The relationship between Section 471(c) and Section 280E in the cannabis industry
Calvin P. Shannon CPA, CVA | April/May 2024 Footnote
The rapidly evolving cannabis industry in the United States grapples with significant legal and financial hurdles, particularly with the intricate dynamics between Section 471(c) and Section 280E of the federal tax code. These sections not only pose challenges but also shape business strategies, underscoring the need for compliance and the pursuit of sustainable growth paths.
Section 280E: A stumbling block for cannabis businesses
Introduced in the early 1980s, Section 280E was designed to prevent businesses selling controlled substances from deducting expenses, aimed at illegal drug traffickers. With the legalization of cannabis for medical and recreational use in various states, legitimate cannabis businesses find themselves caught by this provision. The inability to deduct expenses can lead to higher tax rates for cannabis operators compared to other industries.
Due to the federal illegality of cannabis, Section 280E prevents plant-touching companies from deducting expenses. Consequently, some cannabis businesses pay more in taxes than they earn. This provision has turned economic losses into taxable gains for many cannabis companies.
The silver lining: Section 471(c) offers a glimpse of hope
In contrast, Section 471(c) — a relatively new addition to the tax code — offers some relief by allowing small businesses to account for their inventory costs in a way that can mitigate the harsh effects of 280E. Created under 2017’s Tax Cuts and Jobs Act, Section 471(c) allows small taxpayers to account for inventory according to their applicable financial statements or their underlying books and records.
This provision appears to provide cannabis businesses with the ability to include costs into inventory and cost of goods sold (COGS), where they aren’t disallowed under Section 280E. By characterizing costs disallowed under 280E to be recognized as COGS, Section 471(c) may open the door for small cannabis businesses to reduce their taxable income.
A complex interplay between sections: Key questions to consider
The relationship between Section 471(c) and Section 280E in the cannabis industry is intriguing and complex. While 471(c) offers potential relief from the harsh realities of 280E, the lack of concrete guidance from the IRS and the complexity of applying these provisions leaves the industry with more questions than answers. While considering the potential risks and benefits, cannabis businesses must work closely with their advisers and accountants to navigate these intricate issues to consider key questions:
- Applicable financial statements. What are they, and how do they relate to Section 471(c)? Applicable financial statements refer to audited financial statements required for non-tax purposes, such as credit or regulatory compliance.
- Risks and challenges. Using Section 471(c) to navigate the hurdles of 280E is not without risks. From potential legal disputes to additional tax liabilities, cannabis businesses must weigh their options carefully. Accountants must also be cautious in applying this provision, maintaining accuracy and proper justification for using 471(c).
As the industry evolves, staying informed and adaptable is crucial for success.
Calvin P. Shannon CPA, CVA, is a principal of BGM. With more than 20 years of experience, Calvin provides tax, advisory, and business valuation services and specializes in serving cannabis operators. You may reach him at cshannon@bgm360.com or 651-287-6347.
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