IBA, as the premier business brokerage firm in the Pacific Northwest, is firmly established as a respected professional service firm in the legal, accounting, banking, mergers & acquisitions, real estate, and financial planning communities.  Periodically, we will post guest blogs from professionals with knowledge to share for the good of owners of privately held companies & family businesses. The following blog article has been provided by David Belzer of Belzer Accountancy Corporation:

Cannabis: Thinking of ignoring Section 280E?  Think again.

There are some “cannabis accountants” and “cannabis attorneys” out there who are advising cannabis operators to ignore Internal Revenue Code Section 280E.

The rationale is based upon the following:

Section 280E restricts deductions for businesses trafficking controlled substances “within the meaning of Schedule I or II”. Because “federal findings have established that cannabis no longer meets the actual criteria of a Schedule I or II drug”, 280E should no longer apply – even ahead of formal, finalized rescheduling.

DON’T MAKE THIS MISTAKE.

CHALLENGING SECTION 280E CARRIES SUBSTANTIAL RISKS that every operator must weigh against their own risk tolerance:

Taking a “No 280E” position ahead of formal IRS approval creates a high probability of an IRS audit. If the IRS rejects the position, the business faces hefty back-taxes, accumulated interest, and accuracy-related penalties.

There is a risk of litigation. Operators must be financially and operationally prepared to take their case through administrative appeals or judicial review if the IRS contests the filings.

To willfully disregard Internal Revenue Code is a crime. This adds to the risk of loss in the event the position is disallowed.

Federal orders may be revoked or amended at the will of the DEA or other government agency.

IF YOU ARE DECIDING WHETHER TO CHALLENGE 280E on original filings or file protective claims for refunds, consider the following blueprint:

1. CONDUCT A STATUTE OF LIMITATION AUDIT: Review your past tax years to determine exactly when your windows to amend or claim refunds expire.
2. QUANTIFY THE RISK-REWARD RATIO: Run parallel tax simulations to calculate the exact dollar amount of your “phantom income” tax burden versus the potential cost of penalties and representation fees if audited.
3. ASSESS RELATED ENTITY FLOW: Ensure your financial foundation is entirely clean. The IRS heavily scrutinizes how activities and expenses flow across related entities, management companies, and individual stakeholders.

You don’t need to take aggressive, risky tax positions to KEEP YOUR CANNABIS PROFITS.  You simply have to employ PROVEN strategies to claim benefits unique to the cannabis industry.

The 280E tax structure can be used to BENEFIT the cannabis operator if properly treated:

• Restructuring officer compensation in order to lower applied tax rates. Pay dividends instead of wages.  Dividends are only taxed at 20% tax rate, not the 36.9% ordinary rate.  Officer wages in a cannabis company are not deductible anyway.
• Allocations of disallowed expenses using Section 263A, which requires a portion of overhead to be applied to cost of sales.
• Employing an S corporation employee stock option plan (ESOP) to shelter cannabis earnings AND TOTALLY AVOID INCOME TAX. An S corp ESOP plan creates a tax-exempt trust, to which company income flows and escapes taxation altogether.
• Employing a tax-free exchange (IRC Section 1042) to avoid taxation of distributions to owners. S corporations can convert to C status to gain this benefit. Stock received through an ESOP distribution can be exchanged tax-free for publicly traded stock.
• Maximizing depreciation deductions and attributing those to cost of sales. Component depreciation can be used for this.
• Use of related entities to isolate deductible expenses from nondeductible.

If you have questions relating to the content of this article, David Belzer would welcome the opportunity to connect. Mr. Belzer can be reached at (206) 825-6131 and [email protected].

IBA, the Pacific Northwest’s premier business brokerage firm since 1975, is available as an information resource to the media, business brokerage, mergers & acquisitions, and real estate communities on subjects relevant to the purchase & sale of privately held companies and family businesses.  IBA is recognized as one of the best business brokerage firms in the nation based on its long track record of successfully negotiating “win-win” business sale transactions in environments of full disclosure employing “best practices”.