Cannabis Taxation—Part IV—How U S Cannabis Operators Live Alongside Section 280E
Florida’s Cannabis News Podcast
Saturday November 21, 2020
Cannabis Taxation—Part IV—How U.S. Cannabis Operators Live Alongside Section 280E.
This week, David continues Florida’s Cannabis News Podcast’s five part series on Section 280E. In this episode (Part IV), we break down the two legal arguments U.S. cannabis operators use to alleviate the burdens of Section 280E. First, the second-line-of-business argument, and second, using savvy accounting methods to put expenses into COGS (cost of goods sold).
Here are the highlights:
States recognize cannabis companies as legitimate businesses, and lawmakers are thwarting the United States’ ability to compete in the global market because they have not provided a level playing field for U.S. cannabis companies to develop. The most effective way to help business owners stay afloat and give patients and consumers access to safe cannabis is through legislative action. Lawmakers have taken inconsequential steps to address this problem,Â even though Congress did the most significant overhaul of the Tax Code since 1986 when they signed the 2017 Tax Cuts and Jobs Act into law. This bill did not repeal Section 280E, or even amend it. Despite these hurdles, the current legal landscape provides creative avenues for cannabis businesses to alleviate their tax burden. The two most successful methods cannabis businesses owners use to maneuver around Section 280E are the second-line-of-business argument, and accounting as many costs as possible into the COGS section of the business’s tax return.
Under the second-line-of-business argument, a cannabis business owner argues that it is engaged in two trades or businesses, thus Section 280E should only apply to the line of business where cannabis is trafficked. In 2007, Californians Helping to Alleviate Medical Problems, Inc. (CHAMP) raised this argument. Despite a victory in this case, the U.S. Tax Court rarely accepts the second-line of business argument. In contrast, in 2012, Martin Olive, an owner of a medical cannabis dispensary in California, unsuccessfully argued that his company operated two separate businesses. Similar to CHAMP, Olive argued that he should be allowed to deduct expenses associated with his business’s caregiving services. The Tax Court disagreed and held Olive could not deduct expenses from his caregiving services. The primary purpose of Olive’s medical cannabis dispensary was the retail sale of cannabis under California’s medical cannabis law. The business provided minimal activities and services.
CHAMP and Olive are the current templates in determining whether a business expense is deductible under Section 280E. A cannabis business can deduct expenses related to a separate trade or business that does not involve trafficking of cannabis, but the Tax Court has reaffirmed its strict standard when analyzing the second-line-of-business argument in numerous cannabis cases since Olive. Reading these holding together, good works or community involvement are not sufficient, by themselves, to support a tax deduction outside the application of Section 280E. In order to be deductible, such activity must be considered a separate trade or business entered into with a motive to realize profit.
While on its face, Section 280E disallows cannabis businesses the deduction of all business expenses, cannabis businesses owners have used cost of goods sold (COGS) to their advantage. COGS are the costs of acquiring inventory through purchase or production, including shipping costs, and directly related expenses. Taxpayers, regardless of what business they are in, use this formula to calculate gross income + gross receipts minus COGS. The goal of this expansion was to treat taxpayers more fairly, but the U.S. Tax Court is not willing to allow cannabis businesses to use Section 263A.
Will cannabis businesses be treated fairly one day? Maybe. There are arguments that have not been made, for example that the congressional intent behind Section 280E has not been met. It was not until 2015 when the Courts first considered the congressional intent of Section 280E and whether applying Section 280E to state legal businesses aligned with that intent. In an appeal of the 2012 Olive decision, Olive argued that the application of Section 280E to cannabis businesses did not align with the intent of Section 280E to deter illegal drug use. The Ninth Circuit Court of Appeal was not persuaded and affirmed the Tax Court’s decision. Written law governs tax enforcement, yet the U.S. Tax Court and United States Supreme Court always interpret the text of a statute to some degree of interpretation not included in the text.
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