By Rachel K Gillette , Partner and Chair of the Cannabis Practice Group, Greenspoon Marder
So how could this change possibly help lessen the burden of the very punitive (especially to retail cannabis businesses) Internal Revenue Code Section 280E? To answer that question, we need to go back to ancient history in the world of Cannabis – to the only cannabis tax court case containing any good news for the cannabis industry, Californians Helping to Alleviate Medical Problems Inc. v Commissioner, 128 T.C. 173 (2007), also known as The “CHAMP” Case. In CHAMP, the Court found that the taxpayer operated two separate trades or businesses, and therefore the business was able to allocate its expenses between its two businesses, one found to be trafficking and thus subject to 280E, and one not. Expenses allocated to the non-trafficking business were able to be deducted by the business “below the line”.
Now, while CHAMP remains good law, it was later distinguished by Olive vs. Commissioner, 139 T.C. 19, 42 (2012). There, it was found the marijuana dispensary derived all its revenue from marijuana sales and therefore, despite providing free activities to its patrons, the Court found it was a single trade or business trafficking in marijuana, and thus subject to 280E. Bummer.
Having represented dozens of marijuana businesses throughout audits, I know that the IRS will still accept—within reason – CHAMP allocations based on non-marijuana sales vs. marijuana sales. However, this depends greatly on the facts, circumstances, and often the business records of the business under audit. For example, if your cannabis business sells $1,000,000 in total, but $900,000 is cannabis and $100,000 is books or massage services, a 10% allocation of the overall deductible expenses is still possible.[1] The reality though is that most marijuana businesses sell a lot more cannabis than non-cannabis products, so sometimes the proportional income allocation is overall, rather meaningless.[2]
Enter Industrial Hemp[3] and hemp-derived CBD products, which as of January 1, 2020 may be sold in Colorado’s licensed cannabis Adult-Use Retail stores. As of December 2018, Industrial Hemp and products derived from Industrial Hemp were removed from the Controlled Substances Act and thus are no longer listed as Schedule I under the Controlled Substances Act (CSA) 21 U.S.C. 801 et seq. Thus, I.R.C. §280E does not apply to industrial hemp and hemp product resellers. Potentially, the sale of industrial hemp products in licensed cannabis retail stores could substantially impact a cannabis businesses’ ability to allocate greater expenses to non-trafficking activities. However, cannabis businesses should be thoughtful of how this presents itself on a cannabis business tax return and in financial statements.
Things to consider include:
1. How are non-cannabis products (e.g. hemp products and other non-cannabis products) tracked in the point of sale system? Should a separate POS be considered?
We will have to wait and see what true impact industrial hemp sales will have for Colorado’s cannabis retailers. There is a lot of competition out there.
For more information, please contact Rachel Gillette in the Denver office of Greenspoon Marder LLP at 303-665-0860 or Rachel.gillette@gmlaw.com.
[1] This does not always work if the “second trade or business” is merely sales of paraphernalia, as the IRS has argued this is “enhancing” the sale of cannabis, and not legitimately a “separate trade or business”. It would ultimately depend on the facts and circumstances.
[2] Bear in mind there could be alternative methods of allocation, but you should speak with your tax attorney or advisor before committing to a method.
[3] “Hemp” means the plant species Cannabis sativa L. and any part of that plant, including the seeds thereof and all derivatives, extracts, cannabinoids, isomers, acids, salts, and salts of isomers, whether growing or not, with a delta-9 tetrahydrocannabinol concentration of not more than 0.3 percent on a dry weight basis. See the 2018 Farm Bill.
