The following is our response to the Sponsoring Offices’ request for comment on The Cannabis Administration & Opportunity Act, specifically, “considerations related to the non-application IRC 280E, including transition rules and interactions with tax incentives for activities that may have occurred while a business was subject to the limitations on credits and deductions.” This response was prepared by a Certified Public Accounting firm specializing in state legal cannabis businesses since 2013. Our firm provides bookkeeping assistance, tax preparation, and advisory services. Our clients are true small businesses; the majority having gross receipts of less than three million USD.
As professionals working with the cannabis industry, we are extremely concerned about the impacts 280E has had, and continues to have on businesses. The ability of current state legal businesses to compete in the market has been effectively restricted, as intended, by 280E. Once 280E is lifted, these same business will be severely compromised by their existing heavy tax debt imposed under 280E. As new competitors flood into the marketplace without the constraints of 280E or its resultant tax debts, the existing businesses (most of whom are very small) will be unable to survive. Before leveling more taxes on this industry – by way of an excise tax or other methodology– it is incumbent on lawmakers to address the crippling tax burden 280E has inflicted on existing tax-compliant cannabis businesses.
We have worked with many cannabis businesses unable to overcome the taxation levied due to the application of 280E. When we see businesses remain operational while filing taxes, they do that in exchange for not expanding, not hiring at living wages or benefits and not having cash flow to deal with emergencies. They are left with large tax debts; perpetually paying on installment plans because they do not have the funds available to pay the tax in full. Every year they are able to keep their doors open, their tax debts grow. 280E creates an outcome that has led many businesses to choose to either operate in the untaxed legacy market, or be forced to go out of business altogether.
To provide lawmakers with a better understanding of the tax implications, the table below illustrates a comparison between a non-cannabis C-Corp and a cannabis C-Corp subject to 280E.
The cannabis C-Corp, just like the non-cannabis C-Corp has $100,000 of net income. However, because of the application of 280E, the cannabis company is taxed at gross profit rather than net income. This produces a tax bill of $294,000. 280E disconnects the cash flows and economic reality of the business from its taxation obligation. The taxes due cannot be paid by the net income the business generated in that tax year. Due to their lack of resources, they will be unable to pay in full. This scenario repeats yearly as the cannabis business fights to continue as a going concern.
This taxation regime incentivizes cannabis operators to remain in the untaxed, illicit market and will continue to do so if sensible legislation is not enacted. Change is needed to both correct the prior tax debts created by 280E and incentivize the continuing illicit market to become tax compliant. In addition, protections must be put in place for small US businesses to not be overrun by foreign cannabis producing conglomerates, who will be operating without existing 280E tax debts and whose costs of production are significantly lower than domestically-created cannabis.
Considerations to create an equitable post-280E landscape:
The comparison above underscores the challenges that existing cannabis businesses will face on day 1 of legalization. They will face a distinct disadvantage because businesses with large outstanding tax debt will have a difficult time obtaining financing and attracting investors. Whereas businesses who open on day one of legalization will not face such obstacles. This disparity must be addressed so the small, “Mom & Pop” shops, the industry trailblazers, and the industry knowledge-holders are not driven out of business or pushed into the illicit untaxed market. The playing field needs to be retrospectively leveled for the existing businesses that have been abiding by the tax rules when we take 280E off the table. We must not leave existing businesses with an unfair disadvantage when compared with businesses who enter the industry after 280E is no longer applicable to cannabis.
In the options below, we have provided some solutions to address the disadvantages:
a) Allow businesses to amend previously filed federal returns to remove 280E during the period of time when the business had state licensure for either medical or recreational cannabis.
I. Taxpayers owed a tax refund after amendment: In an ideal world, all taxes paid above what would have been owed if 280E had not been applied, would be refunded to the taxpayer. Because these funds have already been spent, it may not be feasible to offer refunds. An alternative to a refund of prior taxes paid would be to offer tax credits going forward to offset future tax burdens.
II. Taxpayers owing tax after amendment: Provide businesses who still owe after amendment the ability to offer and compromise their remaining outstanding taxes due.
b) If allowing amendment back to the beginning of state legal operations is objectionable, a three-years-back amendment time-frame should be applied. This would still provide some relief to existing businesses and would help to create a more level and equitable playing field.
c) If (a) and (b) are objectionable, at a minimum, allow businesses to amend and include the cost of labor, including payroll taxes paid, as a deductible expense. This expense has already been subjected to payroll taxes and will further be subjected to income tax at the individual level.
Considerations to bring the untaxed market into tax compliance:
It is crucial to understand and to address the effect 280E has had in encouraging businesses to not file taxes. Those who are currently operating outside of the taxed market are not going to come forward willingly if doing so means they will be taxed out of existence. Under the current proposal, which would institute an excise tax in addition to income tax requirements, the illicit, untaxed operators will not be incentivized to enter the taxed market.
In our opinion, the solution to bring this group into compliance is to offer a safe harbor that would encourage them to file back taxes and enter the taxed market. The Government has used safe harbors before to entice taxpayers to behave a certain way or to ease the burden on a small taxpayer. We propose that the safe harbor in this situation would give untaxed cannabis businesses three years in which to file their back taxes to date. They would file in the same manner provided above for current taxed cannabis businesses. The safe harbor would waive or reduce penalties and interest associated with those back filings, including the 1040s associated with its owners for Schedule Cs and K-1s. Once these businesses enter the taxed market, the solution to keep them there – along with all other cannabis businesses – is to make sure that the market will not be subjected to substantial, oppressive taxation. Under the current proposal, cannabis businesses would be subjected to income tax, excise tax and potentially state and local sales taxes, effectively taxing them to death.
Without the implementation of thoughtful legislation around taxation, the resulting tax laws will have unintended, negative and counterproductive consequences. We believe our proposals above regarding the equitable treatment of cannabis businesses once 280E is no longer applicable, and the opportunity to bring the untaxed market into compliance will put existing businesses on a level playing field with businesses across other industries, and with businesses who will enter the market in a post 280E landscape.