199A Meets 280E – Cannabis Biz and the New Tax Act
Here we go – the Tax Cuts and Jobs Act signed in December 2017 allows (with limitations and restrictions) pass through entities to take a 20% deduction of their net reportable income as a deduction – this is known as “Section 199A”. A simplified version of the Tax Code would just leave it there. But this is no simple Tax Act, with it comes a whole slew of new and currently unanswered issues.
For instance, with regards to state legal cannabis business’ the tax code also says the following (known as code section 280E):
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.
The key words there are “No deduction or credit shall be allowed.” This has so many implications, many of which are discussed in sections of the CannaTax and Compliance blog. However, the recent tax reform signed in December 2017 has created more questions that need to be addressed for regular, non-trafficking business’ as well as an uncomfortable vagueness in particular for Cannabis business
As always, I need to remind all reading this that Marijuana is a Schedule 1 substance under the Controlled Substance Act and as such it is illegal under federal law. However, since the law also requires that people report all of their income whether from illicit sources or not, and since every situation is different for different taxpayers we want to point out the difficulties of the laws and what you need to consider to be as compliant as you can be.
The new Code section 199A in the new tax reform act, in general, allows a 20% deduction of net profit of “qualified business income” from certain businesses considered to be “Pass Through” entities, under certain limitations. A Pass Through is a business who pays taxes through its owners personal tax returns, in this case a sole proprietor or LLC or S-Corporation. I’ve read many tax professionals analysis’ that speak as though this deduction will apply. However, the IRS scrutinizes the businesses very aggressively in audits and have determined that certain policies like the Domestic Production Activities Deduction is disallowed as is bonus depreciation. There is a very strong argument being made that, without further guidance from the IRS (who is loathe to produce guidance of any sort in these types of business’), pass through entities should not expect to be able to deduct any portion of their income under the new IRC section 199A. Given the amount of money that this entails, I would say err on the side of caution because guessing wrong will be very costly if your deduction gets disallowed, but could be corrected if the evidence shows otherwise.
Of course, another option may be to be treated as a C-Corporation which pays its own taxes. There is a flat corporate tax of 21% (with some caveats of course) no matter what the business.
There is no “one size fits all” in anything tax, but the outcomes in the Cannabis Industry can be more costly than most. Feel free to contact CannaTax and Compliance to schedule an appointment to discussthese issues as they pertain to your specific circumstances.