Tax Reform and how it affects your Cannabis business

|Culter Posts

Here's how tax reform affects your cannabis business

During a recent call with a client, I was asked a question from a cannabis entrepreneur on how the new tax reform rules would affect his business.

He read about the Tax Cut and Jobs Act’s Section 199A Internal Revenue Code (IRC) deduction and wanted to know whether his cannabis businesses would benefit. 

The short answer is no.

Cannabis businesses won’t get the 199A deduction but some of the other tax reform changes may actually work in favor of a cannabis businesses if planned properly.

I’ll go into detail below, to discuss what parts of the tax reform changes won’t apply to cannabis businesses and what will.

What’s Section 199A and why can’t cannabis business take advantage of it?

Section 199A is the part of the tax reform changes that allows certain businesses to deduct 20% of it’s qualified business income.

But not for cannabis businesses.

Section 280E of the IRC is the reason why cannabis businesses won’t be able to benefit from the Section 199A deduction.

At its core, as long as cannabis is considered a Schedule I or II substance, Section 280E significantly limits the deductions and credits that a cannabis business can benefit from.

The limitations on what’s involved in the cost of goods sold calculations of most cannabis business models and the exclusion of the Section 199A deduction will continue to cause the cannabis businesses to have a higher effective tax rate compared to non cannabis businesses.

And although the IRS’s regulations and court guidance are silent regarding the Tax Cuts and Jobs Act’s treatment of cannabis businesses, it’ll be safe to assume that cannabis businesses won’t receive the 199A deduction unless the courts say otherwise.

Which tax reform changes should a cannabis business consider?

While cannabis businesses may not be able to take advantage of the Section 199A deduction, they may be able to benefit from the changes to how C corporations are taxed.

With the tax reform changes, C Corporations are taxed at a flat rate of 21% which makes the C Corporation an attractive entity for a cannabis business.

If you are in a tax bracket greater than 24 percent and operate a cannabis business you should strongly consider the C Corporation as your entity of choice.

Selecting a C Corporation for your cannabis business makes sense from a pure numbers perspective but as always you should have your CPA run the numbers for your specific situation. Be sure to compare all the available entity choices that meets your business model.

Don’t let the “phantom” income created by Section 280E create more of a tax bite for your cannabis business than necessary.

If you have questions, contact us and we’d be glad to provide you with a sanity check.

Rema Washington, CPA