Are Tax Deductions Available for Cannabis Businesses?

 Posted on August 09, 2024 in Taxation Law

Owners of cannabis businesses face some unique challenges as they meet specific legal requirements related to cultivating, distributing, or selling marijuana. Business owners need to understand their tax obligations and whether certain types of deductions may be available to them. Navigating the complex tax landscape can be difficult, but with the help of an experienced tax attorney, business owners can take steps to address small business taxes and other types of taxes that may apply.

Federal Tax Limitations for Cannabis Businesses

While the state of California has legalized marijuana for medical and recreational use, cannabis is still classified as a Schedule I controlled substance by the federal government. This has limited the ability of cannabis business owners to claim deductions that would typically be available to businesses, while still requiring them to pay all applicable income and employment taxes. NOTE: Although in May 2024, the U.S. Department of Justice published a notice of proposed rulemaking to reschedule marijuana (cannabis) from a Schedule I controlled substance to Schedule III, this would only be a first step to easing federal restrictions on cannabis, and it may be a number of months or longer before there is any change to the current Schedule I classification.

Section 280E of the Internal Revenue Code limits the ability of cannabis businesses to claim deductions. Businesses that engage in the trafficking of Schedule I or Schedule II controlled substances, including marijuana, cannot deduct ordinary business expenses such as rent, utilities, or employee salaries. This limitation applies even if a business operates legally under state law. The result is a higher effective tax rate for cannabis businesses compared to businesses in other industries.

However, Section 280E does not bar cannabis businesses from using the cost of goods sold (COGS) to determine gross receipts for tax purposes. COGS may include the direct costs of producing goods, such as the purchase of raw materials, production labor, and shipping costs. By accurately tracking and allocating these costs, cannabis businesses can ensure that they are taxed correctly on the income they have earned.

California State Tax Requirements for Cannabis Businesses

Owners of cannabis businesses will also need to understand state tax requirements in California. Issues to consider include:

• Cannabis Excise Tax: All cannabis retailers in California must collect an excise tax from their customers. This tax is calculated as 15 percent of the gross receipts received from the retail sales of cannabis or cannabis products. These receipts include the sales price, any applicable fees (such as delivery fees or credit card processing fees), and the costs of any other items a customer is required to purchase, such as packaging. The excise tax is collected at the time of sale and must be reported and remitted to the California Department of Tax and Fee Administration (CDTFA).

• Sales and Use Taxes: Cannabis businesses are also required to collect and remit sales tax on their transactions. This tax applies to the retail sale of cannabis and cannabis products to customers, and it is calculated after excise taxes and local cannabis business taxes have been added to the sale. In addition to sales tax, businesses may be subject to use tax. This tax applies to items that are purchased without paying sales taxes and used within the state of California. For example, if a cannabis business sells a product that is about to expire for less than 50 percent of the product’s cost, sales taxes will not apply, but use taxes will apply based on the original purchase price of the product.

• Exemptions for Medical Cannabis: California provides some tax relief in situations where cannabis is provided to qualifying patients for medicinal use. Sales and use tax exemptions are available for medical cannabis transactions, but they are limited to qualified patients who hold a valid Medical Marijuana Identification Card issued by the California Department of Public Health. Businesses can claim deductions for sales and use taxes in these transactions, but they must meet record keeping requirements documenting the ID numbers of patients and invoices or other sales records.

Contact Our San Jose Business Tax Attorney

The tax obligations that apply to cannabis businesses can be complex, and business owners should be sure to understand their requirements under both federal and state laws. For businesses that may need to address tax issues or determine how to handle tax audits, the San Jose, CA business tax lawyer at John D. Teter Law Offices can provide effective legal help and representation. To learn how we can help address tax issues related to various types of businesses, contact us at 408-866-1810 and schedule a consultation.