Most cannabis businesses are aware of the federal tax implications surrounding this industry. In addition, Internal Revenue Code 280E is not going away anytime soon. That said, many accounting professionals encounter different “strategies” to overcome this vexing tax code.
Champ v. Commissioner
The most famous court case was Californians Helping to Alleviate Medical Problems Inc (CHAMP) v. Commissioner. An audit of their 2002 Federal income tax return determined that they had a tax deficiency of $355,056 and an accuracy-related penalty of $71,011. CHAMP operated as a non-profit and did not have Federal tax exempt status. They also operated with a dual purpose. They provided caregiving services to its members and provided its members with medical marijuana under California’s Compassionate Use Act of 1996. Each member paid a membership fee for the right to receive caregiving services and medical marijuana. 47% of their members suffered from AIDS. The remainder had cancer, multiple sclerosis, and other serious illnesses.
The IRS determined CHAMP had only one business. CHAMP responded that they had two businesses — providing caregiving services and supplying medical marijuana to its members. After much legislation, the tax court determined that CHAMP in fact had two separate businesses. This is because their caregiving services were extensive. Services included group therapy, distributing food and hygiene products, and coordinating social events and field trips. The caregiving business stood on its own, separate and apart from providing medical marijuana. This allowed CHAMP to deduct ordinary and necessary business expenses, regardless of IRC 280E.
Since this successful ruling, many cannabis businesses applied the two business model strategy. However, unfortunately there were many tax court cases where the strategy failed miserably.
The Farm Bill
In late 2018, the Farm Bill passed, which did many things. Most importantly for the cannabis industry, it legalized the production of hemp as an agricultural commodity. In addition, the Farm Bill removed hemp production from the Controlled Substances Act. The federally legal limit of THC in CBD products is 0.3%. A CBD line of products in a cannabis business is a great example of running a business completely separate from the sale of marijuana products.
Bison Extracts
Bison Extracts, located in Tulsa, OK is one of the many companies implementing this strategy. After a few years of building a rock solid brand and providing a high quality product, Bison Extracts launched its CBD line known as Bison Hemp Extracts.
Creating the CBD brand allowed Bison Extracts to deduct any advertising, legal, and administrative-related salaries and expenses in relation to their CBD business. These are typically lost expenses in a business that only sells marijuana.
Implementing This Strategy
Red Bud Advisors say this strategy is also available for implementation in dispensaries that unfortunately are often hit the hardest by IRC 280E. Below are a few tips to implement this strategy:
- If you operate a separate line of business — treat it as such. Keep separate books and records.
- Have a completely separate area in the store/display for the high THC products.
- The products cannot benefit from the other. For instance, having a second line of business that only sells your branded merchandise equates to advertising and promoting the sale of your THC products.
- Income is a must. This seems obvious, but without income, it is not a viable second business.
In addition to the cost of CBD products being tax deductible, you reap the tax benefit of picking up other deductible expenses. These are related to the advertising expense of CBD, some overhead expenses like rent, and utilities that would otherwise be lost in a THC-only dispensary.
In addition to the tax benefits, this strategy is effective for some customers that are new to exploring the THC world. Many new patients start with CBD and then move to higher THC products, as they determine what matches their medical needs. This helps with future market development — something we believe is a key element when you look to sell your business.
The Bottom Line
Accurate and contemporaneous record keeping is critically important if you own a cannabis business. IRC 280E is still very much in play, and the IRS denies all of your non-COG deductions if the strategy described above is not implemented properly. It is important to have an accountant that truly understands the cannabis industry and its nuances and that has your best interests in mind.
