It is estimated that medical and recreational cannabis sales could exceed $33.6 billion with an additional economic impact of $100.8 billion by the end of 2023. The industry is maturing beyond its early days following legalization and is leaving behind the stigmas and legal barriers that existed prior to 2012.

One such legal barrier is the denial of the ordinary business expense deduction under Internal Revenue Code 280E. The recent successful amended return filings by two cannabis Multi-State Operators (MSO) to claim deductions for ordinary business expenses that until recently had been excluded under 280E may have opened the door for other cannabis businesses to do the same. The resulting refunds generated by the inclusion of the deduction for ordinary business expenses on previously filed returns may be worth millions.

What is 280E and how does it apply to cannabis businesses?

This code section disallows tax deductions for ordinary business expenses for businesses involved in the “trafficking” of controlled substances that are classified under Schedule I or II of the Controlled Substances Act (CSA). This includes cannabis, which remains a Schedule I substance at the federal level despite state-level legalization for its medical or recreational use.

The primary impact of Section 280E on cannabis businesses is that it significantly increases their federal income tax burden. Unlike other businesses that can deduct a range of operating expenses, such as rent, salaries and marketing costs from their gross income to determine their taxable income, cannabis businesses are prohibited from taking these deductions. The only deduction allowed under 280E for cannabis businesses is the Cost of Goods Sold (COGS), which includes the direct costs associated with producing or purchasing inventory.

This restriction has led to a situation where cannabis businesses, operating legally under state laws, face effective tax rates that are substantially higher than those of similar businesses in other industries. It’s not uncommon for cannabis businesses to face effective tax rates of 70% or higher because they are taxed on their gross income rather than their net income after the deduction of ordinary business expenses.

The impact of 280E creates significant financial strain on cannabis businesses which already have elevated licensing and regulatory costs. The practical outcome of the additional income tax cost is that cannabis businesses have a reduced ability to reinvest in their operations, hire new employees and expand their businesses.

Once states began legalizing cannabis, the application of 280E to cannabis businesses became a point of contention between these businesses and the federal government. The argument for the inapplicability of 280E to cannabis is that it unfairly penalizes businesses that are complying with the strict compliance framework already present in state laws when compared to non-cannabis businesses who can deduct their ordinary business expenses.

Efforts to reform 280E have included legislative proposals such as The Small Business Tax Equity Act, which seeks to exempt cannabis businesses operating in compliance with state laws from the 280E provision. Additionally, some states have taken steps to provide tax relief at the state level by decoupling their tax codes from the federal restrictions imposed by 280E. These efforts, while a step in the right direction, do not address the applicability of 280E to federal income tax returns.

Cannabis Companies Receive 280E Refunds

As previously mentioned, two cannabis MSOs filed amended tax returns to add back in the ordinary business expense deductions that were previously excluded under 280E for their 2020, 2021 and 2022 tax returns. Additionally, these two MSOs have stated that they will pay income tax as regular corporate filers beginning in the 2023 tax year.

Florida-based Truelieve filed amended returns to add back in the deduction for ordinary business expenses in Q4 of 2023 and received $113 million in tax refunds for the 2019, 2020 and 2021 tax years. The very next quarter, New York-based Ascend Wellness Holdings filed amended tax returns for the 2020, 2021 and 2022 tax years, seeking refunds related to 280E. Both entities plan to file 2023 tax returns as normal corporate taxpayers excluding 280E for all tax returns beginning in 2023.

This new filing stance by the MSOs sent shockwaves through the cannabis industry. Never before had cannabis businesses applied for and received refunds on the basis that 280E did not apply to their income tax returns. In response to requests from other cannabis businesses for more detail, both MSOs declined to comment beyond citing the evolving legal landscape and the call by the Biden administration to reclassify cannabis as the basis for the amended returns.

