With the passage of the Compassionate Medical Cannabis Act (§381.986, Florida Statutes) in 2014 and Amendment 2, the Florida Medical Marijuana Legalization Initiative, this past November, Florida is entering the realm of legalized medical marijuana and poised to achieve significant growth in sales tax revenue. State projections of sales of medical marijuana and other cannabis-based products range from $138 million to $5.6 billion. State projections of tax revenue range from $8.3 million to $338 million.
However, under federal law, it remains illegal to sell or use any type of marijuana. While the Department of Justice has all but ceased prosecuting marijuana growers, dispensaries and retailers in states that have legalized marijuana, the IRS continues to wield its power when it comes to cannabis-based businesses. The IRS has a long and storied history of bringing down the infamous with seemingly mundane tax violations; i.e., Al Capone for tax evasion.
Ironically, while a medical marijuana business is illegal under federal law, it remains obligated to pay federal income tax on its taxable income because §61(a) of the Internal Revenue Code (“Code”) does not differentiate between income derived from legal sources or income derived from illegal ones. “Taxable Income” is determined as follows:
Gross Receipts – Cost of Goods Sold (COGS) = Gross Income
Gross Income – Allows Business Expense Deductions = Taxable Income
The concept of COGS is that a taxpayer has no gain in which the IRS can tax until the taxpayer recovers the economic investment the taxpayer has made into the product sold. In other words, businesses generally can deduct the costs of doing business and creating the product or service, like salaries, rent and materials, which generates the gross income of the business.
The problem for cannabis-based businesses is §280E of the Code. Section 280E, which was enacted by Congress in 1982 at the height of the “War on Drugs,” disallows the deduction of business expenses in carrying on a trade or business if such trade or business consists of trafficking in Schedule I or II controlled substances. Marijuana is a Schedule I controlled substance. Section 280E effectively requires cannabis-based businesses to pay taxes on gross income as opposed to net income, which results in much higher taxes than those taxpayers carrying on any other type of business.
There are ways to “soften” the blow of §280E through inventory and accounting methods, but until the federal law is consistent with state law in regards to the legalization of marijuana, cannabis-based businesses will always be in the crosshairs of the IRS and at a higher risk of audit.
This information is for guidance and reference purposes only. It is of a general and informational nature and should not be construed or relied upon as legal advice. Businesses and individuals facing decisions regarding federal and state statutes, regulations, and the interpretation of the law should consult directly with an attorney.
