The cannabis industry has come a long way in the last several years. Even though there are tax implications at the federal level as cannabis is still considered a controlled substance., there are now 38 states that have legalized cannabis/marijuana for medical and/or recreational uses. The industry has many different segments including farming, resellers, producers, distribution, investors, etc. and the market is expected to grow substantially in the next five years.
From a business perspective, even though many states have legalized cannabis/marijuana, and are treating its sales as a legal business operation, unfortunately, it’s considered a Schedule I controlled substance at the federal level. This means for federal purposes, we must follow IRC 280E, which 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) consist 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”. However, there’s a caveat: the deduction of the cost of goods sold (COGS), which is the inventory, is allowed.
For example:
Marijuana resellers, COGS may include:
• The invoice price of purchased marijuana from the producer, minus any trade or other discounts
• The transportation necessary for the resellers to gain possession of the marijuana
Marijuana producers, COGS may include:
• Direct material costs, such as marijuana seeds or plants
• Direct labor costs, such as planting, cultivating, harvesting, and sorting
• Indirect costs (possible), such as repair expenses, maintenance, utilities, rent, indirect labor, and production supervisory wages, indirect materials and supplies and costs of quality control and inspection.
Accessing banking services at traditional financial institutions to handle payroll, open a checking account, and financing are still an issue in the cannabis industry. As a result, some businesses have been forced to operate solely in cash, which makes them vulnerable to crimes and affects the ability of federal regulators to monitor activities like tax evasion and money laundering. With that being said, with more states continuing to legalize cannabis/marijuana, federal lawmakers and banking regulators are being pressured to provide the cannabis industry with access to regulated banking services.
On December 02, 2024, the Drug Enforcement Administration (DEA) held a preliminary hearing related to the proposed rescheduling of marijuana from Schedule I to Schedule III of the Controlled Substances Act. No ruling on the rescheduling is expected before February 2025.
If the ruling passes, the reclassification would remove the IRC 280E, which prohibits cannabis businesses from deducting ordinary business expenses because their operations are considered to be involved in “trafficking” of a Schedule I substance. Since IRC 280E only applies to Schedule I and II substances, cannabis businesses will then be able to deduct operating expenses the same way non-cannabis businesses do.
We will keep you updated on any changes in the regulations since that will have a material effect on the business model of any reseller of cannabis.
If you have any questions regarding this important topic, please contact our office for assistance.
Contributed by Béatrice R. Calen, EA
