As the Biden administration continues its review of cannabis prohibition, business leaders in the regulated cannabis industry are looking to the possible rescheduling of marijuana under federal drug laws to end the potentially crippling taxes they face. So far, the review has resulted in a recommendation from the Department of Health and Human Services in August to move cannabis from Schedule I to Schedule III of the Controlled Substances Act, a move that would ease restrictions on cannabis that have been in place for more than half a century. A key result of such rescheduling would have a dramatic effect on the financial health of the legal cannabis industry, which, because of an Internal Revenue Service (IRS) rule—Section 280E—faces an effective tax rate of up to 70% for some businesses.
Section 280E of the Internal Revenue Code prohibits cannabis companies from claiming tax deductions that are commonly enjoyed by businesses in other industries. Under the rule, companies that sell drugs that are listed under Schedule I or II of the federal Controlled Substances Act can only claim a deduction for the cost of goods sold. Other commonly claimed deductions such as expenses for rent, payroll, marketing and utilities, among others, aren’t allowed.
The rule can take a huge bite from the bottom line for cannabis industry businesses at tax time. In May, cannabis research firm Whitney Economics released a report on an analysis of the impact the IRS rule has on the cannabis industry that shows businesses in the industry are expected to pay nearly $4 billion in excess taxes in the span of only two years.
“In 2022 alone, cannabis operators paid over $1.8 billion in additional taxes when compared to ordinary businesses,” Whitney wrote in a statement on the economic research. “This excess is forecasted to increase to $2.1 billion in 2023.”
The report also noted that the tax burden on cannabis companies is so high that only 24.4% of operators surveyed said that their business is turning a profit, a figure that is down from 42% only a year ago. The effective tax rate for cannabis dispensaries often exceeds 70%, according to the report. Beau Whitney, chief economist at Whitney Economics, said that “the cannabis industry is under extreme economic distress and the current regulatory and taxation environment is untenable, even in the short term.”
Darrell Carrington, a cannabis industry lobbyist who worked with the Maryland General Assembly to assist in amending the Maryland Medical Cannabis Program in 2014, said that 280E is an obstacle to the growth of the entire industry and is especially harmful to creating diverse ownership of cannabis businesses.
“These regulations are put into place to supposedly regulate against the ills of the industry, but as the perception of cannabis is changing, and legalization is expanding, these rules make it much harder for minorities to get their foot in the door on ownership,” Carrington told Forbes in 2021. “Which is especially an affront due to how many people of color are still locked up on what are now previously illegal charges.”
Pushing Back on 280E
The impact of Section 280E is such a liability that some cannabis companies are attempting to challenge the rule. Earlier this month, Trulieve, a vertically integrated cannabis operator with licensed dispensaries in nine states, announced that it had filed amended tax returns to recoup taxes the company says it overpaid because of 280E.
“In total, the Company is claiming a refund of $143 million from taxes paid which the Company believes it does not owe, although there is no guarantee of receipt,” Trulieve wrote in an October 13 statement from the company. “This determination is supported by legal interpretations that challenge the Company’s tax liability under Section 280E of the Internal Revenue Code.”
Trulieve did not provide additional details of the legal basis for the amended returns, and a company spokesperson declined to comment on the development.
Whether the challenge will succeed remains to be seen. Other companies have set their sights on potential cannabis policy reform at the federal level, including the possible rescheduling of the drug recommended by the Department of Health and Human Services. But that possibility depends on approval from the Drug Enforcement Administration unless Congress acts to pass legislation mandating the change.
Thomas Ostrander, a partner with Philadelphia-based law firm Duane Morris, said that rescheduling cannabis to Schedule III would allow cannabis businesses operating legally under state law to “deduct, for federal income tax purposes, all their ordinary and necessary business expenses, the same as any other company would do.” If that happens, the law firm predicts the tax change will not be retroactive, meaning businesses would not receive a refund of taxes paid and would still owe taxes already due. But if cannabis is rescheduled by sometime in 2024, it is possible that 280E taxes would not be owed for all of next year. Unfortunately, the timing of such a change cannot be predicted.
“It’s hard to say when this is going to happen,” Ostrander said. “Don’t assume that this is going to happen next year.”