By: James Mann and Rachel Gillette
Owners of cannabis businesses that operate in pass-through form – LLCs, partnerships, sole proprietorships and S Corporations – need to consider if the new Section 199A deduction can partially offset deductions disallowed under Section 280E of the Internal Revenue Code. The Tax Cuts and Jobs Act passed last reduced the corporate tax rate from 35% to 21%. In order to keep a level playing field, a new deduction for owners of businesses operated in pass-through form received a compensating deduction, Section 199A. This deduction can be up to 20% of the taxable income from the business.
For owners of businesses affected by Section 280E, the idea is that the increase in taxable income that results from the disallowance of cannabis-related deductions also increases the amount of “Qualified Business Income” that is used as the basis for the new 20% deduction. To be sure, that still leaves 80% of the disallowed deductions to increase taxable income, but reducing the pain by 20% is significant.
The calculation of the Section 199A deduction is quite complicated, however – it starts with the lesser of:
20% of taxpayer’s qualified business income OR
The greater of:
- 50% of the taxpayer’s share of W-2 wages with respect to the business
OR
- 25% of the taxpayer’s share of W-2 wages with respect to the business plus 2.5% of the allocable share of the unadjusted basis of all qualified property (tangible personal property subject to depreciation and depreciable period is later of 10 years or regular straight line depreciation period, so 39 years in the case of a non-residential rental building)
There are numerous sub-calculations, but there are also opportunities for planning to maximize the deduction.
CONCLUSION
New Section 199A does not eliminate the punitive impact of Section 280E deduction disallowances, but it can lessen the pain sufficiently to make it worthwhile to investigate how it could help your tax burden.