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The Dichotomy of Cannabis Taxation

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Cannabis has become the new gold rush.

Its use is legal, either medicinally or recreationally, in several states and the District of Columbia. However, marijuana is still an illegal Schedule I narcotic at the federal level. As such, the taxation of state-legalized cannabis companies is complex.

In 1982, Congress instituted Section 280E, which states:

No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances (within the meaning of schedule I and II of the Controlled Substances Act) which is prohibited by Federal law or the law of any State in which such trade or business is conducted.

What this law means is that a cannabis company can only deduct its cost of goods sold (COGS). There are several methods that can be employed to arrive at COGS; however, they are not the focus of this article.

The states that have made cannabis legal are following the federal guidelines on taxation. For example, say you are a cannabis cultivator in California. When you file your state tax return, you are prohibited from deducting any expenses. The only amounts you can deduct are those that make up COGS.

In January, the State of New Jersey amended its tax laws to allow the deduction of expenses for those in the cannabis industry. However, other states have been reluctant to do so. Why?

Well, on one hand, the states that have legalized cannabis are saying it is legal to buy, sell and possess, but it’s illegal for sellers to deduct expenses. This is one area of tax law that needs to be changed: You can’t say something is legal and then state that it isn’t when it comes to filing income taxes.

In states where cannabis is recreationally legal, there are many taxes imposed on its sale and distribution. However, when it comes to income taxation, it is almost as if the state is double dipping in its collection of taxes from this industry. This can lead to many cannabis companies closing up shop and going out of business because of the taxes they have to pay.

To the states that have made cannabis legal, I say this: You can’t have it both ways. You can’t say on one hand that the sale, distribution, and possession of cannabis is legal, and then on the other that when it comes to income taxation, you are following federal guidelines. This is completely hypocritical.

What is the remedy? I think it’s very simple. If you are filing income taxes for a cannabis business at the state level, simply deduct all of the expenses. However, be prepared for a fight. Currently, I am fighting with four states over this unfair practice. Why is the sale of cannabis different from any other business?

There is nothing new with states following federal guidelines when it comes to income taxation. However, in the case of cannabis, there needs to be an exception. The only reason it is treated the way it is for federal income tax is because of Section 280E. In states where cannabis has been legalized, it is not considered an illegal practice to sell or distribute the drug. I applaud the actions of New Jersey and hope other states join in.

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