could open the doors for federal taxation if industry growth led to interstate commerce. We could also see the end of local companies, depending on the real estate and labor costs in different areas.
De-scheduling is a complicated process, as we witnessed in early 2020. In February, the World Health Organization (WHO) and the United Nations Commission on Narcotic Drugs both planned to vote on cannabis scheduling recommendations. Voting was postponed until the end of the year due to difficulty reaching consensus on policies that would transcend national borders.