The 280e Cannabis Conundrum

By  Keith Richards 

If you are in the Cannabis industry and are not already familiar with IRS Code section 280e, then you are likely going to face a rude awakening this tax season.  Even with all the noise about this issue, it is still surprising to find operators that are not paying attention to some basic business principles such as knowing how costs (in this case taxes) will affect their business. It doesn’t mean that you have to become a CPA because the rules are fairly straight forward and there is significant literature addressing the topic.  However, using a trusted advisor to navigate areas of unfamiliarity (taxes and otherwise) would be the most beneficial way to insure that that you don’t go out of business due to the burden of unexpected taxes or worse, end up in jail ala Al Capone.

First, let’s understand the law:

Internal Revenue Code section 280e specifically states “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.”

Whew….what does that mean? The IRS is a group of clever individuals whose job is to maximize revenue to the United States by taxing income.  They are not concerned whether the income was derived legally or illegally, but whether you pay your taxes on the income generated. Federally, Cannabis is still a controlled substance and illegal and therefore falls under the provisions of IRS Code section 280e. Per the provision, unlike “ordinary” companies that are able to deduct expenses in determining taxable income, 280e related entities (Cannabis being one type) cannot deduction normal and ordinary operating expenses.  The result is that a Cannabis related entity will be denied these deductions, will report higher taxable income and of course pay more taxes. This is where many operators are getting themselves in trouble.  They fail to realize and account for the additional tax burden that will be imposed and then either don’t have the cash to pay or simple didn’t know the law and fail under audit. Under 280e Instead of paying a tax rate of 30% or 40% a Cannabis business might end up paying 60% to 90% in taxes.

Second, understand your cost of goods sold:

From a retail standpoint Cost of Goods Sold (COGS) are the costs that a business incurs such as materials, certain labor and the wholesale price of goods purchased that are subsequently retailed.  From a grower standpoint, COGS can include additional components that are directly related to production such as seeds, nutrients, electricity for grow lighting, supplies etc.  COGS is considered an adjustment to revenue as opposed to an expense deduction and as such does not fall under the provisions of 280e.  Consequently, while a Cannabis company cannot deduct operating expenses, it can adjust revenue for cost of goods sold. Therefore, it would be prudent for an operator to have a good understanding all of the components of COGS.

 

Third, develop a strategy:

Given that Cannabis related entities are limited on expense deductions but can adjust for COGS, in order to minimize the tax burden, hiring professional advice is a relatively small expense when compared to the potential exposure.  That being said, here are a few tips that each Cannapreneur should consider and discuss with their trusted advisor:

Diversify your services – consider offering additional services such as Yoga, or meditation, or stress counseling.  You may be able to allocate some of your operating expenses to these other services and take them as deductions against these goods and services.

Use IRS Code 263a to capitalize costs to inventory – Code Section 263a allows an organization to capitalize certain expenses which then become a component of inventory.  Once the inventory is sold and run through COGS these previously disallowed expenses now become an adjustment to revenue (as opposed to a disallowed expense) as a component of inventory and COGS.

Correct legal entity – A regular S-Corp is required to pay a fair wage to the owners and operators of the entity, yet these wages would be considered a non-deductible expense under 280e. On the other hand, a Limited Liability Corporation (LLC) is not required to pay the owner a salary and instead the earnings of the LLC are the owner’s taxable earnings. The owners would report net income allocated as opposed to salary and therefore there is no salary expense that would be disallowed.

Fourth – Stay well informed of potential law changes

In 2011, a bill called “The Small Business Tax Equity Act” was introduced to congress.  Essentially, the bill attempted to resolve the difference between state and federal law allowing for an exemption from section 280e for medical marijuana entrepreneurs as long they were in compliance with State law. The 2011 bill died and was reintroduced in 2013 emphasizing all marijuana businesses but it died as well.  In April 2015, a pair of congressmen (Rep. Earl Blumenauer and Sen. Ron Wyden of Oregon) have reintroduced the bill for a third time. This legislation is gaining widespread support by organizations such as Americans for Tax Reform, the National Cannabis Industry Association, Drug Policy Alliance, Marijuana Policy Project, Americans for Safe Access, and NORML.  Given the amount of attention and support this topic has garnered, there is hope that “third time’s a charm” and marijuana businesses will finally become exempt from 280e.  However, with congress one never really knows.

Finally – change is a constant:

Cannapreneurs need to recognize that the Cannabis industry is going through growing pains in the same way that many other first time industries have developed. There are many factions, special interest groups and profiteers that are each trying to influence the future direction to their benefit and as such the rules to the game are continually changing. For that reason it is important to stay abreast of change and surround yourself with solid professional advice that can help along the way.  Be sure to consult with your tax and legal advisors and make solid informed decisions for the long term.

 

Keith Richards is a successful CEO/COO & CFO.  Currently he is a Partner with the Newport Board Group, a national professional services firm of strategic advisors. He’s also a Director with Integral Edge Partners focusing on high performance leadership transformation and corporate culture development. He is a regular commentator on a variety of business radio programs, keynote speaker and blog author. Keith can be reached at keith.richards@newportboardgroup.com followed on LinkedIn at www.linkedin.com/in/keitharichards and on twitter @KRLeadership.

