Identifying whether deductions can be allocated as Cost of Goods Sold (COGS) can significantly minimize the tax impact of 280E on your cannabis business.
280E Tax Deductions and Cost of Goods Sold:
If you cultivate, produce, extract, or infuse cannabis, COGS related to the growth and production of goods that are then wholesaled by your business, are potentially subject to 280E. The bulk of activities of a cultivation or extraction within a vertically-integrated operation can be considered COGS.
Here is a suggested list of the types of 280E deductible labor COGS you can leverage:
Cannabis cultivators may also claim deductions for:
Raw materials and supplies (seeds, clones, fertilizer)
Indirect product costs, such as: equipment maintenance, utilities used to grow cannabis, supervisory wages, and costs of quality control and inspection
As a stand-alone dispensary, COGS are limited to the cost of the product and the costs of acquiring the merchandise, including the transportation costs to purchase the wholesale cannabis. You may also claim deductions for electric bills for designated inventory areas. From that point on, virtually everything else is subject to 280E scrutiny in the retail environment.
Take note of employees’ tasks:
Employee job descriptions are essential not only for having an organized internal process, but for accurate reports on salaries as well. You have to track the employees’ tasks and time spent on each to determine how many hours of wages are deductible under Section 280E of the tax code.
For example, there might be instances where your cultivator will work as a part-time budtender. The cultivation task is directly involved in the production of cannabis. Thus, it is deductible and included in the cost of goods sold. The budtenders wages, meanwhile, are not deductible.
Your cannabis business is subject to more audits than other businesses since you are operating with a federally illegal substance. Therefore, it is important to be ready for an audit at all times.
To deal with 280E and be audit-ready, you must document all expenses and revenue from seeding and cultivation to marketing and sales. You should have a receipt for every transaction—even those that involve the smallest bill—to avoid submitting an inaccurate tax return. Keep in mind that the IRS will ask for a detailed documentation of your COGS, and you may face a fine if you fail to show how you came up with the deductions.
Ken Mierzwinski, CPA, Managing Partner