I’d like to send a shoutout to tax lawyer Nick Richards for an intriguing opinion piece Updated on Friday, September 1 in Marijuana Business Daily. Nick outlines two approaches to potentially help cannabis businesses recoup buckets of cash from Uncle Sam. One approach, which is known to us, may be utilized by cannabis businesses throughout their terms of existence. The second approach, which seems novel, relates to treatment of taxable gains upon sale.
As with most tax strategies specific to cannabis, these approaches center on IRC § 280E, the federal law that disallows deductions and credits for traffickers of Schedule I and II controlled substances. Let’s look at the novel approach first, for cannabis business sellers.
The 280E Asset strategy on sale
Nick’s theory, dubbed the “280E Asset”, posits that deductions disallowed by 280E during the lifecycle of a cannabis business can still be factored into a business’ basis, or the basis of its assets, at sale. This would be highly desirable in many cases, because increased basis means lower taxable gains at sale.
What’s basis? Simply put, it’s the amount of capital investment made by a taxpayer into a business or asset. Nick gives the example of a taxpayer buying an airplane for $1 million and then immediately selling that airplane for $1.5 million. The taxpayer’s basis is $1 million; the taxable gain would be $500,000. If the airplane were a disallowed expense, however – like many cannabis business expenses under 280E – then the entire sale price of $1.5 million would be taxable. Pretty tough.
Enter the 280E Asset theory. This position holds that although 280E prohibits deduction of expenses when incurred by a cannabis businesses, these expenses may be recognized on sale. In support, Nick cites CBS Corp. & Subsidiaries v. U.S (“CBS Corp”), a 2012 tax court decision which held that certain disallowed expenses were recognizable as basis, and could thereby reduce taxable gain on sale. Such a principle would be great for cannabis businesses. Unlike businesses in most other industries, cannabis firms have plenty of disallowed expenses under 280E– especially retailers and other non-grower parties.
Rather than rely on my summary of Nick’s summary of CBS Corp, I suggest you read his short treatment. Then, I suggest you read the case itself; or better still, have a tax lawyer analyze and Shepardize it. Finally, you will need the CPA who prepares your return to sign off.
The 280E Asset strategy appears to be untested– at least in the context of cannabis business windups. I will emphasize again that use of the 280E Asset at sale seems novel, and litigating against the IRS has seldom gone well for cannabis businesses. In fact, I’ve explained that other than Champ v. Commissioner, no cannabis taxpayer has won a §280E case (and there have been a bunch of them).
Dealing with 280E prior to sale
The second approach is for going concerns, and arises out of statutory changes enacted after CBS Corp was decided. Let’s call this one the 471(c) Approach, because it comes into play under § 471(c) of the Tax Cuts and Jobs Act of 2017 (TCJA). In the IRS’s own words, the TCJA “changed deductions, depreciation, expensing, tax credits and other tax items that affect businesses.” On that point, everyone agrees.
Here’s the untested part. As with the 280E Asset strategy, the 471(c) Approach posits that disallowed expenses aren’t irretrievably lost under 471(c) accounting. For that reason, the 471(c) taxpayer may also report its costs of goods sold (COGS), which are not disallowed, according to its own books and records. In this manner, a cannabis business can report otherwise nondeductible expenses as COGS.
Another Marijuana Business Daily article from last month examines the 471(c) Approach in greater depth. For now, I will note that we work with several businesses and CPAs implementing this strategy (perhaps more than I know). I should also caution that I’m unaware of any IRS audits rejecting or allowing the strategy, or of any litigation on point. I’d love to hear from people on this.
Wrapping up on cannabis tax strategy
The good news is that these arcane exercises and tax uncertainties may soon go away. As I explained last week, “marijuana” appears headed for Schedule III. This means that the scourge of 280E would no longer apply, and the cannabis industry would be taxed like other industries at the federal level.
Let’s hope rescheduling goes according to plan, and quickly. Until then, it may be a good idea for cannabis businesses to take a hard look at the strategies set forth above– whether at sale or all along the way.