While both MSOs stated during their most recent earnings calls that they view the amended refunds to exclude 280E to be based on “a very sound tax position,” the issue is far from settled. It is important to note that Trulieve posted a $152 million uncertain tax position to its balance sheet related to these refunds and hinted at future litigation with the IRS related to 280E. The position of both businesses seems to be that they expect additional scrutiny from the IRS in the form of audits and litigation at a later date.

What Should Cannabis Businesses do in Response?

This is the million-dollar question. The U.S. Supreme Court affirmed in 2005 the right of the federal government’s authority under the Commerce Clause of the Constitution to regulate cannabis, including in states that have legalized its use for medical and recreational (adult) use. See Gonzales v. Raich, 545 U.S. 1 (2005). But the case also led to a dissent by Justice Clarence Thomas and additional guidance by the Department of Justice (DOJ), indicating that it should exercise prosecutorial discretion for cases in states that have “strong and effective state regulatory system[s].” In particular, Justice Thomas and the DOJ were specifically critical of the enforcement of 280E and the CSA on the sale and use of medical cannabis.

Although the revenue numbers for Trulieve and Ascend are not publicly available, the number of the dispensaries in states that either recently legalized recreational use or permit cannabis use for medical purposes only suggests that revenue from medical cannabis use plays some role in their recent refund claims. The distinction between revenue generated through medical cannabis sales and recreational sales seems to be on firmer footing based on the sources of revenue reported by these two businesses.

While these two MSO claims are pending a final resolution from the federal government and other related litigation is ongoing, cannabis companies should actively position themselves to take advantage of any favorable changes to 280E. One important area where this is especially true concerns previously filed tax returns that comply with 280E. It is important to note that businesses generally have three years to amend their tax returns if they intend to claim a refund. It is generally not possible to claim a refund for tax returns filed more than three years ago. This means that the deadline to file an amended return for the 2021 tax year will be April 15, 2025.

In light of this fact, cannabis businesses should consider filing amended protective returns to preserve their ability to claim a retroactive refund for 2021 if the federal posture on 280E were to change this year. Filing a protective amended return with the IRS involves a process that allows taxpayers to preserve their right to a refund while awaiting the resolution of a contingent event.

In this case, the contingent event is the applicability of 280E to cannabis businesses. The process for filing a protective amended return is the following:

  1. Identify the Basis for the Claim: Clearly identify the basis on which the protective claim for a refund or credit is filed. This involves specifying the contingent event is an expected change to the application of 280E.
  2. Provide Sufficient Facts: Include sufficient facts to apprise the IRS of the underlying reasons for the claim. This should include a detailed description of the 280E ordinary business deduction and how it specifically affects the claim and the specific tax year or years involved.
  3. Quantify the Refund, if Possible: If the amount of the 280E refund is known or can be reasonably estimated, quantify the amount of the expected 280E refund in your claim.
  4. Filing Requirements: The claim must be in writing and signed and dated under penalty of perjury. While there is no specific form for filing a protective claim, you can use Form 1120-X, “Amended U.S. Corporation Income Tax Return,” for corporations. Ensure that the document clearly states “Protective Claim” at the top of the first page.
  5. Deadline for Filing: File the protective claim for 2021 before the expiration of the statute of limitations for claiming a refund on April 15, 2025. The other amended protective returns for 2022 and 2023, if necessary, can be filed later.
  6. Follow Up: After the 280E contingency is resolved, amend your protective claim as soon as practical to provide any additional required information or to formalize the claim based on the resolution. This will require close monitoring of the MSO cases and any changes to the legal landscape impacting 280E.
  7. Administration by the IRS: Be aware that the IRS may hold a protective claim in abeyance indefinitely until the contingent event is resolved. The IRS has discretion in deciding how to process protective claims, and in general, it is in the interests of the IRS and taxpayers to delay action on these claims until the contingency is resolved.

By filing a protective amended return, cannabis businesses can preserve their right to claim a refund if 280E and its applicability to cannabis businesses should change in any way. For more information on 280E or protective returns, contact a tax professional.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.