When congressional lawmakers first conceived the obscure federal tax rules known as 280E in the early 1980s, the goal was to strip drug kingpins and smugglers of ill-gotten proceeds. A particularly brave drug trafficker had attempted to deduct a yacht and firearms purchases from his taxes.
Washington politicians in response authored 280E, which added to the arsenal of tools available then to enforcers at the height of America’s war on drugs. According to a report published earlier this year by a research arm of Congress known as the Congressional Research Service, the original intent of rulemakers at the time was to “codify a sharply defined public policy against drug dealing.”
Under federal law, the research service wrote, “all income is taxable, including income from unlawful activities. … In contrast, not all expenses are deductible from a taxpayer’s gross income. … Taxpayers conducting lawful activities may deduct ‘ordinary and necessary’ trade or business expenses when computing their taxable income.”
The unplanned effect of 280E today is to punish state-legal cannabis operators by barring them from reducing their tax burdens with standard deductions for everyday expenses enjoyed by most other businesses.
A major question facing legislators, and cannabis operators and advocates, is whether banishing 280E is better or worse than what pending proposals in Congress are offering in exchange for federal sales taxes on cannabis purchases that compound with existing state and local taxes.
On the one hand, cannabis operators could take more business tax deductions. On the other hand, cannabis consumers would face stiffer prices at the cash register, so operators may be reluctant in tightly competitive markets to pass off those costs entirely.
Is cannabis reform worth it?
On the House side in Washington, there’s Democratic Congressman Jerry Nadler’s Marijuana Opportunity Reinvestment and Expungement Act, or MORE Act, which envisions an excise tax of five percent that steadily climbs to eight percent after five years. On the Senate side is Democratic Sen. Charles Schumer’s Cannabis Administration and Opportunity Act, which does the same but proposes a far higher excise tax that begins at 10 percent and builds to 25 percent.
Both would calculate this rate based on an average, everyday market price for cannabis products, rather than, for example, a set tax on each pack of cigarettes or bottle of alcohol. In other words, for the sake of reform, we may be replacing one cost with another that continues to punish and penalize legal cannabis businesses where we were seeking to legitimize them.
Even conservative Supreme Court Justice Clarence Thompson asked recently if the value of 280E in relation to its original policy intent from Congress had simply faded away as the public mood steadily shifted on cannabis from one state to the next.
Justice Thomas’s remarks came after a Denver dispensary called Standing Akimbo challenged whether federal tax enforcers could obtain private records from a state-legal cannabis business in Colorado without a warrant to determine if the company was wrongly deducting expenses to lower its tax bill.
While Thomas is known among legal watchers for mostly staying quiet during oral arguments, he surprised observers with his forthrightness about 280E when the court turned down the opportunity to review Standing Akimbo’s case in June:
“Once comprehensive, the federal government’s current approach is a half-in, half-out regime that simultaneously tolerates and forbids local use of marijuana. This contradictory and unstable state of affairs strains basic principles of federalism and conceals traps for the unwary. … A prohibition on intrastate use or cultivation of marijuana may no longer be necessary or proper to support the federal government’s piecemeal approach.”
The real drivers behind 280E
Now as Congress once again considers comprehensive cannabis-reform legislation in both chambers, policymakers are worried about the effect of repealing 280E. Ironically, the reason is no longer a fear of rogue drug kingpins. As one state after another has moved to decriminalize or legalize cannabis to various degrees, blocking cannabis businesses from reducing their tax burdens under 280E has become a major source of revenue for the federal government.
The Tax Foundation, a nonprofit policy think tank, reported in mid-July that by the estimation of Congress itself, doing away with 280E would lower federal tax receipts over 10 years by a whopping $5 billion. If Congress enacted substantial reform in either chamber during 2021, the loss to federal-government coffers would be an estimated $400 million for the fiscal year.
Federal auditors had already found last year that state-legal cannabis businesses were getting away with not paying their taxes at all or hiding income in assets. So the true amount owed is probably far greater. The trade publication Marijuana Business Daily determined in April that where cannabis businesses are paying their taxes, a comparable, non-cannabis retailer pays $375,000 less each year in taxes.
Tax hikes, rather than tax deductions, were always a likelier outcome with federal cannabis reform, the Tax Foundation writes. The long-hyped cannabis reform bills coming out of both chambers would bring relief to cannabis entrepreneurs. But they would also incrementally add to cannabis taxation that falls on consumers but ultimately falls on businesses in competitive markets:
“While the proposed federal rates start at the lower end, they quickly become substantial. Since all states with recreational sales already tax either cultivation, wholesale, or retail sales, the federal government should err on the side of lower tax rates. Overtaxing marijuana could result in a competitive advantage to illicit sales, which are still prevalent in most states — even in states that offer a licensed market.”
Will cannabis reform (in its current state) really help?
For the time being, cannabis businesses need to rely on tax expertise to explore the full range of options that are still available for easing state-and-federal business taxes when relief from Congress is uncertain.
So is repealing 280E better or worse for cannabis operators and consumers in the end? Under the bills proposed by Congress, both suffer. By one estimate, the effective tax rate for cannabis businesses under 280E is as high as 60 percent. Federal cannabis reform would relieve that pressure on entrepreneurs but become a new cost in the form of higher retail prices.
“For cultivators, they can take a lot of deductions currently,” said Ulrik Boesen, a Tax Foundation expert who’s been examining the reform proposals in Congress, in an interview. “ … Especially the MORE Act … For retailers — who are very limited today in the deductions they can take — they pay a very high income-tax rate — repeal of 280E, even with a five or six percent excise tax rate — that may result in an effective tax cut. … But you get a nasty multiplication effect in some states. That’s one of my main concerns with a higher federal tax. … I don’t want the federal government to add regulatory burdens and taxation burdens that mess with that progress.”