WASHINGTON, D.C. – Bipartisan federal legislation reintroduced this week could provide desperately needed tax relief for state-legal cannabis businesses.
Rep. Earl Blumenauer’s (D-OR) Small Business Tax Equity Act would allow companies to fully deduct “normal and necessary” operating expenses including rent, most utilities, and payroll from their federal tax returns. Under current law—the much-reviled Internal Revenue Code Section 280E—legal cannabis businesses may deduct only some of the costs directly related to manufacturing and selling inventory.
The bill is co-sponsored by Reps. Nancy Mace (R-SC), David Joyce (R-OH), and Barbara Lee (D-CA).
“State-legal cannabis businesses are denied equal treatment under 280E,” said Blumenauer. “If Congress wants to get serious about supporting small businesses and ending the illicit cannabis market, it is common sense that we allow legal cannabis operations to deduct business expenses, just like any other industry.”
Similar versions of the bill have been introduced multiple times since 2013, most recently by Rep. Nancy Mace during the last day of the 117th Congress in January 2023. However, previous congressional efforts to provide legislative relief for the industry’s enormous tax burden failed to advance to a hearing or vote.
“There is a growing recognition in Congress that a majority of voters are in favor of ending prohibition and increasingly view it as a priority,” said Morgan Fox, political director at advocacy organization NORML. “In a narrowly divided Congress in which it might be difficult to pass any type of substantial legislation, more and more lawmakers on both sides of the aisle are supporting cannabis policy reform—especially narrowly tailored incremental bills—both because it is sensible policy and because it represents an opportunity to effectively legislate.”
Even with growing support in Congress, the Small Business Tax Equity Act likely will face an uphill battle to break through whatever barriers have kept it off committee schedules in previous terms.
“Federal reform has always been a long game, and we aren’t under the illusion that passing this legislation is easy,” said Aaron Smith, co-founder and chief executive officer at the trade group National Cannabis Industry Association. “That’s why it’s important for small businesses at the heart of our industry to come together to support national advocacy efforts. There has been a significant shift in public opinion and a growth in the number of states that have adopted adult-use cannabis programs since the last time this bill was introduced, so I’m hopeful that will translate into more attention on 280E during this Congress.”
The industry’s tax troubles originate from the 1981 United States Tax Court case Edmondson v. Commissioner, in which convicted drug trafficker Jeffrey Edmondson won a lawsuit against the Internal Revenue Service after the agency refused to allow him to claim the expenses he incurred selling amphetamine, cannabis, and cocaine.
In 1974, Edmondson reported $105,300 for his cost of goods sold along with other itemized deductions for travel, packaging costs, phone calls, and a portion of rent for his home office. While the court disallowed $30,341.69 of Edmondson’s claimed cost of goods sold, he ultimately was allowed to take business-expense deductions for his rent, phone, vehicle, and $30,000 worth of drugs in what The Washington Post called the “deduction of the week” in November 1981.
The following year, Congress created IRS Tax Code 280E to prevent others from claiming ordinary and necessary business expenses related to the sale of controlled substances as defined by Schedule I and II of the Controlled Substances Act. As a result, today’s state-legal cannabis businesses are subject to effective tax rates of as much as 70 percent.
The 2007 case Californians Helping to Alleviate Med. Problems, Inc. (CHAMP) v. Commissioner created an exception for costs of goods sold, opening the door for legal cannabis businesses to deduct certain expenses if they can separate plant-touching activities from other business-related expenses. While businesses are allowed to deduct some of the cost of goods sold or the cost of inventory, understanding exactly what can and cannot be deducted is a complex matter that often requires the assistance of tax attorneys and certified public accountants.
Depending on the type of business, allowable deductions can include expenses for curing, inventory, cleaning, trimming, packaging, equipment maintenance, supplies, and raw materials like seeds and fertilizer.
Some states, including California and Oregon, exclude the 280E tax code in calculations for state income tax, but the relief can feel minor without federal deductions for expenses such as rent, interest, banking fees, office supplies, marketing costs, payroll taxes, legal fees, software, and other basic costs of doing business in any other industry.
With bipartisan support and a new Republican sponsor in Joyce, who’s served since 2013 and co-chairs the Congressional Cannabis Caucus, this year’s version of the Small Business Tax Equity Act could stand a puncher’s chance at making real progress.
“There are a lot of reasons to be cautiously optimistic about ending 280E in the current session, including the increased focus on supporting small businesses post-COVID,” said Fox.
[…] Section 280E disallows the deduction of most normal and ordinary business expenses for the production, distribution, and sale of substances listed on Schedule I or II of the federal Controlled Substances Act. Cannabis resides on Schedule I. […]