States that have income taxes (not all do) and that legalize marijuana face an arcane income tax issue: 280E conformity. Simply put, should marijuana businesses, on their state income tax returns, be able to deduct all expenses? Federal section 280E, discussed a good bit at www.newrevenue.org, allows businesses in violation of federal narcotics laws to deduct only cost of goods sold – and not, for instance, selling expenses. Many state income tax laws track — conform to — the federal tax Code. That’s why, when you fill out a state tax return, much of the data you need to enter peels off the federal return.
In Oregon, before the 2014 marijuana initiative, state tax law conformed to 280E — it followed the federal tax Code. Then Measure 91 repealed the state’s version of 280E across the board. Now critics are saying repeal should apply only to marijuana – not to all federally illegal drugs, such as meth and heroin. Good catch, I suppose, so long as Oregon voters are mad at other drugs.
In California, there is 280E conformity for individuals but not for corporations. (Huh?) That is, California tax law tends to conform automatically for individuals, but not for corporations. I include below in 1. and 2. material explaining in laborious detail that conclusion. (I supply the elaboration, which I needed to to figure the situation out.)
Is that just an accident of history, or a quirk of California law? That’s what I gather from this editorial: http://caltax.org/homepage/110113_CA_Conformity.html, which says that California’s Constitution makes conformity tricky.
Anyway, there are a couple of policy questions: Does it make any sense to treat corporations better than individuals here? And should the industry’s predictable desire to repeal 280E completely be satisfied? (For what it’s worth, I’m interested in kind of a middle ground, suggesting that advertising and marketing expenses not be deductible. See pasted article in III. below.)
Background, if you need it:
- Conformity for individuals – no deductions
Here is section 17201, in the Individual Tax section: http://www.leginfo.ca.gov/cgi-bin/displaycode?section=rtc&group=17001-18000&file=17201-17299.9
- (a) Part VI of Subchapter B of Chapter 1 of Subtitle A of the Internal Revenue Code, relating to itemized deductions for individuals and corporations, shall apply, except as otherwise provided.
(b) Part VII of Subchapter B of Chapter 1 of Subtitle A of the Internal Revenue Code, relating to additional itemized deductions for individuals, shall apply, except as otherwise provided.
(c) Part IX of Subchapter B of Chapter 1 of Subtitle A of the Internal Revenue Code, relating to items not deductible, shall apply, except as otherwise provided.
Part IX, http://www.law.cornell.edu/uscode/text/26/subtitle-A/chapter-1/subchapter-B/part-IX, covers 280E — and much more.
So individuals can’t deduct 280E expenses.
2. Nonconformity for corporations
California corporate tax law, http://www.leginfo.ca.gov/cgi-bin/displaycode?section=rtc&group=24001-25000&file=24421-24449 conforms, for corporations, only with selected parts of Part IX, like 263A, 264, and 280H. 280E is not listed.
https://www.caltax.com/research/california-taxletter/uncategorized/medical-marijuana-can-cause-a-tax-headache has a long description. I’m excerpting, and italicizing some a few relevant parts:
Under California’s corporate tax law, California does not conform to IRC §280E. This means that a corporate taxpayer may, absent a determination that they are participating in drug trafficking (see below for discussion), be allowed full deductions for cost of goods sold and business expenses.
Thus, if a corporation is not determined to be participating in these activities through a formal proceeding, all deductions are allowed.
The same reading comes through in http://taxation.calbar.ca.gov/Taxation/Publications/CaliforniaJournalofTaxLitigation/2014ThirdQuarter.aspx
That ends the present law discussion.
III. Preliminary policy thoughts on 280E generally, not about corporate-individual issue:
Marijuana Advertising: The Federal Tax Stalemate
Lawyer; Former Congressional tax staffer
Posted: 08/25/2013 5:48 pm
“Marijuana Industry Eager to Pay Taxes — and Cash in on Deductions” says a recent McClatchy headline. There’s a conundrum: The state-legal marijuana industry (1) understands that a new federal excise tax would give it legitimacy, but (2) seeks repeal of the discriminatory Reagan-era statute saying that taxpayers “trafficking” in “narcotics” cannot deduct ordinary business expenses on their Federal income tax returns.
But that current no-tax-deduction rule makes marijuana advertising nondeductible – and that probably makes sense. For most proponents of marijuana legalization, advertising is a frill, not an essential. But for opponents of legalization, marijuana advertising is anathema.
Before looking at taxes, here’s the marijuana legalization story. Twenty states have legalized medical marijuana; Washington State and Colorado have also legalized recreational marijuana. All state-legal marijuana sales are made by private taxpayers. That’s because no state has copied the cautious state-store monopoly model that more than a dozen states use for liquor. That model, free of the profit motive, provides the least possible incentive for advertising — and it’s the model Uruguay is using for marijuana. But using the monopoly model would mean the state would sell marijuana itself and violate federal law — which continues to outlaw marijuana.
