The cannabis industry is here and accounting and tax are running quickly to keep up with the rules and regulations.
Whether you agree or disagree with legalization of marijuana in the United States, there is a tsunami of activity in the industry that is rippling across the finance and accounting worlds. Marijuana is legal today in 10 states plus the Washington D.C. Michigan is the latest state to add itself to the list following the November midterms. 23 states have legalized medical marijuana. It is estimated that over the next decade, $132 billion in federal tax revenue could be generated and over 1 million jobs in this industry. Folks, we have a juggernaut on our hands here.
But the accounting rules are complicated and for businesses in cannabis that want to actually build real businesses, these rules must be understood. One of the greatest areas of confusion is what is allowable as a deduction from income for retailers for the purpose of calculating taxes.
We have a number of cannabis related businesses that come to Stride for bookkeeping and accounting. But when it comes to tax, we go directly to Dean Guske. Dean is an expert tax accountant in all things cannabis related.
Recently he shared with us the result of a November 29, 2018 U.S Tax Court ruling on a case involving Harborside, a well-known and iconic California dispensary. The ruling explains in detail expenses for the purposes of calculating gross income (gross revenue less cost of goods sold).
The short story on this topic is that language contained in Section 280E of the Internal Revenue Code prevails and that there are certain expenses that simply cannot be deducted if you are a business that traffics in Schedule I or Schedule II controlled substances as defined in the Controlled Substances Act.
To make this even easier, the only deductions that Harborside can take are the deductions of the purchase of cannabis, plus the transportation costs but excluding any indirect costs. 280E isn’t going anywhere folks. If you want to get some expert tax advice, reach out to Dean and his team at dean@deanguske.com. If you want to discuss bookkeeping and accounting for your cannabis related business, contact us.
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The cannabis industry is booming, with more states legalizing medical and recreational marijuana. However, despite its rapid growth, businesses operating in this space face significant tax challenges due to Section 280E of the Internal Revenue Code. Understanding the intricacies of cannabis accounting and tax compliance is crucial for financial success.
Understanding Section 280E and Its Impact on Cannabis Businesses
Section 280E is a tax code provision that prohibits businesses engaged in trafficking controlled substances from deducting typical business expenses. Because cannabis remains a Schedule I controlled substance under federal law, marijuana-related businesses (MRBs) must navigate strict limitations on deductions, making tax planning a critical component of financial management.
Key Implications of Section 280E:
- No Standard Business Deductions – Cannabis companies cannot deduct operating expenses such as rent, utilities, advertising, and employee wages.
- Higher Effective Tax Rates – MRBs often pay significantly more in taxes compared to other businesses.
- Limited Exceptions for Cost of Goods Sold (COGS) – Only direct costs related to cannabis production and acquisition can be deducted.
Structuring Your Cannabis Business for Optimal Tax Efficiency
To mitigate the financial burden imposed by 280E, cannabis businesses should implement strategic accounting practices:
1. Proper Cost Allocation to Maximize Deductions
The key to tax efficiency under 280E is properly categorizing expenses under COGS. The IRS permits deductions only for expenses directly related to the production of goods, such as:
- Raw material costs (cannabis plants, seeds, nutrients)
- Labor costs for cultivation and processing
- Packaging and labeling costs
- Warehousing expenses related to production
Retail businesses, on the other hand, have fewer deductible expenses, making strategic planning even more essential.
2. Implementing GAAP-Compliant Accounting Practices
Adopting Generally Accepted Accounting Principles (GAAP) ensures compliance with IRS regulations. This includes:
- Accurate inventory tracking – Using perpetual inventory systems to separate COGS from non-deductible expenses.
- Cost Segregation Analysis – Identifying indirect costs that may be allocated to production rather than operations.
- Comprehensive bookkeeping – Maintaining detailed records to support tax filings and withstand IRS scrutiny.
3. Utilizing Multi-Entity Business Structures
Some businesses employ a multi-entity strategy to separate non-cannabis activities from direct cannabis sales. Examples include:
- Holding Companies – A parent company owns intellectual property, branding, and real estate, leasing assets to the cannabis-operating entity.
- Ancillary Businesses – Non-plant-touching operations (such as consulting, software, or accessories) may be structured separately to qualify for standard deductions.
Tax Planning Strategies to Reduce Your Liability
1. Optimize Inventory Valuation Methods
Choosing the right inventory accounting method can make a significant impact on taxable income. Commonly used methods include:
- Full Absorption Costing – Maximizing deductible COGS by including indirect production costs.
- Section 471 Compliance – Aligning inventory accounting with IRS-approved methodologies to increase deductible expenses.
2. Maintain Detailed Financial Records
Increased IRS scrutiny of cannabis businesses means maintaining meticulous records is essential. Ensure that:
- Every expense is properly categorized
- Transactions are documented with invoices and receipts
- Separate accounts exist for plant-touching and non-plant-touching expenses
3. Work with Cannabis Tax Professionals
Due to the complexity of 280E compliance, partnering with tax professionals experienced in the cannabis industry is highly recommended. A skilled CPA can help:
- Develop tax-efficient strategies
- Ensure full compliance with IRS guidelines
- Prepare for potential audits
The Future of Cannabis Taxation
As cannabis legalization advances, there is hope for tax reform. Potential changes include:
- Federal rescheduling of cannabis – Moving marijuana from Schedule I to a lower category could eliminate 280E restrictions.
- SAFE Banking Act and other legislative efforts – Ongoing discussions in Congress may ease financial barriers for MRBs.
Visualizing the 280E Taxation Process
Conclusion
Navigating cannabis accounting under Section 280E requires meticulous financial planning and strategic tax structuring. By optimizing COGS deductions, maintaining proper accounting practices, and consulting industry experts, cannabis businesses can mitigate tax liabilities and position themselves for long-term success. Staying informed on potential legislative changes will also help businesses adapt to an evolving regulatory landscape.
