Until today, the cannabis industry had little to look forward to when discussing IRC §280E and its draconian application. See Marijuana Taxation: 280E Ain’t Getting Better Anytime Soon and Marijuana Taxes: The IRS on Section 280E. Now Washington State producers, processors and retailers have some good news to consider regarding their 2014 tax return: IRC §280E does not apply to the three-tier Washington Marijuana Excise Tax (“MET”) as in effect through June 30, 2015.
This is because on July 31, 2015, the IRS Office of Chief Counsel issued an internal memorandum (“July Memo”) outlining how taxpayer’s should account for the State of Washington MET. The July Memo is not precedential but it does reveal how the IRS views the MET. Though in the July Memo, the IRS is taking an approach that seemingly sidesteps its own analysis offered earlier this year, their conclusion is favorable to Washington producers, processors and retailers and may offer an outline on how other states’ marijuana excise taxes could be treated for federal tax purposes.
It has been a long time since I have been able to put “IRS,” “favorable” and “marijuana” in the same sentence.
IRC §280E prevents a cannabis producer, processor or retailer from deducting costs incurred in conducting a trade or business unless those costs are considered a Cost of Goods Sold (COGS). As a consequence, marijuana businesses are required to determine what expenses are included in COGS. Until this July Memo, the IRS has offered no guidance regarding how any specific state’s marijuana excise tax would be treated for purposes of COGS or IRC §280E.
In the July Memo, the IRS interpreted IRC §164 addressing the deductibility of taxes. Specifically, IRC §164(a) identifies the following six types of federal, state and foreign taxes allowed as a deduction:
- Real Property Taxes
- Personal Property Taxes
- Income and Profit Taxes
- GST Taxes
- Environmental Taxes
- Motor Vehicle Taxes
IRC § 164(a) states that any taxes not described above, are deductible if paid or accrued …”in carrying on a trade or business” and further provides that “[n]otwithstanding the preceding sentence, any tax (not described in the first section) …paid or accrued … in connection with an acquisition or disposition of property, shall be treated … in the case of a disposition, as a reduction in the amount realized on the disposition”
The July Memo states that the MET is imposed “in connection with the disposition of property” and so for federal tax purposes, the amount of gross receipts is reduced by the amount of MET with the same economic consequences as if a deduction were allowed. Significantly, the Memo concludes that the MET is neither a cost to be considered included in COGS nor a deductible expense. Accordingly, IRC §280E and the regulations and guidance regarding COGS do not apply.
Beginning July 1, 2015, HB 2136 reconfigured the MET into a trust-fund tax imposed on the retail purchaser so that taxpayers no longer need to consider the deductibility of the MET for federal tax purposes.
In light of the July Memo, each state’s excise tax should be reviewed to determine the federal tax treatment under IRC §164. Such analysis may prove to be difficult. To encourage the development of the cannabis industry in their state, policymakers should consider restructuring the state’s excise tax in the form of a trust-fund tax to reduce uncertainty regarding the federal tax implications of their marijuana excise tax.