Beyond the incentive to bifurcate businesses, http://www.forbes.com/sites/anthonynitti/2012/10/25/the-top-ten-tax-cases-of-2012-10-the-irs-wages-war-with-the-medicinal-marijuana-industry/, tax Code section 280E creates an incentive to shift expenses into cost of goods sold, the only deduction it allows to state-legal marijuana business. This tax distortion is something its authors never thought about, I suppose. 280E didn’t get a lot of analysis as it sailed through Congress without objection in the first Reagan term.
We might shake our heads at 280E today. While that rule might make sense for something voters are really mad at like heroin, it’s crossing purposes with state law in Washington and Colorado (and the 16 or so medical marijuana states). States know how to collect taxes from mass production. Craft industry and small business are harder to tax — the restaurant industry is a notorious example. But 280E creates incentives to stay small. One example is the nondeductibility of advertising. Word of mouth is a staple of publicity for small business, and one substitute for advertising. Packaging may be another substitute.
I haven’t studied accounting since MBA school in the 70s, but I remember a few things.
Packaging is part of cost of goods sold. Marijuana businesses have a tax incentive to add value for the customer as part of packaging costs (rather than as non-deductible costs). I’ve just started thinking about cost of goods sold, but one way to shift costs might be to put information or messages that might ordinarily be used in advertising on the packaging. The information can be about anything, but it can’t be branded and it can’t go on the web; cute, clever, or informative, it has to go on the package. (Put it on the web, too, and there is cost splitting that could lead to an audit and even a lawsuit.)
To plan with this rule, from now on, maybe a taxpayer could collect information for customers, to put it not on the web but on the package. Would the research costs of gathering that information go into packaging, and thus cost of goods sold? Testing of the product can go into cost of goods sold, I would think, so packaging could go so far as to describe each batch offered for sale. (That creates jobs.)
Packages for valuable things sometimes are big, to discourage theft – look at the ugly, stiff clamshell for electronics. What about a long, stiff, recyclable piece of paper – maybe even as thin as shirt cardboard, loaded with entertaining material?
Another example: maybe labor costs for hand-done art on individual packages could support artists in a tax-deductible way. Those costs are for a product sold; they are not non-tax-deductible advertising, but the packages might give consumers a good feeling about the seller. They might become collector’s items. (Getting to the bottom of the idea barrel here?)
But here there be dragons: If material goes beyond packaging that adds value to the consumer and carries the brand of the seller, all bets are off. What about long, technical descriptions of a branded product?
Section 280E is strange new territory. Maybe other taxpayers in other contexts face similar distortions.
Some basics of CGS, From http://www.retailpackaging.com/blog/2009/06/book-keeping-and-packaging/:
When To Include Packaging In COGS
Perhaps you’ve recently purchased a series of antique china vases. To make these containers really get noticed on display you’ve adorned them with bow ribbons. In fact, the presentation generates so much interest for the vases that you include the bow with each purchase. In this instance, you would include the bow as a cost of goods sold.
Here’s another example involving florists. When designing a beautiful floral display, ribbons, cello and enclosure cards are an inseparable part of the total creation. Again, these items would be tallied in COGS.
In general, any packaging that is included as part of the final product will be counted toward COGS.
When To Count Packaging As A Marketing Expense
There are exceptions to including packaging as part of COGS. Lets take the previous florist example, this savvy business owner decides to include their logo on the stationary cards, and have the company name printed on the ribbons used to hold the bouquet together. In this case, these items would be counted as a marketing expense.
In general, any branded items such as gift boxes, paper bags or even printed ribbons should included as a marketing expense.