Incoming Income Tax Changes for Cannabis Companies

IRC 280-E Overview – The Current State of Cannabis Taxation

Many of you are well aware of the tax impacts 280E on a cannabis company already:

• No deductions

• No credits

• Resultantly much higher taxable income

However, on December 2, 2024, the DEA will hold a hearing before an administrative law judge on the cannabis rescheduling proposal. This can be a short or long process, but it can possibly mean many amazing things for the cannabis industry as a whole, and may change the way that cannabis operators and investors look at accounting and taxation.

So what specific changes can we expect?  What are we hoping for?  And how can we prepare?  Well, let’s get into it!

What Will Happen – Equal Tax Treatment

First and foremost, ordinary deductions will be allowed to cannabis plant touching businesses. 

Currently, cannabis companies can only reduce taxable income by cost of goods sold, and aren’t allowed to write off ordinary expenses, like marketing, administrative costs, or professional fees.

Normal businesses, under IRC 162A, are able to do this.

And once cannabis is rescheduled, it will have the tax treatment of a normal business.  Therefore, it will be able to utilize 162A to write off ordinary and necessary business expenses.

The other big deduction on the horizon is depreciation.

Currently, cannabis companies must use GAAP accounting to calculate depreciation.  This primarily means using Straight-Line, Double-Declining Balance, or Sum of the Years’ Digits.  These basically mean that you depreciate the same amount every year, or a little faster.  The calculations must be supported through internal documentation, and must be reported on a regular cadence.

However, normal businesses don’t have to do this.  They can use MACRS and Bonus Depreciation to accelerate depreciation on fixed assets much faster.

These tax depreciation methods can result in over 2X the depreciation rate!

For example, let’s take a piece of equipment that must be written off over 5 years with GAAP depreciation.  With bonus depreciation, however, you may be eligible to write off 80% of it in year-one.  Not only that, but there is a chance that bonus depreciation will go back up to 100% coming soon, and that can result in even faster write offs.

And then there’s the tax credits.

Depending on the business’s vertical – cultivation, manufacturing, or retail – there will be opportunities for tax credits.

And there are some interesting opportunities here…

The R&D tax credit is going to be a big one.  This lets companies that are engaged in the improvement or discovery of processes tax credits against those associated expenditures.  Since cannabis is a nascent industry, a lot of what happens is considered R&D. 

As it stands, we can’t take R&D credits on federal income returns, but once 280E doesn’t apply any longer to cannabis companies, then we will be looking at big tax credits on the horizon.

And then there’s the renewable energy tax credit.  This let’s you take a credit for expenditures on renewable energy sources.  Usually 30% of the expenditure.  And then half of it goes against the depreciable basis of the asset.

For example, let’s say you buy a piece of equipment that uses renewable energy for $30K.  In this case, $9K would be a credit (30,000 * 30%) and the depreciable base would be $25,500 = [30,000 – (9,000/2)] 

And specifically for farmers, we would see the fuel tax credit come in.  This is a credit that lets certain taxpayers, including farmers, receive a tax refund for certain fuel expenditures.

All of this will result in higher net income, better cash flow, and an increased ROI for owners.

What We Hope Will Happen – the Elephant in the Room

These tax benefits moving forward seem promising, but what about amendments? 

Once cannabis is rescheduled, can you go back, reverse the impacts of 280E, and claim tax benefits retroactively?

And the answer to this question is… Nobody really knows.

We certainly hope that you can, but it seems unlikely that the IRS is going to reissue billions of dollars in tax refunds to cannabis companies. 

Personally, I don’t see the IRS saying “Well, I guess we were wrong.  Here’s all the tax dollars we took from you guys.  Sorry.”

There will likely be many court cases on the matter, but the IRS will probably argue that, since cannabis was classified under Schedule 1 at the time of dispute, it will be subject to 280E for that time period.

The only thing I can say with certainty is that, if and when rescheduling occurs, there will be many legal battles between corporations and the IRS, and it will take time before we know the answers to these pressing questions.

In Summary

Cannabis currently suffers from a terrible tax situation, but recent developments have given us reason to believe that things will change for the better.

Once cannabis businesses receive the tax treatment of most ordinary businesses in the United States, we will see massive decreases in taxable liabilities, which will boost the bottom line and balance sheet of most every business in the industry.

The specifics about what will happen are yet to be seen, but we will keep our eyes open and update you with any developments as they occur.  But whatever happens, I am optimistic that cannabis businesses will be better very soon.

And if you are looking for a CPA that can help you plan for rescheduling and beyond, feel free to free Strategy Session with me and we can discuss it😊

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Hope to hear from you soon,

— Jonathan Sussman CPA