Section 280E in Cannabis Taxes and AB 37 in California
The cannabis industry is exploding in California and many other states. Unfortunately, marijuana and cannabis remain unlawful controlled substances under federal law. The conflict between state and federal law creates a number of financial hurdles for California cannabis businesses, including with regard to banking, financing, and taxation, such as through Section 280E of the Internal Revenue Code (IRC). California has taken steps to aid cannabis businesses, at least under state law, including through the passage of Assembly Bill 37 in late 2019. Continue reading to learn about AB 37 and how it affected cannabis taxes in California, and contact a knowledgeable cannabis business attorney for help with compliance, startup issues, or expansion of a California cannabis enterprise.
What is Section 280E?
Section 280E of the Internal Revenue Code is a tax code provision specifically attacking businesses that traffic in “controlled substances,” including cannabis (at least until federal law changes). According to the section, businesses that traffic in controlled substances are not eligible to deduct ordinary business expenses on their tax returns. There is a limited exception for the cost of goods sold. The law was meant to prevent organized crime enterprises from benefiting from tax deductions. Now, the law continues to harm cannabis businesses, even where the cannabis industry operates legally under state law.
Until 2019, California’s tax law reflected the same exclusion on tax deductions for businesses trafficking in controlled substances. AB 37, effective January 1, 2020, changed California’s rules. Pursuant to the revised California tax code, cannabis enterprises licensed under MAUCRSA are now permitted to deduct ordinary and necessary business expenses on their California income tax returns.
What Businesses Can Benefit from AB 37?
Businesses properly licensed under MAUCRSA are permitted to take advantage of the new tax deductions. The provision applies to businesses licensed between January 1, 2020, and January 1, 2025, that would have been affected by Section 280E. Section 280E applied to California taxpayers operating under the Personal Income Tax (PIT) law, including individuals operating sole proprietorships, partnerships and partners, PIT investors in S-corporations, and LLCs treated as partnerships (as well as their members). Before AB 37, LLCs and other entities were unable to take these itemized deductions but corporations were eligible.
What Cannabis Businesses are Unaffected by AB37?
The law applies only to licensed cannabis enterprises under California law. Unlicensed businesses operating under the Personal Income Tax law are not covered by AB37, meaning that they still may only deduct the cost of goods sold from their state taxes. They may not deduct ordinary and business expenses.
Additionally, the IRC rule only applies to the California business structures identified above. Cannabis corporations operating under California’s Corporation Tax Law are not subject to Section 280E and thus were already permitted to deduct the cost of goods as well as ordinary business expenses.
Call a Dedicated California Cannabis Business Lawyer for Help With Your Marijuana Business
If you are facing cannabis taxation concerns in California, or if you are dealing with regulatory, licensing, or other legal issues with your hemp, CBD, or cannabis business in Los Angeles or Southern California, call McReynolds Vardanyan, LLP, in Glendale at 818-855-2115. Our California cannabis business lawyers will work with you to get your budding business off the ground efficiently, effectively, and legally.