IRS Section 280E - The Marijuana Tax Burden
What is Section 280E? Section 280E of the Internal Revenue Code forbids businesses from deducting otherwise ordinary business expenses from gross income associated with the “trafficking” of Schedule I or II substances, as defined by the Controlled Substances Act. The IRS has subsequently applied Section 280E to state-legal cannabis businesses, since cannabis is still a Schedule I substance.
A throwback from the Reagan Administration, Section 280E originated from a 1981 court case in which a convicted cocaine trafficker asserted his right under federal tax law to deduct ordinary business expenses. In 1982, Congress created 280E to prevent other drug dealers from following suit. It states that no deductions should be allowed on any amount “in carrying on any trade or business if such trade or business consists of trafficking in controlled substances.”
With 23 states and the District of Columbia now allowing some form of legal marijuana, 280E is applied to state-regulated cannabis businesses more often than it is to the types of illegal drug dealers that the provision was intended to penalize.
How does Section 280E hurt state-legal cannabis businesses?
Federal income taxes are based on a fairly simple formula: start with gross income, subtract business expenses to calculate taxable income, and then pay taxes on this amount. Owners of regular businesses often derive profits from these business deductions.
Cannabis businesses, however, pay taxes on gross income. These businesses often pay tax rates that are 70% or higher.
Below is a simplified model that illustrates the tax structure for cannabis businesses compared to a normal businesses. In this scenario, the normal business’s taxable income is $150,000, while the cannabis business is taxed on $350,000, despite having the same costs and expenses.
Non-Cannabis Business CannabisBusiness
Gross Revenue $1,000,000 $1,000,000
Cost of Goods Sold $650,000 $650,000
Gross Income $350,000 $350,000
Deductible Business Expenses $200,000 $0
Taxable Income $150,000 $350,000
Tax (30%) $45,000 $105,000
Effective Tax Rate 30% 70%