Optimizing 280E deductions for cannabis retailers and dispensaries is the key to lowering tax exposure and boosting profitability. Above all, IRS Code 280E was intended to prevent “drug traffickers” from claiming tax deductions for business expenses. With cannabis still illegal from a Federal perspective, legally operating cannabis businesses cannot make many of the standard deductions mainstream businesses enjoy. As a result, cannabis companies face much higher federal tax rates than other industries — as much as 40-80% more in taxes, while the corporate tax for traditional industries is 21%. With taxes set to rise, it is more important than ever than retailers and dispensaries understand what they can, and cannot deduct to lower their 280E exposure.
In the following article, we will show how cannabis retailers and dispensaries can limit their tax exposure while complying with 280E. Moreover, we’ll discuss how to analyze cash flow, properly plan, and optimize deductions, and provide instructions on how to make sure your documentation supports your position in the event of an IRS tax audit.
If you’re vertically-integrated or a cannabis cultivator, be sure to check out our guide to 280E deductions for cultivators.
How does 280E impact cannabis retailers?
Firstly, all verticals in the cannabis industry are affected by IRS Code 280E and the limitations around reducing tax payments. Because 280E directly relates to the sale of or “trafficking” cannabis-related products, the rule most influences the retail and dispensary operations. Similarly, it is essential to have a deep understanding and organized seed-to-sale structure to minimize the tax burden. By identifying which deductions you can allocate as the cost of goods sold (COGS), operators can significantly reduce the impact of 280E on their retail establishment. Furthermore, our industry professionals assist operators in maintaining accurate inventory by applying the inventory accounting method.
In contrast, cannabis businesses can be affected differently depending on which state they are organized. Therefore, it’s essential to obtain the advice of licensed professionals if you operate out of multiple states or are unsure about the 280E tax law for your area. Similarly, GreenGrowth CPAs operates nationwide in all states with legal cannabis adult use and has experience analyzing financial data for all verticals.
How retailers and dispensaries can approach 280E deductions
Dispensary operators are the most limited vertical for allocating expenses under Cost of Goods Sold (CoGS). In other words, for retailers, the cost of goods sold is the product’s initial purchase expense and any costs associated with acquiring the cannabis, including transportation expenses. You can also often claim deductions for electric bills for designated inventory areas.
Therefore, operators must keep accurate records to track and code direct and indirect costs properly. However, retailers who work within other verticals in the industry must correctly document expenditures associated with operations of each vertical.
Direct vs. Indirect Costs for cannabis retailers
Direct expenses for cannabis retailers can often be deductible if you can prove they relate directly to the production of goods, and therefore cost of goods sold. Since COGs are the only deduction under 280E, it is crucial to understand and allocate costs accordingly.
Retail operators can claim deductions for the following direct costs:
- Invoices for product (COGS)
- Related directly to production (ex. Bud-tender hourly rate for rolling joints)
- Lab testing
- Shake & Trim
- Transportation – Expenses associated with travel to buy cannabis products and legal shipping costs.
Indirect costs are not generally deductible on the cannabis retailer’s business tax return. Although, some are considered mixed costs, where a portion of the expense may be tax deductible. Since determining the correct allocation is complex and we recommend the assistance of an experienced accounting professional. Depending on your business model, the following costs are sometimes deductible:
- Cleaning Expenses
- Computer, Telephone & Internet Expenditures
- Insurance – (liability & workers compensation)
- Interest Expenses
- Lease Software
- Office Expenses
- Payroll Processing Fees
- Payroll Taxes – (FICA & FUTA)
- Rent Expense
- Utilities (electricity used in sales areas is not deductible).
The in-direct expenses below are never deductible for cannabis retailers:
- Website Design
- Charitable Contributions
- Meals & Entertainment
- Franchise Fees
- Banking Service Charges
- Advertising & Marketing
Sample P&L Statement
Ex. Tax Liability for Cannabis Retail Dispensary vs. Non-Cannabis Retail Location
|Cannabis Retailer||Non-Cannabis Retailer|
|Cost of Goods Sold||$500,000||$500,000|
|Tax Liability at 25%||$125,000||$50,000|
|Income After Taxes & Expenses||$75,000||$150,000|
In other words, we can demonstrate the disadvantages retailers face in the cannabis space. The orange highlighted areas (Rent, Utilities, Insurance, Maintenance) are all deductible costs for organizations outside the cannabis sector. The green highlighted cells are deductible expenses for both industries. As a result, the cannabis retailer has the same expenditures, but their profits are half as much as the non-cannabis retailer. Why? Because they cannot take the same deductions available to typical retailers and minimize their tax exposure, therefore they end up paying more in taxes. In this example, the cannabis retailer owes $75,000 more in taxes than the non-cannabis industry operator.
Importance of accurate record-keeping
For instance, operators can streamline 280E deductions by working with a team of professionals to help identify, track and allocate direct and indirect expenses accurately. Having methods specifically developed for the cannabis industry, such as timesheet software, can help automate the process and cut down on manual tracking for labor deductions.
Unlike other technology for general industries, cannabis systems’ structure supports the regulatory challenges operators face in the cannabis space. This is also extremely helpful in the event of an audit; since operators can show reports of allocations and provide detailed accounts to the IRS.
We also recommend working with a strong team of cannabis accounting experts. Although identifying 280E workforce deductions can be challenging. Likewise, incorrect allocations can lead to audit investigations where the IRS can assess penalties and fines to organizations operating outside of regulatory standards. Therefore, if managed correctly, retailers can increase their bottom line by lowering tax liabilities. In order to determine your individual business needs, operators can schedule a free consultation to discuss how GreenGrowth CPAs can assist your cannabis retail establishment in navigating the 280E deductions.
280E tax reform on the horizon?
In the 1980s, legislators initially passed Section 280E to prevent “traffickers” or drug dealers from writing off business expenses on their tax returns. However, it was never meant to apply to legitimate businesses operating in accordance with state laws. While cannabis remains a Schedule I drug under the Controlled Substances Act and illegal under federal law; the industry will continue to see the adverse effects of 280E.
Today, lawmakers urge President Biden to assist with cannabis legalization and industry reform. While Democrats continue to exhaust initiatives asking congress for cannabis reform, cannabis legalization has become a bi-partisan issue across the US. However, Republican legislators are joining their Democratic counterparts and recently submitted a bill to Congress proposing the legalization of cannabis. While legalization would make the IRS 280E Code obsolete, it would also significantly impact dispensary businesses operating across the US. Consequently, if cannabis companies are allowed to take typical tax deductions they can invest more into their operations and the communities they serve through higher wages, better benefits, more community outreach, and better education for the consumer.
For more information on navigating the 280E, reach out to our financial experts at GreenGrowth. We are here to help your cannabis venture through any level of the tax filing process. In addition, we employ several financial programs that can assist your company with fiscal responsibilities including, tax planning and compliance, outsourced CFO support, audit preparation, tax controversy support, and much more.
For recommendations and assistance with an IRS audit, schedule a free consultation or contact us at 1-800-674-9050.