280E tax credit refund
280E tax credit refund

Cannabis Companies Could Be Sitting on Billions of Dollars in Tax Refund Credits from the IRS if 280E Gets Eliminated

The 280E Tax Credit is a dream that many companies have been banking on for their future survival!

Posted by:
Nanci Chi-Town on Tuesday Oct 10, 2023

tax credit refund for 280E

Did the cannabis company thread the needle on paying federal taxes to the US government?  As Cannabis.net wrote up in their summary of the Benzinga Cannabis Conference in Miami, many cannnabis companies weren't paying their federal taxes, hence propping up their reported profits.  Why weren't they paying their taxes?  Two fold, one being they didn't have the money, and two, they were hoping that with federa legalization and the removal of the 280E code, they could go to court and argue they should have never been paying those taxes since cannabis is now legal.  It was a risky strategy, stiffing the IRS year after year and hoping for federal legalization.

But did that "kick the can" strategy actually work?

MJ BIZ recently picked up on this idea and continued the discussion online for the cannabis industry. A combination of tax strategies can assist cannabis companies in alleviating their tax burden by Section 280E of the federal tax code. If recent legal precedent is applied fairly, the cannabis industry may have access to substantial unclaimed federal tax refunds.

One such strategy, which Nick Richards refers to as the "280E asset method," finds support in long-standing case law and a recent ruling by a federal claims court that prohibited the recognition of deductions as the basis.


Basis, in this context, pertains to the investment made by a business owner in their enterprise and the corresponding investment made by the company in its assets. To illustrate, if a taxpayer purchases an airplane for $1 million and sells it for $1.5 million immediately, the basis would be $1 million, resulting in a gain of $500,000.


The 280E asset accepts that Section 280E prohibits the deduction of costs that cannot be recognized as cost of goods sold (COGS). It also posits that 280E cannot permanently disallow the recognition of ordinary and necessary business expenses.


Under this theory, 280E expenses cannot be deducted in the year incurred. Still, they must be allowed as basis in the business or its assets and recognized on exit (when the company is sold) or when permitted under the taxpayer's accounting method (more on later).

U.S. tax law provides that if costs such as depreciation are deducted during the life of a business, you can't recoup them (again) on exit.

Case Law in Action

In the case of CBS Corp. & Subsidiaries v. U.S., the federal claims court established a precedent that disallowed expenses, similar to Section 280E expenses, had to be acknowledged and allowed as a basis. This recognition served to reduce the taxable gain upon exit.


In this case, the specific expenses under consideration pertained to the depreciation of an airplane leased to a foreign commercial airline. At the time, U.S. tax law stipulated that 30% of foreign source income was exempt from taxation, while an equivalent 30% of deductions were disallowed, mirroring the provisions of Section 280E. In response to this tax law, CBS Corp. adhered to it by depreciating only 70% of the airplane's value.


In the CBS Corp. & Subsidiaries v. U.S. case, the central question revolved around whether the taxpayer had the right to reduce its gain on the sale of the airplane by 30%, which had not been depreciated throughout the business's operation.

The IRS argued in court that the airplane should be treated as two distinct types of property – one for which deductions were permitted and another for which deductions were categorically disallowed, akin to the treatment of cannabis businesses under Section 280E.

However, the court did not concur with the IRS's stance. Instead, it held that the disallowed deductions for ordinary and necessary business expenses resulted in "erroneously inflated gains," thus justifying the taxpayer's claim for a tax refund.


The marijuana industry is quite familiar with the problem of "erroneous inflated gains" resulting from Section 280E. However, up to this point, there have been few instances of refunds within the industry.


Suppose the precedent set by the CBS Corp. case applies to the cannabis industry. In that case, it implies that there could potentially be millions of dollars in federal tax refunds available to cannabis companies and their owners upon exit from the business. This could have significant financial implications and benefits for those operating in the cannabis sector, as it would relieve the burden of excessive taxation under Section 280E.

Prepare for Partisans

When cannabis companies seek refunds for expenses related to Section 280E, they may encounter opposition based on a counterargument. This counter argument asserts that since the IRS has the authority to permanently disallow deductions for certain expenses like bribes, personal fees, and meals, it can also permanently disallow deductions under 280E.


In the CBS case, the IRS presented a similar argument and cited previous instances where deductions for the personal-use portion of airplanes were permanently denied. However, the court distinguished these cases as "inappropriate" because they primarily involved the disallowance of personal expenses, distinct from the issues surrounding 280E costs.

Because Section 280E costs are considered ordinary and necessary business expenses, the IRS should acknowledge that they cannot be permanently disallowed.


The court's ruling in the CBS case poses a more significant challenge to the government than Section 280E. In the CBS case, the taxpayer was not only permitted to claim all of its deductions but also received a 30% income exclusion from taxation, resulting in a substantial financial benefit. Conversely, cannabis companies must pay taxes on their 280E costs and, as per the CBS case, are still obligated to carry these expenses until they exit the industry.


The encouraging development is that, thanks to Section 471(c) of the 2017 Tax Cuts and Jobs Act, small businesses may no longer need to wait until they exit the industry.

Section 471(c) represents a statutory provision and accounting method that exempts businesses from the tax rules that typically limit their Cost of Goods Sold (COGS). Instead, taxpayers can report their COGS by their books and records.


Like the 280E asset theory, Section 471(c) is expected to be effective because 280E does not permanently erase an expense; it only disallows its deduction. If the law provides an accounting method that allows a deductible expense to be treated as part of the COGS, 280E should not prevent its inclusion.


Section 471(c) empowers the taxpayer, rather than the IRS, to determine its COGS, and it could serve as the method that enables the recovery of costs that cannot be deducted under 280E.


These are intricate concepts that necessitate the guidance of a qualified tax professional. However, it seems that cannabis companies may be more financially viable than previously anticipated. This is due to the CBS case ruling, which suggests that current and past 280E costs could be reclaimed upon exit or incorporated into COGS, provided they align with the taxpayer's chosen accounting method.


Combining tax strategies like the "280E asset method" with the CBS Corp. case precedent offers hope for cannabis companies, potentially reclaiming substantial tax refunds. These approaches, rooted in law, enable recognition of costs disallowed by Section 280E, easing financial burdens in the industry.





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