The Capitalized Costs of Cannabis

In 1937, Congress ratified the Marijuana Tax Act which made it illegal under federal law to deal in the business of buying or selling cannabis. In recent years, states have passed legislation of their own that makes the dealing of cannabis legal for medical or recreational purposes. However, these states are still in violation of federal laws, which gives rise to some interesting tax implications, many of which leave cannabis business owners puzzled.

Many cannabis-related businesses believe that they are treated unjustly under the current law. They are not allowed to take deductions for “ordinary and necessary” business expenses, which businesses in other industries enjoy. Plaintiffs, such as Alpenglow Botanicals LLC, have argued that the Internal Revenue Code (IRC) is in violation of the Eighth and Sixteenth Amendments. The Court of Appeals for the Tenth Circuit, per Code Section 280E, upheld that business deductions are not allowable if the business consists of trafficking a controlled substance, including marijuana. In essence, the court determined that the IRS acted within their jurisdiction and no amendments were violated. Deductions are acts of legislative grace and may be allowed or disallowed as the IRS sees fit, with one exception being the cost of goods sold.

Cost of goods sold is a deduction from revenue to arrive at gross income. This is a deduction which is allowed for all businesses that sell inventory, regardless of the legality of the product being sold. From here, additional allowable deductions are taken to arrive at taxable income. With this in mind, cannabis-related businesses will be taxed on their gross income, meaning it will be imperative for these businesses to properly capitalize costs associated with their inventory.

Capitalizable costs differ greatly for resellers and producers of cannabis. If the marijuana is simply purchased, then the only deductible expenses are the specific purchase price of the product plus any costs to transport the product to the buyer. However, producers may also capitalize costs associated with the cultivation of their product, which includes, but is not limited to, cost of materials, wages of farmers, leasing of land, use of utilities in production, as well as many indirect expenses incurred during the production of the inventory.

Since many cannabis-related businesses also possess segments which operate completely legal activities, it may prove to be advantageous for them to identify each segment and create separate entities to maximize the deductibility of ordinary and necessary business expenses.

Contact Aprio’s Business Tax Services team today to connect with an experienced advisor. 
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