So you are one of the new Washington D.C.-based marijuana dispensaries, making perfectly legal money hand over fist. You've got your occupancy permit from the city and your business license, and heck, even the cops keep the streets in front of your dispensary clear from any criminal activity, making a visit to your store for prospective customers no different from visiting Starbucks. You pay your sales and use tax every month to the city on time, and if you own your store, property tax to the tax department on time. Even your employees get pad above board, with real W-2's and 1099s, and withholding reported to the IRS and the city on a regular basis. Everything is good.
Until you have to file your federal tax return. That's because in spite of what the DC council says (or the Colorado, Washington state, and Alaska legislatures), the federal government still says that selling marijuana is illegal. That's right, marijuana is on Schedule I of the Controlled Substances Act, a law that has not been amended, nor does not seem to be in any danger of being amended in the near future. And controlled substances are subject to Section 280E of the Internal Revenue Code (IRC), which says "no deduction is allowed for any amount incurred in a business that consists of trafficking in controlled substances".
Don't Panic Yet
The U.S. Senate clarified Section 280E when it approved the change in the IRC to eliminate deductiosn for illegal businesses, providing for the ability to deduct the cost of goods sold (COGS: the cost of the product and services actually being sold, but not the indirect costs of running the business. Thus while rent and utilities were still not deductible, the cost of growing and packaging the product was still deductible. Since the average dispensary COGS is around 75% of sales, this clarification made quite a difference in the federal taxation of marijuana businesses.
It is usually at this point that Section 263A would come to your rescue. That's because Section 263A of the IRC allows resellers and producers of merchandise to inventory a proper share of indirect costs allocable to that merchandise. The good news--more deductions. The bad news--you have to capitalize your inventoriable indirect costs. What does that mean? That's means if you have $500,000 of product inventory, but have only sold $75,000, only 15% of your inventoriable indirect costs can be immediately recognized as a deduction. Unfortunately Section 280E prevents marijuana dispensaries, which are illegal business under federal law, from taking deductions for expenses, even those provisions like Section 263A intended to add indirect costs to COGS.
The bottom line: plan for paying federal income tax on your gross income, not your net income. Proper tax planning will help you avoid problems--contact us for a free consultation.