The sweeping national trend toward the relaxation of cannabis prohibition laws at the state level continues to gain momentum in 2019, with Illinois recently becoming the 11th state to legalize recreational usage. Over the past several months, even the federal government has begun taking measured steps to loosen restrictions on the sale of cannabinoids (CBDs).
With broader societal acceptance, venture financing and public offerings (albeit generally in cannabis-friendly Canada) of cannabis and ancillary businesses has exploded in recent years. The introduction of equity investment has resulted in the need for audited financial statements, including a tax provision.
By now, almost every person in the cannabis industry is familiar with Section 280E of the Internal Revenue Code. Consisting of just one sentence and enacted during the “Just Say No” years of the early Reagan administration, this stipulation 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.” As a Schedule I substance, cannabis (other than CBD in certain cases) falls within this section. To date, no underlying regulations to Sec. 280E have been drafted.
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While the legalization of cannabis has created tremendous business opportunities, proper application of income tax accounting rules can prove challenging for the unwary. While effective tax rates are significantly higher than other industries, some of this impact may be mitigated with proactive tax planning.
