For those who wish to get involved in the now legitimate Pennsylvania business of medical marijuana, be prepared to be unfairly taxed by the IRS. While medical marijuana is now legal in Pennsylvania, as well as 24 other states, it remains classified as schedule I drug under the Federal Controlled Substance Act. This allows the Federal government to unreasonable tax gross revenue or income from the operation of any marijuana business under section 280E of the Internal Revenue Code. Section 280E does not allow a business to deduct otherwise ordinary business expenses from gross income generated from the trafficking of Schedule I or Schedule II substances.
Section 280E 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.
Section 280E was originally enacted in 1982 in response to a Minneapolis drug dealer arguing in Court that he should be allowed to write off expenses related to his business under the Federal tax law. Congress enacted section 280E to prevent other illegal drug dealers from following suit.
While section 280E has been around since 1982, in January of 2015, the IRS issued an internal memorandum rejecting many of the tax deductions utilized by legal marijuana businesses and requiring strict interpretation of Section 280E. Under 280E, standard business deductions such as employee salaries, utility costs, internet, telephone, insurance, advertising costs, repairs and maintenance fees, and rental fees will be scrutinized and likely denied.
Since marijuana remains illegal and classified as a Schedule I drug, small businesses cannot deduct ordinary business expenses on their Federal Income Tax. The effective tax rate for a small marijuana business can exceed 70% of the gross revenue as result. Getting taxed at a rate of 70% of your gross revenue will destroy even the most efficient business.
In other words, if a legal marijuana business had gross revenue or income of $1,000,000.00 for 2016 and $600,000.00 in standard deductions, that business could not deduct the $600,000.00. Instead of being taxed on $400,000.00 (or whatever the net income was after all other deductions), the legal marijuana business net income would include those deductions and it would be taxed on the full $1,000,000.00.
Legal marijuana businesses can deduct the Cost of Goods Sold under the internal revenue code. Through creative setup or accounting, legal marijuana business can try to attribute deductions to non-marijuana aspects of their business. Indirect costs may also be deductible under section 263A of the Internal Revenue Code.
The easiest way to fix this problem is to reclassify marijuana as Schedule III drug under the CSA. While the DEA is considering that, there is no idea when and if that will happen.
Last year, the Small Business Tax Equity Act was introduced in the U.S. Senate and the U.S. House which would amend the Internal Revenue Code of 1986 to allow deductions and credits relating to expenditures in connection with marijuana sales conducted in compliance with State law.
Section 280E is an outdated provision of the Internal Revenue Code which was enacted to keep drug dealers from benefitted from the illegal drug business. With the change in state drug laws allowing legal marijuana businesses, 280E’s application to those legal marijuana businesses will only punish and destroy otherwise legal job creating businesses.