President Joe Biden just dropped the federal budget for 2024. The White House boldly claims that the tax plan will reduce the deficit by $3 trillion over the next 10 years. But several parts of the budget’s tax reforms are likely to significantly (and adversely) impact the cannabis industry. Today, I’ll analyze a few key provisions of the tax plan and why they will be significant.
First off, we can’t talk about cannabis industry tax issues without bringing up section 280E of the Internal Revenue Code, which states, “No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances (within the meaning of schedule I and II of the Controlled Substances Act) which is prohibited by Federal law or the law of any State in which such trade or business is conducted.” We’ve written about 280E many times, but most recently here, where we discussed some potential for 280E reform in 2o23. In pains us to state, however, that there was nothing of the sort in Biden’s tax plan. So that can has been kicked down the road…again.
Now let’s get into some of the key points in the tax plan. President Biden wants to raise the corporate tax rate across the board, and to increase capital gains taxes on certain wealthy individuals. This will undoubtedly make corporations a less desirable entity form for the cannabis industry. I’ll take these provisions one at a time.
The current corporate income tax rate is 21 percent. This was set by President Donald Trump with the Tax Cuts and Jobs Act, and as we noted when that law was passed:
The centerpiece of GOP tax reform is the reduction of tax rates. As we have written before, in determining the legal structure for your cannabis business, one choice is the C Corporation.
C Corporations pay tax at the corporate level. Individual shareholders are then taxed on dividends at a rate as high as 20%. In the past, this “double taxation” has discouraged the use of C corporations. The Act mitigates the problem of double taxation by reducing the C Corporate tax rate to 21%. The tax rate on dividends does not change under the new law.
President Biden’s tax plan proposes to increase the corporate income tax to 28 percent. While in his fact sheet, President Biden claims that this will “Revers[e] the Trump Tax Giveaway to Large Corporations,” this will increase the tax rate across the board. Whatever you may think about large corporations paying taxes, this will have an effect on small corporations as well. In the cannabis industry, where 280E and state regulators already pillage cannabis businesses with taxes, even a 7 percent increase is likely to make people move away from corporations as the entity of choice.
Additionally, as mentioned, President Biden wants to increase capital gains taxes for certain wealthy individuals. This is not likely to have an effect on the average cannabis business, though it could put limits on equity finance from wealthy investors. It is also likely to make corporations even less desirable since the “double taxation” would be much more severe for wealthy stockholders.
In addition, President Biden’s tax plan proposes to eliminate like-kind exchanges of real property. Here’s how the IRS presently describes like-kind exchanges:
Like-kind exchanges — when you exchange real property used for business or held as an investment solely for other business or investment property that is the same type or “like-kind” — have long been permitted under the Internal Revenue Code. Generally, if you make a like-kind exchange, you are not required to recognize a gain or loss under Internal Revenue Code Section 1031. If, as part of the exchange, you also receive other (not like-kind) property or money, you must recognize a gain to the extent of the other property and money received. You can’t recognize a loss.
Under the Tax Cuts and Jobs Act, Section 1031 now applies only to exchanges of real property and not to exchanges of personal or intangible property.
This proposal comes at a time when the real estate industry is already in a crunch, and this is not likely to help. If the tax plan becomes law, the lack of like-kind exchanges will mean that there will be one less tax benefit. Again, this will have a significant impact on the cannabis industry given the precarious nature of tax policy in the industry.
The bottom line is that so long as 280E exists, any tax reform that increases taxes will unduly impact the cannabis industry. It is time that the federal government does something about 280E now but, unfortunately, I don’t see that happening any time soon. In the meantime, Congressional Republicans are very unlikely to allow Biden’s tax plan to proceed as written, so there’s some possibility of negotiations.
Stay tuned to the Canna Law Blog for more updates on Biden’s tax plan and how it will impact the cannabis industry.