Section 280E and Cost of Goods Sold for Cannabis Businesses
As anyone in the cannabis or hemp industries knows, preparing for 280e cannabis taxes is a regular—if dreaded—annual (or even quarterly) event. We’ve written about 280E and its implications for cannabis business tax preparation: Unlike most enterprises who tabulate COGS (or “cost of goods sold”), cannabis operators bear an additional burden regarding this uncontroversial aspect of tax law. Cannabis retailers, in particular, are especially hard hit, as they cannot consider selling and budtender labor as a COGS.
But recent guidance from the IRS suggests the bureau is working to help clarify some of the inequities associated with 280E cannabis business tax filings. If you’re tasked with bookkeeping for dispensaries, this is news you can’t afford to miss!
Cost of Goods Sold, Cannabis-Style: Implications of 280E
In essence, Section 280E of the tax code disallows cannabis and other businesses from claiming average depreciation taxes:
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 activities which comprise such trade or business) consists of trafficking in controlled substances.
For most other businesses, the COGS expenses—such as the cost of materials and labor, the wholesale price of goods to be resold, overhead, storage, and other costs—can account for a sizable deduction. But in cannabis accounting, the only COGS deductions generally allowed are for equipment used in storage and packaging. And as we’ve seen time and again, any efforts to circumvent 280E usually ends poorly for cannabis operators.
That said, many cannabis CPA firms such as Bridge West are finding that IRC 471, a section of code dealing with inventories, offers at least some clarification and guidance. In general, 471 stipulates that the method used for inventory must clearly and precisely reflect the business’s income. Of course, there are many different types of cannabis companies. Various sections of 471 pertain to retailers and dispensaries, cultivators, and processors of concentrates and edibles, among others.
In the recent IRS guidance we referenced above, the bureau acknowledged the confusion surrounding the cost of goods sold for cannabis companies, adding that while normal overhead expenses—including advertising, wages, and travel expenses—still aren’t deductible, the cost of obtaining a business’s inventory is.
While this doesn’t remove the burden of 280E entirely, the IRS letter strengthens what we hope is a coming sea change regarding how cannabis business tax is calculated. As we shared earlier this year, passage of the 2018 Farm Bill expanded the range of deductions allowed to cannabis growers and extractors, including the cost of depreciable assets such as cultivators and processors.
In the short term, what can you do to reduce your 280E cannabis tax exposure?
- Keep exceptionally clean and precise records of all business expenses
- Back up your data regularly and ensure that more than one person in the organization has knowledge of and access to financial information
- Use GAAP principles and keep good production numbers and records. While it may cost you more in the short term, it’s well worth it in the long run!
- Use the best cannabis accounting software you can afford: A platform explicitly tailored to the industry will be an immeasurable help in keeping accurate records and delivering information to the IRS in a simple and timely fashion.
Cannabis CPA: Expert Advice on 280E, Cannabis Taxes, and More
At Bridge West CPAs & Advisors, we focus on helping our clients reduce their tax burden. If you’d like to know more, we’d love to talk. Now into our second decade of assisting entrepreneurs in navigating the intricacies of 280E, Bridge West CPAs is ready to help you reach your business and financial goals.