How to Mitigate 280E

280E has a huge financial impact on the cannabis industry. To minimize that impact, businesses must take proactive steps to prepare for 280E mitigation. These recommendations alone cannot be relied upon to protect your business from the burden of 280E, but it’s a good start. Seek professional guidance to tailor rock-solid accounting procedures to fit your company.

Cannabis businesses face a plethora of challenges that must be tackled before becoming profitable. The most impactful challenge to the bottom line is 280E. Before learning how to mitigate 280E, it’s important to understand what it is. If you already have a basic understanding of 280E, skip to the numbered list.

What is 280E?

If you are a licensed cannabis business following state law, you are still trafficking a Schedule I controlled substance. Section 280E of the Internal Revenue Code states that if you’re in the business of trafficking a controlled substance, you cannot write off operating expenses like legal businesses. This means that the ONE thing you CAN write off is cost of goods sold (“COGS”). Being the one thing you can write off, it behooves you to allocate everything you (legally) can into COGS.

What can you allocate into COGS?

The cost of the actual product, or “inventory”, is included in COGS. Other production costs get allocated into the cost of inventory, and thus included in COGS as well. This means production costs are “inventoriable”. Production costs (generally) include the cost of getting the product to its customer-ready state. For the advanced explanation on inventoriable costs, review IRC Section 471 – General rule for inventories.

How do you show the IRS what your production costs are?

1.      Thorough documentation. Remember “if you didn’t document it, it didn’t happen”.The burden of proof falls on YOU if the IRS challenges any deductions. To protect yourself, you need documentation for every dollar you deduct. In addition, it can open the door to future tax breaks as your business grows or tax law changes.

 2.    Detailed time tracking. Whether you use timesheets, time-tracking apps, or an old-school punch card, employee time should be documented in detail if you want to allocate any of that time into COGS. Your time tracking must differentiate between time spent producing the inventory versus nondeductible time such as admin work.

 3.    Accurate floor plans. Rent is a big expense. If you have a cultivation that uses 80% of the square footage for growing cannabis, 80% of your rent is inventoriable. A clear and up-to-date floor plan will serve as evidence that there are designated areas for cannabis production.

4.      Record power consumption. Most cannabis businesses have a high utility bill. Cannabis businesses need to document how much of the utility spending is due to production costs. Similar to rent, you can deduct the portion used for production, but not the portion used for the back office, restrooms, etc.

5.      Keep your receipts. Production costs such as repairs, maintenance, lab testing, and supplies necessary for producing inventory may be deductible. While you should keep all receipts, it is particularly important to keep receipts for anything  deductible. Electronic copies are much easier to manage.

6.      Designate an expert. Some larger companies can handle 280E mitigation in-house. For most small to midsize companies that don’t have the need or financial resources for an in-house accounting department, investing in an outsourced expert pays itself back in multiples. Every cannabis business needs a trusted expert well-versed in 280E to properly set up and maintain its financial records to avoid overpaying in taxes or surprise tax liabilities.

The financial impact of 280E is significant. Proactive detailed record-keeping and cost allocation is crucial. A deficiency in this process will lead to an unexpected tax burden, which can be a business-ending mistake in the cannabis industry. Take the time to operate in a way that properly minimizes the impact of 280E. Your bottom line will thank you.

For expert advice on mitigating 280E, email Jim Vigland at 
jim.vigland@ viglandadvisors.com

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