Highlights
- Cannabis businesses are subject to limitations on tax deductions under IRS Code Section 280E.
- This imposes higher tax bills compared to other businesses in different sectors and requires a strategic approach.
- Greenleaf HR provides expert tax and payroll guidance for cannabis businesses. Contact us today for a consultation.
Even though the cannabis market is booming across many states both for medical and recreational uses, federal law continues to classify marijuana as a Schedule I controlled substance. This creates serious legal obstacles, impacting cannabis payroll and, as we’ll explore in this post, tax deductions.
How do dispensaries pay federal taxes? Let’s dive into the unique challenges and strategic approaches required to navigate regulations as a cannabis company.
Understanding IRS Code Section 280E
Unlike most businesses, which can deduct standard operating expenses, cannabis businesses face unique limitations on federal tax deductions.
The Internal Revenue Code Section 280E specifically prohibits businesses that traffic Schedule I or II controlled substances, including marijuana, from deducting ordinary business expenses. For cannabis companies, this means calculating and paying federal income tax on their gross income, rather than their net income. The result? A much larger tax bill that significantly increases the cost of doing business.
Even though this rule was originally aimed at illegal drug enterprises, it applies even in jurisdictions where cannabis has been legalized.
How 280E Impacts Cannabis Businesses
The application of Section 280E affects different sectors of the cannabis industry in varying ways.
For those on the retail side of the marijuana business (dispensaries and provisional centers), the impact is huge. They are unable to deduct most of the expenses related to their operations, such as:
- Rent or mortgage payments for facilities used for their cannabis business
- Utilities, such as electricity, water, and gas
- Employee salaries and wages
- Marketing and advertising expenses
- Professional fees for legal, accounting, or consulting services
- Equipment or facilities repairs and maintenance costs
Cultivators and manufacturers of cannabis products face a slightly different scenario. While they are still subject to Section 280E, they may be able to deduct certain expenses related to the “cost of goods sold” (CoGS). This includes expenses directly associated with the production or acquisition of the goods sold, such as raw materials, labor costs, and certain overhead expenses.
For dispensaries, there are only a few costs that may be included as COGS, which are typically limited to the direct cost of acquiring the cannabis products they sell. This generally means the actual cost they paid to purchase the cannabis from cultivators or wholesalers and includes transportation costs directly related to acquiring that wholesale cannabis.
Strategies and Best Practices for Dispensary Tax Compliance
For cannabis dispensaries, navigating the limitations imposed by IRS Code Section 280E and ensuring tax compliance requires a strategic approach. Here are some best practices to consider:
Maximizing the Cost of Goods Sold (CoGS)
This is a critical strategy for dispensaries to reduce their taxable income, as it represents one of the few deductible expenses under federal tax law.
To maximize CoGS, consider the following:
- Detailed inventory tracking. Implement a point-of-sale (POS) system for detailed inventory tracking, maintain precise purchase invoice records, and conduct regular physical inventory counts.
- Accurate product costing. Clearly define and document all direct costs associated with acquiring finished cannabis products for resale. Include costs such as purchase price, transportation to the dispensary, and any necessary testing or packaging.
- Documentation. Keep all CoGS-related documentation organized and readily accessible for potential IRS audits.
Strict Payroll Tax Compliance
Maintaining strict compliance with payroll tax obligations is essential for dispensaries. This involves:
- Accurate employee classification: Ensure your employees are classified properly to avoid miscalculations in payroll taxes. Use payroll software that automatically calculates and withholds federal income tax, Social Security, and Medicare taxes.
- Timely filings: Adhere to all deadlines for filing payroll tax forms (e.g., Form 941, Form W-2). Consider partnering with a cannabis payroll company to minimize errors and ensure timely filings.
Professional Accounting and Legal Guidance
Seeking professional accounting and legal guidance is highly recommended for cannabis business owners.
Engage with professionals specialized in cannabis taxation, with a deep understanding of Section 280E’s implications for dispensaries. Seek legal counsel to ensure compliance with both federal and state regulations.
Staying Informed and Adaptable
Stay informed about changes in local and state regulations that may impact dispensary operations and tax obligations. Consider attending industry conferences and workshops to stay updated on best practices.
Closely monitor IRS publications and updates for any changes related to cannabis taxation. Seek professional guidance to understand the implications of any new regulations.
Navigating Cannabis Tax Compliance with Expert Guidance
Tax obligations, particularly under IRS Code Section 280E, represent a huge challenge for cannabis businesses. Keeping with compliance requirements is time-consuming and requires specialized knowledge. So why not engage with a trusted partner?
At Greenleaf HR, we provide tailored HR and compliance solutions for the cannabis industry. Our team of dedicated payroll and tax experts can help you develop robust tax strategies and implement rigorous record-keeping practices, ensuring your business stays safe and legally compliant.
Contact us today for a consultation and discover how our specialized solutions can empower your cannabis business.