 

 

 

Music Legend Nelson To Roll Out Own Brand Of Marijuana

TEXAS: Music legend Willie Nelson is jumping into the movement to commercialize marijuana and plans to roll out his own brand of cannabis that he intends to make “the best on the market.”

The singer-songwriter announced in a statement Monday that Willie’s Reserve will be grown and sold in Colorado and Washington, two states where recreational use of the drug is legal.

A release explaining Willie’s Reserve says it reflects Nelson’s appreciation for “the many varieties and range of the plant’s qualities.”

The release says the 81-year-old Nelson will collaborate with master growers to define standards for the strain.

Pot Talk: Radio Stations Adopting Marijuana Formats

COLORADO: With more states legalizing marijuana for medical and recreational use, marijuana media is growing like a weed, including an array of new online publications, social networks, and podcasts targeting consumers and business people.

Now broadcast radio is joining the list.

Several stations around the country have flipped to a new format: marijuana talk.

This week, Colorado Springs AM station 1580 dropped its old format, KREL/Fox Sports, and unveiled its new identity as KHIG/K-High 1580, devoted to all things marijuana-related.

The new station’s weekday lineup includes “Wake and Bake,” a morning show, “High Noon” for midday, and “High Drive” for the evening commute. It will also carry hourlong newscasts from the National Marijuana News Service, a syndicated content provider based in Los Angeles.

Regulating Water Use By Pot Farms

CALIFORNIA: The California Assembly plans to hold an unprecedented hearing on April 15 to examine a proposal to regulate a controversial, billion-dollar state crop: marijuana.

At first glance, Humboldt County Assemblymember Jim Wood’s proposed regulation bill, the “Marijuana Watershed Protection Act” looks innocuous: It would add a single paragraph to the state’s water code, and one to the health and safety code. But, in truth, AB 243 represents a groundbreaking new vision for the future of California cannabis agriculture — especially when it comes to water use.

Pot Problem: Banks Still Don’t Want This Cash

COLORADO:  The Fourth Corner Credit Union was created to serve the pot industry. It got state approval back in November, but is still waiting for a green light from the Federal Reserve. That typically takes weeks, not months for a new bank to get.

Recreational pot is legal in four states and D.C., and medical marijuana is legal in 19 other states. The hitch: Marijuana is still illegal on the Federal level, which also regulates banks.

That leaves pot shops in states like Colorado, where it’s legal, in a bind. Many banks won’t offer them accounts, leaving them stuck with piles of cash and nowhere to put it. Fourth Corner wants to change that.

Oregon’s MBank Now Nixing All Pot Accounts After Colorado Plan Fizzled

OREGON: Just two months after Oregon-based MBank pulled back on a promise to work with the marijuana industry in Colorado, the $170-million institution said it is dropping its cannabis clients entirely.

CEO Jef Baker said MBank doesn’t have the “resources necessary to manage the compliance” requirements for banks maintaining accounts with legal marijuana businesses.

But others familiar with the bank’s situation said the move from the marijuana space was forced by regulators who recently audited bank records over an extended period, eventually downgrading the institution’s rating and indicating marijuana deposits might be too risky to handle.

The bank has been under scrutiny because of a prior consent agreement with federal regulators that was the result of financial problems it had a few years ago. But now, regulatory examinations that normally were taking about two weeks suddenly were taking six, according to people familiar with that process.

Apple “WeedWatch” Ad To Be Featured In Marijuana Green Pages

WASHINGTON – A clever parody ad showcasing Apple’s canna-friendly chronometer, iWatch,  has taken out a full page ad in the upcoming Marijuana Green Pages business directory.  Seattle-based multi-media company Higher Ground released the “WeedWatch” ad to coincide with the April 20th pot holiday, “4/20”, and the release of the Apple Watch on April 24th.

The ad, featuring a photo of the iWatch with the simple text, “Time for a Change: Legalize It” will appear in a Premium Position of the Marijuana Green Pages in the Wearable Technology section.

“The Apple Watch is a revolutionary product, and the legalization of marijuana in States across the country is also a revolutionary movement,”notes Higher Ground Editor-in-Chief Michael A. Stusser. “The message of our parody is as simple as the solution to the War on Drugs: Legalize It.  It’s time to end Prohibition, and legalize, regulate and tax cannabis at the federal level. I can think of no better place to showcase this powerful message than as a full page ad in  a premium position in the Marijuana Green Pages, the most authoritative business directory of legal cannabis businesses ever created. The Weed Watch just had to be represented.”

One of the most innovative features of Apple’s Watch is the ability for users to customize the face of the device, and add additional information. In Higher Ground’s parody, they have taken the liberty to do just that! The watch face is full of humorous and advocacy-related apps including NORML (National Organization for the Reform of Marijuana Laws), SXSW, Leafly (a Yelp-like mobile app for marijuana), 7-11, Cannabis News Network, and Doritos. The time? 4:20.

