The Tax Cuts And Jobs Act Of 2017 (“TCJA”) was signed into law by President Trump on December 22, 2017. It has been a good 30 years since the last time the Internal Revenue Code received such a major updatebut just how does this effect the cannabis industry?
Major Changes From The TCJA Include:
Lower Income Tax Rates For Individuals.
Increased Standard Deduction For Individuals
Elimination Of Personal Exemptions
Lower Corporation Tax Rates.
No Repeal Of Section 280E
The TCJA did not modify Section 280E. That provision provides:
No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances (within the meaning of schedule I and II of the Controlled Substances Act) which is prohibited by Federal law or the law of any State in which such trade or business is conducted.
Accordingly, cannabis businesses must still pay federal income taxes on their gross profits which is Gross Receipts less Costs Of Goods Sold. No deductions for operating expenses are allowed.
Reduction InTax Rate For C Corporations
All C corporations, including those engaged in marijuana-related endeavors, now benefit from a 21% tax rate (down from the previous 35%). The corporate alternative minimum tax has been eliminated. In addition to the tax reduction, C corporations also provide limited liability protection, greater credibility, and other advantages. As there is no distinction between cannabis and non-cannabis businesses, cannabis businesses organized as C-corporation should benefit from this reduced tax rate.
New Deduction ForPass-through Entities (S-corporation, LLC’s and partnerships)
This area has been given the most attention over the last year in anticipation of the first tax season that this benefit applies. The TRJA provides a new 20% deduction under 26 U.S. Code § 199A to certain S Corporations, LLC’s and partnerships but there are a number of limitations including (but not limited to) exclusion of specified service trades and businesses, and income limitations ($157,000 for individual filers and $315,000 for joint filers).
The calculation of the Section 199A deduction is quite complicated, however – it starts with the lesser of:
20% of taxpayer’s qualified business income OR
The greater of:
- 50% of the taxpayer’s share of W-2 wages with respect to the business
- 25% of the taxpayer’s share of W-2 wages with respect to the business plus 2.5% of the allocable share of the unadjusted basis of all qualified property (tangible personal property subject to depreciation and depreciable period is later of 10 years or regular straight-line depreciation period, so 39 years in the case of a non-residential rental building).
There are other calculations that apply but before working through the details of Section 199A can cannabis business owners benefit from this deduction?
Can TheSection 199A Deduction Apply To Cannabis Business Owners?
Clearly Section 280E puts cannabis businesses in a different category than non-cannabis businesses. The focus on Section 199A is that this deduction applies to enterprises that“carry on any trade or business”. The deduction thought is not made at the business level but instead at the individual level. It should be most noteworthy that this deduction does not appear on any forms for a business to report its taxable income and deductions.
In order to be a qualified trade or business, an activity must rise to the level of being a trade or business (Code Sec. 199A(d)(1)). Because the term “trade or business” is not defined in the Code, the determination of whether an activity rises to that level is subject to different interpretations. As a result, several distinct bodies of administrative guidance and case law have developed around the meaning of the phrase under different Code sections.
For purposes of Section 199A, the meaning of “trade or business” under Section 162 is controlling (Reg. Sec. 1.199A-1(b)(14)). Under Section 162, an activity must be regular and continuous to be considered a trade or business (Groetzinger v. Comm’r, 480 U.S. 23 (1987)). Whether a business has enough regular and continuous activity to be considered a trade or business is generally a facts and circumstances question.
When interpreting Section 280E, it could be argued that this provision denies cannabis business from deducting expenses normally deductible under Section 162 but in no way impacts whether the enterprise is operating as a trade or business. Nevertheless, it may be beneficial to disclose this position on the 2018 individual income tax return to avoid penalties in the event that on audit and any appeal this position is not respected by the IRS.
What Should You Do?
There is no one size fits all tax answer for every cannabis business but it is clear that Section 199A does not eliminate the punitive impact of Section 280E deduction disallowances.Protect yourself and your investment by engaging the cannabis tax attorneys at the Law Offices Of Jeffrey B. Kahn, P.C. located in Orange County (Irvine), the Inland Empire (including Ontario and Palm Springs) and other California locations. We can come up with tax solutions and strategies and protect you and your business and to maximize your net profits.