Chevron’s End Can Help Cannabis Firms Use Tax Code Favorably
Cannabis accounting experts assess Chevron impact on business
Firms may be able to challenge some tax code interpretations
The US Supreme Court’s June decision in Loper Bright Enterprises v. Raimondo offers immediate support for cannabis companies and their advisers to challenge IRS interpretations of Section 471(c) of the Internal Revenue Code. With the elimination of Chevron deference to agencies when laws are ambiguous, cannabis companies may be in a stronger position to use this tax code section to mitigate the onerous tax consequences of Section 280E.
Section 280E disallows deductions and credits for expenditures connected with illegal sale of drugs, requiring most cannabis businesses to add back such significant expenses as rent and wages for sales staff when calculating their federal income tax. The only expenditures that have been deductible for cannabis companies have been those related to cost of goods sold.
While some states have decoupled from 280E, allowing their cannabis companies full deductions on the state level, the predominant tax burden from that section is federal and is the main reason marijuana businesses have paid over $2 billion more in federal taxes compared to businesses in other sectors. It also helps explain why approximately 75% of cannabis businesses currently operate without a profit.
This has been especially problematic for cannabis dispensaries and delivery service retailers, which have a much larger portion of their expenditures devoted to sales and general and administrative expenses compared with cultivation or manufacturing companies. Section 471(c) has been used by some cannabis tax practitioners to allocate a greater portion of those expenditures to cost of goods.
Section 471(c), added by Tax Cuts and Jobs Act in 2017, provides an exemption for small businesses with yearly gross receipts under $30 million as of 2024 when determining inventory accounting methods for tax purposes. Under 471(c), small businesses can treat inventory for tax purposes the same way they do in their financial statements or books and records.
If their tax return agrees with their accounting records, a qualifying cannabis business can capitalize much more overhead, including payroll and facility-related costs such as rent, thereby increasing their cost of goods sold and reducing their tax burden under 280E.
While some accountants and tax attorneys have found success with this method, many others have been unwilling to use it due to its perception as too aggressive. Even those that have used it successfully have been more cautious in their application to avoid kicking the hornet’s nest.
In January 2021, the IRS pushed back on this approach with a regulation that said, in part, “nothing in Section 471(c) permits the deduction or recovery of any cost that a taxpayer is otherwise precluded from deducting or recovering under any other provision in the Code or Regulations.” The battle lines are clearly drawn with tax court the future field of combat.
Tax Opportunities
In its decision in Loper Bright, the Supreme Court removed a doctrine that has guided court decisions regarding administrative actions for the last 40 years, rolling back judicial deference to some agency rules.
Initial legal analysis of the decision is mixed, with some experts suggesting there will be more challenges to some tax regulations, potential additional IRS struggles, and more rulemaking complications. Many tax specialists agree, however, that any preexisting resistance to challenging IRS interpretation of the tax code has been lessened since the problems created by Chevron deference have been removed.
This is good news for cannabis companies and their advisers. Cannabis businesses now may have a stronger position to challenge IRS interpretations of 471(c) which they believe are overly restrictive or unfair. Tax courts will no longer automatically side with the IRS’s interpretation, potentially leading to more favorable outcomes for these businesses.
Action Items
Cannabis companies and their advisers looking to use 471(c) need to get their books in order, making sure they reflect the movement of expenditures into cost of goods sold in a manner that mirrors the deductions shown on the tax return. Those businesses must be ready for an audit and be able to substantiate the existence of every claimed expense.
Beyond this, the amount and type of expenses capitalized into cost of goods sold must be arrived at by discussion between the cannabis business and its adviser.
The tax and legal landscape surrounding cannabis has shifted following the Drug Enforcement Administration’s April decision to begin the process of reclassifying cannabis to a less dangerous controlled substance. This bodes well for cannabis’s tax status in the long term.
And although Loper Bright doesn’t directly address Section 471(c), its principles align with the need for clear accounting practices, which can benefit cannabis companies seeking fair treatment under tax laws. Consulting a tax professional in this situation can help businesses get sound financial advice.
Author Information
Abraham Finberg is principal at AB Fin and has worked in the cannabis sector since 2009, counseling clients in all phases of business advisory and tax.
Simon Menkes supports accounting firms, their clients, and advisers through accounting and advisory services.
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Reproduced with permission. Published Aug. 9, 2024, 4:30 AM EDT. Copyright 2024 Bloomberg Industry Group 800-372-1033. For further use please visit https://www.bloombergindustry.com/copyright-and-usage-guidelines-copyright/
