This Outdated Tax Law Makes Turning a Profit Tough For D.C. Cannabis Businesses

Since 2015, Jen Brunenkant has been running Herbal Alternatives, a medical cannabis dispensary in Dupont Circle, one of D.C.’s most upscale neighborhoods. 

From a local perspective, her business is totally above board: D.C. legalized medical cannabis over a decade ago, and Brunenkant has a city-issued dispensary license.

So when tax season rolls around, Brunenkant does what legal businesses do: she sits down, crunches numbers, and files state and federal tax returns.

But unlike most businesses—such as the liquor store down the block, for example—she’s federally prohibited from writing off most operating expenses. That’s because, in the eyes of the federal government, Herbal Alternatives is selling a prohibited drug, making it subject to a somewhat obscure clause in federal tax laws.

Section 280E of the Internal Revenue Code prevents businesses that sell federally banned or “scheduled” drugs from deducting most expenses from their taxable income. The provision has become a thorn in the side of the cannabis industry, particularly for smaller businesses who are trying to turn a profit with limited access to capital.

It stipulates that “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 consists of trafficking in controlled substances.”

The provision grew out of a 1981 court case in which Jeffrey Edmonson, a convicted cocaine and methamphetamine dealer, sued the IRS for the right to deduct operating expenses from the taxes for his illegal drug business. 

Surprisingly, the court ruled in his favor, and Edmonson recovered his expenses. But one year later, the decision was overturned, and Congress passed 280E.

At the time, cannabis was banned across the country, so the law was at least consistent. But today, medical cannabis is legal in 36 states, leaving an awkward gap between state and federal tax laws. 

“It doesn’t matter whether you’re licensed in the state or not,” Brunenkant said. “From the federal standpoint, you’re an illegal operation.”

When it comes to federal taxes, she says, cannabis businesses get the short end of the stick. According to some experts, the effective tax rate for cannabis businesses fluctuates between 60% and 100% of profits –– roughly two or three times the rate for traditional businesses. 

Brunenkant said that it hurts her bottom line: “That liquor store is getting to write off all of their wages. They’re getting to write off all of their rent, all of their utilities, all of their expenses.”

There’s one small exception to the no-deductions rule: Even businesses that sell banned drugs can write off their costs of goods sold, or COGS for short. This includes the cost of the actual product, along with any materials or labor needed to create it—from shipping to packaging.

The COGS exception tends to benefit growers most because cultivation requires higher production costs, such as the labor needed to grow, trim, and package cannabis flower. Dispensaries, on the other hand, usually have more administrative costs, like paying for a receptionist, though those aren’t tax deductible expenses under 280E.

Brunenkant explained that some dispensaries minimize their taxes by purchasing cannabis in bulk and getting employees to package it, allowing them to deduct the labor as costs of goods.

“If you buy a lot of bulk products, and therefore your budtenders are almost primarily doing weighing, labeling, and packaging, then a good amount of your wage costs become part of costs of goods,” she said.

But the deductions only go so far. On top of high taxes, cannabis businesses are often denied basic financial services like loans, card processing, or even accounts. Most banks are unwilling to work with pot companies because they fear legal repercussions from federal authorities.

For that reason, patients at Herbal Alternatives can only pay in cash or use the shop’s ATM machine to wire money to the company’s account. 

“Not taking credit cards is a huge issue,” Brunenkant said.
Last week, Sen. Majority Leader Chuck Schumer unveiled a working draft of a bill to legalize cannabis at the federal level. The legislation would remove pot from the Controlled Substances Act, meaning that Section 280E would no longer apply to businesses that sell cannabis.

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