In addition to their other challenges, cannabis businesses must contend with punitive federal tax rules. In 1982, Congress enacted Section 280E of the Tax Code as a way to punish drug traffickers. This provision disallowed all deductions or credits for business expenses related to the trafficking of most illegal drugs. The Federal Government classifies marijuana as a schedule I narcotic, so it falls under this rule. In 2007, the US tax court ruled that Section 280E applies to cannabis businesses even where the business activities are legal under state law.

Section 280E has a huge impact on a provider’s bottom line. Take, for example, a marijuana business with deductible expenses of $100,000. If the IRS does not allow the outlet to deduct these expenses, that outlet would see a rise in its tax bill of at least $22,000. It is very difficult for medical cannabis providers to sustain a tax hit that large. Congress enacted Section 280E well before medical cannabis had reached its current level of acceptance in the medical community. It is a real threat to the existence of dispensaries and cooperatives in every state. Tellingly, Harborside Health Center, a medical cannabis dispensary out of Oakland, California, is finding out firsthand the damage 280E can cause.

Operators of medical cannabis providers are at least able to mitigate the impact of Section 280E. A business can still deduct the portion of its business expenses that is not related to actually providing cannabis. If a dispensary or cooperative provides other services, like yoga or massage, it can deduct expenses related to those other services. Co-ops can manage their businesses in a few different ways to take advantage of this rule.  A co-op can maximize physical floor space it devotes to other services and minimize floor space it devotes to medical cannabis. It could give employees not directly involved in distribution job descriptions that don’t involve medical cannabis. This way, the co-op can place the greatest amount of expenses in the deductible column. The tax hit won’t hurt quite as much.

The mitigating rule will not help every dispensary or cooperative. Many providers are not set up to provide other services. It still does not address the problem that providers are being taxed unfairly. Trying to shift expenses around increases accounting costs and stress associated with filing tax returns. It also breeds uncertainty. As providers seek to deduct as many of their expenses as they legally can, they run the risk of the IRS disagreeing and demanding a higher tax payment with a penalty.

In the end, medical cannabis providers will only have full relief from Section 280E when Congress amends the tax code. Medical cannabis patients, providers, and allies should engage politically to encourage Congress to amend this out of date and punitive rule. Apart from that, providers should consult with an attorney and/or an accountant familiar with the intricacies of Section 280E. This way, co-ops can plan ahead of time to keep damage from this tax rule to a minimum.

Despite the unfairness of the rule, it is still a bad idea to lie to the IRS. A business that evades taxes that it owes is playing tennis against a brick wall; it may work for a time, but it will undoubtedly lose in the end. Remember that Al Capone didn’t get convicted of racketeering or bootlegging; he went to prison for tax evasion. The medical cannabis community benefits overall when its members act within the bounds of the law. With the support of the community, this abomination of a tax rule will fall in due time.