As the United States’ Drug Enforcement Agency (DEA) moves to reclassify cannabis as a less-dangerous substance, the most major and immediate financial impact plant-touching operators are considering is the impact to their federal tax obligations.
Currently, cannabis is a Schedule I drug under the Controlled Substances Act (CSA), which means that entities that directly interact with the plant are subject to IRC Section 280E. Section 280E stipulates that businesses handling Schedule I drugs cannot deduct any expenses other than their cost of goods sold (COGS) for tax purposes–significantly increasing their federal tax burden compared to most other businesses in the U.S.
As a result, tax rates for cannabis businesses often reach 70%, and sometimes higher. This has significantly hindered cannabis business’ profitability, especially in today’s economic environment where cannabis prices have decreased as inflation has increased.
The Department of Health and Human Services (HHS), under its formal review, has recommended cannabis be rescheduled to Schedule III. In addition to making cannabis easier to research from a medical perspective, Schedule III removes the 280E tax burden from cannabis businesses.
Once this happens, cannabis businesses will be able to deduct regular business expenses like other normal businesses and therefore increase their cash flow–which is good for everyone operating in this industry.
Here are a few financial considerations for plant-touching cannabis operators keep in mind while navigating this 280E transition:
1. It’s Business As Usual For Now
Nothing has changed yet, and therefore cannabis businesses must continue to operate just as they had before the rescheduling announcements, according to recent guidance from the Internal Revenue Service (IRS). Cannabis operators are under increased scrutiny because of cannabis’ federal illegality, which makes them a target for audits.
2. Begin Thinking About Your Future Cash Flow Predictions Now
With a lessened tax burden, your cannabis business will have more free cash flow. What do you want to be doing with those dollars in the future?
Perhaps that means you’ll have the ability to buy more licenses, pay dividends back to your shareholders, buy equipment, or build-out parts of your business that you may not have been able to afford because of 280E. Regardless of what you decide to do, you’ll want to have a plan.
If you’ve already built out those multi-year projections for a 280E environment–you’ll want to revise those projections to plan for a non-280E environment sooner rather than later.
3. Plan For Multiple Scenarios For When Cannabis Rescheduling Happens
Depending on when rescheduling actually happens, you may need to prepare for at least two different scenarios.
a. When rescheduling formally takes place, the lack of 280E regulation may apply retroactively to that tax year, meaning you’ll be able to treat the entire year as a “non-280E” year from an accounting perspective.
Or, what we believe to be the more likely scenario:
b. You will need to account for expenses incurred before the specific date that cannabis is officially rescheduled, and then treat expenses in a “non-280E” manner on or after that date. This means you’re going to account for your taxes in two different ways throughout the year. Then, you’ll need to combine those together for an overall tax return.
Because of the complexities here, it will be even more important to work with a certified public accountant (CPA) with experience in the cannabis space to ensure your taxes are filed correctly for the year when rescheduling takes place.
The discontinuation of 280E if cannabis is rescheduled will be a major industry development that will help cannabis businesses better navigate this complex, challenging, and highly regulated market. Preparing now for a 280E-free future will be key to navigating this transition well, strengthening the health of your business, and lowering your overall tax burden.
Photo by The New York Public Library on Unsplash
