The marijuana industry has been significantly hindered by Section 280E of the IRS Code, which prevents businesses dealing with substances listed in Schedules 1 and 2 of the Controlled Substances Act (CSA) from deducting regular business expenses.
Although Section 280E affects federal deductions, the regulations are not governed by federal laws in half of the markets where marijuana businesses are licensed to sell the drug for recreational or medical purposes. This implies that when cannabis businesses submit their state taxes, they are not subject to Section 280E.
This provision has stunted the growth of legal cannabis businesses across the country. However, the sector is about to undergo a major financial shift due to the Biden administration’s proposal to reclassify the drug from Schedule 1 to 3.
Cannabis enterprises are subject to significant limitations on their income-tax obligations and tax filings under Schedule 1. They must also consider whether the states in which they conduct business adhere to federal tax rules.
Section 280E prevents companies from claiming a wide range of administrative, selling and general expenses that are typical for other businesses, including the following:
- Rent: Leasing space, a common deductible expense in other industries, cannot be deducted in the marijuana sector.
- Salaries and wages: Paying employees, from executives to budtenders, does not provide any tax relief.
- Utility costs: Essential utilities such as water and electricity cannot reduce the tax burden.
- Maintenance and repairs: Keeping facilities in good condition is a nondeductible expense, limiting reinvestment and improvements.
- Advertising and marketing: Promoting and building a brand drains funds without the benefit of tax write-offs.
- Health insurance: Providing medical coverage for employees is an unrecognized expense, affecting workforce stability.
- Amortization and depreciation: The gradual loss of asset value over time is not acknowledged by federal tax rules for nonplant-touching assets.
What could change if cannabis businesses were freed from the constraints of Section 280E? It would result in a scenario where the industry is no longer categorized alongside substances such as LSD and heroin but rather with everyday prescription medications.
For starters, cannabis businesses could claim deductions for typical expenses such as salaries, rent, utility bills, and advertising and marketing costs. Money saved from 280E could be reinvested into the enterprise, spurring growth, job creation, research and development.
Further, cost savings could be passed on to consumers, making medical marijuana more affordable and accessible. Additionally, with reduced stigma, obtaining loans, credit lines and banking services could become easier. Relief could also lead to competitive pricing for patients and consumers, reducing the appeal of the black market.
The potential for these changes has the industry excited and speculative. Will these possible deductions create a thriving economic environment for marijuana businesses, or will financial parity with other industries remain elusive?
One thing is certain: rescheduling cannabis and making Section 280E irrelevant for marijuana entities could unleash a flood of prosperity and turn a once-restricted sector into a major player in the financial world.
The question: when will the industry be able to reach its full potential financially? Marijuana companies such as Aurora Cannabis Inc. (NASDAQ: ACB) (TSX: ACB) can only wait for the final rule to be published so that they ascertain how the change in policy will impact their tax obligations.
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