Based out of Seattle, where recreational marijuana was legalized in 2012, Higher Ground is attempting to “Elevate the Dialogue”and broaden the movement nationally. While legal in Washington, Colorado, Alaska and Oregon, the use, sale or distribution of cannabis is still a felony at the federal level, and over 600,000 Americans are arrested every year for marijuana-related offenses.

The launch of the Apple Watch continues to garner significant media coverage, as it is the first new product device from Apple since CEO Tim Cook took over the company. PreOrders for the iWatch began on April 10th, selling over a million units, and will begin shipping on April 24th. Using guerilla-style marketing, In addition to the Marijuana Green Pages, Higher Ground’s WeedWatch campaign will appear on posters, leaflets and mobile billboards adjacent to Apple stores nationwide.

ABOUT HIGHER GROUND

Higher Ground produces the world’s first satirical news program about the legalization movement, along with a newspaper column and website. A multi-media company, Higher Ground creates highly-produced video assets including a flagship program (a mix between The Daily Show and CNN, just without that annoying Wolfe Blitzer fellow), a syndicated column on the legalization movement, a comprehensive and entertaining news website, events (Cooking with Cannabis!), along with viral social-media parodies.

Higher Ground has created a variety of videos and parodies that attempt to vaporize stoner-cliches (including a ReMix of Cheech & Chong’s iconic “Up in Smoke”), while also educating the public on the changing landscape of legalization. Along with their YouTube videos, the company has repurposed posters from the Reefer Madness era with an Original Artists Series, updated MadMen (whose characters smoke from vaporizers instead of cancer-sticks), and even crafted a Seattle Seahawks logo entirely out of marijuana in honor of the Beast Mode strain (named after running back Marshawn Lynch). Stusser’s Higher Ground column also runs in the Seattle Weekly.

For more information, contact Michael Stusser at michael@michaelstusser.com

 

Spokesman-Review Editorial: Lawmakers’ Tweaks Of Pot Law: Some Smart, Others Not

WASHINGTON: Lawmakers are replanting Initiative 502 before it’s had a year to establish roots. Some of this cultivation is warranted, some is premature.

The House and Senate are working on ways to harmonize the unregulated medical marijuana market with the regulated recreational one. Voters legalized medical marijuana in 1998, but the Legislature has failed to establish a regulatory framework for distribution and sales. This has caused headaches for municipalities ever since. Spokane Valley, for instance, has declared a moratorium on new medical marijuana busineses as it awaits state action.

Both chambers wisely passed bills that fold medical marijuana into the regulatory structure for recreational pot created by the Liquor Control Board. The bills create a voluntary registry for authorized patients who would be able to purchase greater quantities and gain access to tax exemptions.

 

Officials: Growers Bogarting Taxes Owed To California

CALIFORNIA:  The California Board of Equalization says the medical marijuana industry isn’t paying the taxes it owes.

The Board of Equalization staff and board members -including George Runner recently met with marijuana dispensaries, nurseries, and growers in Humboldt County.

Runner says the County has begun to add marijuana growers to the tax rolls by establishing a permitting and licensing process.

“They’ve got concerns with water permits, with business licenses with seller’s permits and Humboldt County is doing good work trying to figure out how to bring those people into the normal business stream.”

Letter: Busting Myths About Marijuana Dispensaries

CALIFORNIA:  We should like to respond to the article “Zoning issues: Child care, marijuana, residential density” published on April 10. This article mentions the Zoning Ordinance Update rules for medical marijuana dispensaries. Santa Monicans for Safe Access (SAMOSA) would like to point out a few important things, as follows:

The article says “Despite the plethora of options in the surrounding municipalities … .” In fact, there is not a plethora of legal dispensaries in surrounding areas. Of the total 134 dispensaries Los Angeles allowed a couple of years ago, less than 50 of these legal dispensaries remain.  Plus, only a few of them are on the Westside. Any other dispensary is illegal. Surely, it is unsafe and unwise to encourage patients to go to illegal dispensaries. Moreover, if there is a plethora of any type of business outside of Santa Monica, it is alcohol stores and drug stores. And yet, our reasonable and compassionate City officials do not ban those types of stores from Santa Monica. Nor are residents required to drive outside the City to visit these stores.

This article also states that “The Police Department and the city officials had opposed that inclusion [of dispensaries], noting that residents could simply order delivery …. .” However, in an SMDP article published last February, the SMDP confirmed that only one of the four delivery services cited at that time by City Staff was legal.  Today, there are no — as in none — legal delivery services anywhere in L.A. Worse, last year in other articles, City Staff acknowledged that any delivery service operating in Santa Monica would have to have a Santa Monica business license.  And yet, City Staff confirmed that none had been issued. SAMOSA believes that it is very unsafe to invite illegal delivery services into one’s home. About the police, Chief Seabrooks said in her testimony to the Planning Commission that if the City asked her, the Police would have no problem policing medical marijuana dispensaries — just as they do for any other business.