Marijuana Investor Summit Takes on 280E
Section 280E of the Internal Revenue Code sharply limits the deductions legal marijuana businesses can take against federal income tax liability. It may be the biggest threat to the financial viability of many fledgling cannabusinesses. According to Jim Marty of Bridge West CPAs and Consultants, LLC, “Two major issues face the industry: banking and 280E. Banking makes [operation] inconvenient and can be dangerous, but 280E is the most important because it can wipe out a business. You can plan around 280E, but you can’t get rid of it.”
On Tuesday, April 21, 2015, Marty and Adam Fayne, partner at the law firm of Arnstein & Lehr LLP, will co-host a session at Marijuana Investor Summit in Denver to explore the implications of this potentially crippling tax provision and possible solutions for a problem facing every legal marijuana business and investor.
An Artifact of the War on Drugs
Passed in 1982, at the height of the War on Drugs, IRC Section 280E specifically denies tax credits or exemptions to businesses “trafficking” in controlled substances. Those credits and exemptions are the difference between profit and loss for many new businesses, and without them, many new marijuana businesses will fail.
Under the restrictions of 280E, businesses may pay as much as 90 percent of their revenue in federal taxes. Marty noted that he has seen effective tax brackets as high as 120 percent on audit. Many early entrants into the legal marijuana industry were caught by surprise with the IRS’ highly restrictive approach and are now struggling with financial projections that appear to be unrealizable.
The approach many businesses take to the problem, known as “bundling,” involves offsetting income from the sale of marijuana against exemptions and credits for expenses less directly related to the product itself, the so-called “back of the store” functions. Common wisdom has been that integrated businesses have the advantage of having more of these indirect expenses. For them, the question has been how much to bundle in an industry already under federal scrutiny.
Newly Restrictive IRS Rules
In December 2014, the Office of the Chief Counsel at the IRS issued a memorandum that further limits this approach, a move expected to cost the legal marijuana industry millions of dollars. According to Marty, however, this approach is nothing new in Colorado, where the local IRS office has been disallowing all retail expenses as directly related to sales.
The next chapter in this story may come as early as this summer. All eyes have turned to Feinberg v. Commissioner, a case focused on the disallowance of deductions for a medical marijuana dispensary under Section 280E. Feinberg is scheduled for trial in the Denver Tax Court on June 1, 2015.
Section 280E may lack the glamour of some other challenges facing the marijuana industry, but it can make or break fledgling businesses and the investors with a stake in their success. Entrepreneurs struggling with this issue and investors who need to be aware of its implications for due diligence purposes will have the opportunity to share insights and ask questions at the afternoon session on April 21.