Now for taxes, starting with income taxes: Criminals, those who want to avoid the fate of Al Capone, know to pay taxes even on illegal income. But when marijuana sellers (whose tax returns might discreetly say their business is “Herbal products”) fill out their 1040s, they suffer a unique penalty: Federal Income Tax Code’s section 280E says taxpayers “trafficking in controlled substances” get “no deduction” for any expenses beyond the cost of producing or buying inventory. They can’t deduct perfectly normal selling expenses like travel, utilities, salaries, and advertising — or even state taxes or fees paid to comply with the law and to file tax returns.
280E came into the Tax Code in 1982 when the pendulum of opinion was swinging wildly in favor of the War on Drugs, and when the Reagan Administration was getting all the credit for being tough. Bob Dole’s Senate Finance Committee took notice of a Tax Court case that allowed a drug dealer to deduct travel expenses; without hearings, Congress passed 280E to make expenses of drug dealers nondeductible.
Other illegal activities — prostitution, gambling, gun-running — weren’t touched: There is no deduction disallowance for them. They can deduct all their expenses, just as you or I can. Congress singled out drug sellers in 1982 to prove that it, like the Reagan Administration, was really mad at drugs. So state-legal marijuana is now treated like the hardest drugs – and the marijuana industry says “the federal tax situation is the biggest threat” it faces.
Scholars suggest that 280E, singling out a single activity for punishment, is an aberration. But as a practical matter, 280E’s unique disincentive could make marijuana legalization more palatable to the public. Here’s how: Because 280E discourages advertising and marketing, it reduces the ability of the industry to increase marijuana use by creating demand. Opponents of legalization vehemently object to advertising of marijuana on the grounds that it will stoke demand and that it will influence children. By encumbering marijuana advertising and marketing with the burden of non-deductibility, 280E curtails that advertising. In a limited and inadvertent way, 280E moves the legalization debate toward a middle ground.
Opponents of marijuana are likely to find, as legalization progresses, that an outright ban on advertising of a federally legal product will face Constitutional free speech scrutiny. Even now, states figure than banning marijuana advertising violates freedom of speech clauses in their own Constitutions. But a tax deduction disallowance, unlike an advertising ban, creates no Constitutional problem. 280E does not ban advertising; it just makes it more expensive. More expensive sounds good: A peace settlement in one theater of the national War on Drugs could involve, among other things, (1) legalization of marijuana, (2) retention of 280E’s financial burden on advertising, and (3) imposition of whatever restrictions on advertising are Constitutionally permissible.
Still, the industry says 280E is broken — overbroad and discriminatory. So why not fix it?
This question is not just for the long term. Colorado’s legislature has already repealed the state tax law that copied 280E. Other legal-marijuana states whose tax rules conform to the Federal Code may want to follow Colorado’s lead.
What would a fix to 280E look like? While the industry would like repeal, maybe there’s a middle ground, drawing bright lines between (1) expenses that tend directly to stoke demand for marijuana (disfavored) and (2) expenses that are existentially necessary for the operation of the business (acceptable).
To start with, advertising expenses would still be disfavored. Meanwhile, other expenses seem both necessary and totally disconnected from demand creation — like a license fee paid to the state just for operating. Legal and accounting fees look acceptable, too (though lawyers and accountants sometimes stray into giving business advice).
But there are grey areas. Take rent, for instance. Retail space can be organized to stoke demand: The tobacco industry, banned from broadcast advertising, makes the experience of entering a convenience store a come-on. Square footage devoted to point-of-sale displays is professionally designed to entice buyers.
And what about salaries of retail clerks? Effective, motivated sales people can stoke demand. But legislators may be more concerned about creating jobs than about dampening demand for marijuana. So they could cap the tax deduction for pay to for sales people, say at the level of the minimum wage. That approach would tend to favor jobs — and spread them around. So pay for successful, high-priced salespeople could be only partly deductible — only up to $7.25 an hour, with the excess nondeductible. The possibilities are endless. A hodge-podge of rules reflecting conflicting policies — like much of today’s Tax Code – could result from an effort to fix 280E. So fixing 280E could prove too complicated.
How about the industry’s proposal for a federal excise tax on marijuana? Already, Washington State and Colorado will explicitly impose excise tax on sales of the substance at so many cents on the dollar. The industry hopes for a federal excise tax on marijuana only if the tax is part of a deal that includes simultaneous and explicit federal legalization. But politically, federal legalization won’t happen soon. There are too few Members of Congress willing to be seen helping the industry.
There’s a tangential issue: If a new federal excise tax is part of a package containing explicit legalization, objections could arise under decades-old multilateral narcotics treaties that require us to outlaw marijuana. But 280E now is a penalty consistent with illegality of marijuana, so 280E raises revenue but doesn’t violate treaties.
For now, Congress won’t repeal or repair 280E — Congress doesn’t want to give the marijuana industry a tax cut. But the industry is right about one thing: If 280E is repealed, a Federal excise tax on marijuana will take its place. That change could mean a higher tax burden overall for the industry — and loss of the useful anti-advertising bias of the law today.
The leading article I’ve found on conformity is by Ruth Mason: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2023413.
If you made it this far, you must be interested in 280E. I’m looking for a long post I had on that topic and deleted, months and months ago. If anyone copied it and can send it to me, I’ll be grateful.