The Internal Revenue Service’s (IRS) Taxpayer Advocate is reminding people of the unique financial challenges that state-legal marijuana businesses face under federal prohibition.
In a blog post published on Tuesday, the independent agency under IRS explained that cannabis companies are still obligated to pay federal taxes—but they’re barred from deducting most expenses that other industries can claim because the federal government considers marijuana a strictly controlled substance.
National Tax Advocate Erin Collins didn’t call for a specific policy change, but she did acknowledge efforts in Congress to enact legalization, or at least protect banks that work with state-legal businesses from being penalized by federal regulators.
The purpose of the new post was to “shed some light on the frustrations encountered by a growing segment of the business taxpayer population—the growers, distributors, and retailers of marijuana-related products—and educate them on federal tax law,” the agency said.
“There are significant federal tax-related consequences for businesses engaged in the ‘trafficking’ of marijuana, even in states that have legalized (or de-criminalized) the use of it,” the tax advocate wrote, adding that a federal tax provision known as 280E specifically precludes cannabis businesses from claiming most deductions.
Cannabis companies are able to make deductions for the cost of goods sold, which can “offset their gross receipts,” but that still means that businesses in the industry “end up paying federal taxes on gross profit rather than net income.”
The IRS tax advocate gave a hypothetical example to illustrate what that distinction means:
Example. A marijuana retailer has gross revenue of $1,000,000. It spent $750,000 on COGS and incurred another $200,000 in business expenses (which are nondeductible per Section 280E). Assuming a 30 percent effective tax rate, the marijuana retailer has a federal tax burden of $75,000 ($250,000 taxable income x 0.30). Had the business been allowed to deduct the other $200,000 in business expenses, its tax burden would have been reduced to $15,000 ($50,000 taxable income x 0.30).
“Not only is the marijuana retailer effectively taxed at a higher rate, it may take longer for a marijuana-related business to recoup its start-up expenses and turn a profit than other businesses,” the post says.
Adding to the complexity of operating a marijuana business under the current federal policy, cannabis businesses also face burdens in paying their taxes because it needs to be deposited in cash at specific IRS sites that can handle the cashflow.
The tax advocate cited comments from Treasury Secretary Janet Yellen, who has said on several occasions that a bipartisan bill to safeguard financial institutions that work with state marijuana markets could help simplify tax collection for IRS.
“Regardless of your personal or political views, or whether this disparate treatment is fair or not, taxpayers involved in the production, distribution, or sale of marijuana should be aware that there are significant federal income tax challenges that apply to this industry and understand the federal tax consequences,” the post says.
“Until Congress changes the law removing marijuana from the definition of a Schedule I controlled substance under the CSA, these businesses are not entitled to claim deductions and expenses like other businesses and need to understand the federal tax consequences in conducting its business,” Collins concludes.
While the office doesn’t specifically endorse any proposals to reform federal marijuana laws, it’s notable that the IRS body is working to promote tax education in the industry and tracking potential solutions.
Collins, the tax advocate, previously misstated IRS policy on tax deductions for medical cannabis, saying during a C-SPAN appearance in February that there was a “medical deduction” that could apply to marijuana patients. But she clarified in a statement to Marijuana Moment that that isn’t actually the case.
The new blog post also reiterates that “because marijuana is not a federally recognized course of medical treatment, individual taxpayers are prohibited from claiming associated expenses as itemized deductions on Schedule A of their Form 1040 tax return.”
IRS, which falls under the Treasury Department, has made clear that it doesn’t have discretionary authority to adopt policies that permit marijuana-related deductions while cannabis remains illegal under federal law. But the agency has taken steps to clarify tax policy for state-legal marijuana businesses.
De Lon Harris, commissioner of examination at the IRS Small Business/Self Employed (SB/SE) Division, recently spoke about tax-related issues in state-legal marijuana markets in a webinar hosted by PBC Conference. He said that while cannabis remains federally illegal, businesses that deal in the controlled substance must still file federal taxes, and IRS is here to help.
Harris also provided tips for marijuana businesses on tax compliance in a blog post published in September. And IRS separately hosted a forum in August dedicated to tax policy for marijuana businesses and cryptocurrency.
Another top IRS official who’s since left the agency also participated in a PBC Conference webinar in 2020. He offered similar recommendations to cannabis businesses, while also recognizing that the legalization movement will potentially succeed in ending prohibition in “all states.”
Former Treasury Secretary Steve Mnuchin, during the Trump administration, repeatedly addressed the cannabis issue, saying the current policy conflict creates “significant problems” for IRS and financial regulators. It “creates significant risk in the communities for collecting this amount of cash. It’s problematic,” he said last year.