State revenues generated from tax collection on sales of recreational cannabis, or “adult-use marijuana,” continue to make a splash across headlines. Earlier this year, Michigan announced that for the 2021 fiscal year, more than $111 million was collected from the 10% adult-use marijuana excise tax, and more than $42.2 million in tax collected from adult-use sales will be distributed among 163 municipalities and counties as a part of the Michigan Regulation and Taxation of Marijuana Act.1
Similarly, Massachusetts reported collecting $112.4 million from its marijuana excise tax in 2021. The Rhode Island Legislature voted to legalize recreational cannabis on May 24, 2022, and more states are sure to follow as the generation of tax revenue has not gone unnoticed by lawmakers. It has been estimated that cannabis-related retail sales could reach in excess of $30 billion in 2022.2
Despite the tremendous contributions tax collection on adult-use marijuana sales is providing to state budgets, the federal government is still seeking to formally adopt “legalized” positions. On July 21, 2022, Senators Chuck Schumer of New York, Cory Booker of New Jersey, and Ron Wyden of Oregon proposed the most recent iteration of a bill aimed at cannabis reform. Under the Cannabis Administration and Opportunity (CAO) Act, states that have already legalized cannabis would be subject to the restriction that recreational use and access be limited to individuals having reached a minimum of 21 years of age. Additionally, in states operating legalized programs, an excise tax would be levied similar to current alcohol and tobacco taxes.
On April 1, 2022, the U.S. House of Representatives passed the Marijuana Opportunity Reinvestment and Expungement (MORE) Act. The MORE Act included provisions for declassifying cannabis as a controlled substance and imposed a 5% federal excise tax on sales of cannabis and cannabis products for two years, increasing by 1% annually for the subsequent three years. The MORE Act initially passed the House in December 2020 but was not voted on in the Senate at that time.3
The issue of federal legality cannot be overlooked when considering federal tax implications for businesses in the cannabis market. Effective since the early 1980s, Internal Revenue Code (IRC) Section 280E denies standard deductions and credits for amounts paid or costs incurred in carrying on in the trade or business of trafficking Schedule I and II controlled substances. Consistent with the federal classification of cannabis as a Schedule I controlled substance, IRC Section 280E disallows taxpayers from taking tax deductions for ordinary and necessary expenses incurred by businesses involved in the direct handling of cannabis and cannabis products, known as “plant-touching” businesses. The types of businesses subject to IRC Section 280E include businesses such as cannabis plant cultivators, processors, wholesale distributors, retail dispensaries, transporters, and other businesses with activities that directly touch the cannabis plant.
Lacking the ability to deduct ordinary expenses such as facility rental, employee wages, utilities, and marketing costs, plant-touching businesses are subject to an effective tax rate that is significantly higher than businesses that do not fall within the purview of IRC Section 280E. However, plant-touching businesses may find some relief in IRC Section 162(a), which allows for a deduction for the cost of goods sold (COGS). Depending on the type of business activities performed, COGS deductions allow plant-touching businesses to recoup a small amount of the tax savings disallowed by IRC Section 280E. Aside from COGS deductions, there is little latitude for cannabis businesses to navigate around IRC Section 280E.
Industrial hemp growers, farmers, and CBD companies where the CBD contains less than .03% THC are not subject to IRC Section 280E because such cultivation and production activities are considered legal under federal law.4 Therefore, businesses in states with industrial hemp cultivation programs, as well as businesses operating in states with low THC programs, such as Georgia, Tennessee, Texas, and Wisconsin, are not subject to the crippling tax restrictions of Section 280E.
Contrasted with plant-touching businesses, “ancillary businesses” are exempt from the limitations of Section 280E. Ancillary businesses are businesses not directly involved in the buying, selling, or transporting of cannabis and cannabis products and include, but are not limited to, businesses such as agricultural suppliers, packaging material and labeling companies, and licensing and branding companies. Ancillary businesses such as software developers, quality assurance laboratories, and developers of agricultural machinery and control systems servicing the industrial hemp and cannabis industries may also be eligible for research and development (R&D) credits under IRC Section 41 for performing activities related to the development, design, or improvement of products, processes, formulas, or software.5
With the Legislature’s summer recess fast-approaching, many cannabis-related businesses will likely continue to face the restrictions of IRC Section 280E for the near future, despite the introduction of the CAO and MORE Acts. We will keep you updated on the progress of the MORE Act, the CAO Act, and cannabis developments for state and federal taxation purposes.
To understand the potential tax deductions available for your cannabis business, contact one of the Ryan experts below for assistance with determining eligibility.
1 Treasury: Adult-Use Marijuana Payments to be Distributed to Michigan Municipalities, Counties. Press Release (March 24, 2022).
2 MJBizDaily: Legal US cannabis sales could top $30 billion by 2022 thanks to continued growth, new markets, (December 17, 2021) available at: https://mjbizdaily.com/us-cannabis-sales-could-top-30-billion-by-2022/
3 HR 3884, Marijuana Opportunity Reinvestment and Expungement Act of 2020.
4 The Agricultural Improvement Act of 2018, Pub. L. 115-334 (2018 Farm Bill).
5 26 U.S.C. § 41.
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The material presented in this communication is intended to provide general information only and should solely be seen as broad guidance and not directed to the particular facts or circumstances of any individual who may read this publication. No liability is accepted for acts or omissions taken in reliance upon the content of this piece. Before taking (or not taking) any action, readers should seek professional advice specific to their situation from Ryan, LLC or other tax professionals. For additional information about this topic, please contact us at info@ryan.com.