The Internal Revenue Service (IRS) has issued a stern warning to marijuana businesses attempting to sidestep federal tax rules. The agency highlighted misuse of a supplementary form by cannabis companies trying to claim deductions they are not entitled to under the restrictive Section 280E of the tax code. This provision prohibits deductions related to activities involving federally controlled substances, including marijuana.
The notice underscores the agency’s intent to tighten oversight on an industry already grappling with complex tax compliance challenges.
What Is Section 280E, and Why Does It Matter?
Section 280E is a federal tax provision that prevents businesses dealing with Schedule I or II substances, such as marijuana, from deducting expenses related to their operations. This rule applies even to cannabis businesses operating legally under state laws.
The regulation stems from a decades-old court case involving a drug dealer. Although its enforcement might seem out of step with today’s expanding legal cannabis market, the law remains in force. It results in significantly higher federal tax burdens for marijuana companies compared to businesses in other industries.
The cannabis industry has long called for reforms to 280E, arguing that it creates unfair economic strain. While the Biden administration’s recent efforts to reschedule marijuana as a Schedule III drug could alleviate some of this burden, the process is far from complete.
IRS Flags Misuse of Form 8275
The IRS notice reveals that some cannabis companies have been using Form 8275, a disclosure form meant to report questionable or unusual tax positions, to justify deductions barred by 280E. The form is designed to help taxpayers avoid certain penalties by disclosing positions that might otherwise not be reported correctly on a tax return.
However, the IRS clarified that to qualify for relief using Form 8275, businesses must meet a “reasonable basis” standard. This standard requires a higher level of justification than simply avoiding frivolous claims. The agency stressed that marijuana companies attempting to bypass 280E through such filings lack the required basis, making their actions improper.
Cannabis Businesses Caught in a Legal Limbo
The cannabis industry’s frustration with 280E is not new. The federal tax burden disproportionately affects marijuana businesses, even in states where cannabis is fully legal. Multi-state operators have sought refunds for alleged overpayments in the past, but federal tax relief remains elusive.
The IRS reiterated in its notice that 280E does not prohibit businesses from calculating their gross income based on the cost of goods sold (COGS). This distinction allows some level of expense reduction, but it is far from the relief most cannabis businesses need.
State-Level Tax Relief: A Patchwork Solution
While federal rules remain unchanged, several states have taken steps to mitigate the effects of 280E on local cannabis operators. By allowing state-level deductions, these measures aim to provide partial relief. However, the inconsistency between federal and state tax laws continues to pose challenges for marijuana businesses, especially multi-state operators.
The broader cannabis industry hopes that the Biden administration’s push to reclassify marijuana as a Schedule III drug will address these issues. If successful, the rescheduling would allow marijuana businesses to access federal tax deductions previously unavailable under 280E.
Legislative and Administrative Action on the Horizon?
Efforts to reform 280E have been ongoing. Last year, Rep. Earl Blumenauer (D-OR) reintroduced a bill to amend the IRS code, enabling state-legal marijuana businesses to take standard deductions. While the proposal aligns with industry demands, it faces significant hurdles in a divided Congress.
The IRS, for its part, has faced criticism for insufficient guidance to marijuana businesses. A 2020 report from the Treasury Department’s inspector general for tax administration called on the agency to better educate cannabis companies about compliance. In response, the IRS updated its guidance, clarifying the rules around COGS and deductions. However, the recent notice suggests the agency remains unsatisfied with compliance levels.
Industry Implications and Next Steps
For cannabis operators, the latest IRS notice is a clear signal to tread carefully. Misusing Form 8275 to claim improper deductions can result in penalties, further compounding financial challenges. The agency’s emphasis on “reasonable basis” highlights the need for businesses to consult tax professionals to ensure compliance.
At the same time, the cannabis industry continues to advocate for reforms at both the state and federal levels. With federal rescheduling discussions underway and growing state-level tax relief measures, the landscape could shift in the coming years. However, until substantive changes occur, businesses must navigate a regulatory minefield.
For now, one thing is clear: the IRS is watching closely, and marijuana companies cannot afford to take shortcuts.
