Section 199A of the Internal Revenue Code, introduced by the Tax Cuts and Jobs Act (“TCJA”), created an opportunity for business owners to substantially lower their income taxes. Subject to many qualifications, beginning in 2018, business owners were potentially eligible for up to a 20% deduction on “qualified business income” (“QBI”). For those owning a cannabusiness, caution should be exercised in claiming the QBI deduction until further guidance is issued by the Internal Revenue Service or provided by court precedent.
While businesses are generally permitted deductions for “ordinary and necessary” expenses under I.R.C. § 162, cannabusinesses are significantly limited by I.R.C. § 280E. That section provides that:
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.
I.R.C. § 280E. In general, that section has been interpreted to disallow any deductions relating to indirect expenses incurred in carrying on a cannabusiness. See, e.g., Californians Helping to Alleviate Medical Problems, Inc. v. Commissioner, 128 T.C. 173 (2007). However, no case has yet dealt with the application of section 280E and its application to the deduction under section 199A. Understanding this potential issue, the American Institute of Certified Public Accountants (AICPA) submitted a formal request for guidance to the Internal Revenue Service after the passage of the TCJA.[1] Amongst other requests for clarification relating to section 199A, the AICPA noted that a “QBI deduction is not paid or incurred” and, therefore, it does not fit within the purpose of section 280E. Unfortunately, the Internal Revenue Service did not provide any clarifying regulations on this point.
So what to do? Although practitioners have opined that section 280E should not limit the section 199A deduction, the Tax Court has not historically been friendly to cannabusinesses in interpreting existing tax laws. See, e.g., Patients Mutual Assistance Collective Corporation v. Commissioner, 151 T.C. No. 11 (November 29, 2018); Loughman v. Commissioner, T.C. Memo. 2018-85. And although section 199A is not in the nature of a “trade or business” deduction under I.R.C. § 162 in that no expense needs to be incurred for the deduction to apply, it would not be a surprise for the Internal Revenue Service to take an aggressive litigation position. (Alternatively, it could be argued that I.R.C. § 280E only applies at the business level and, therefore, cannot limit the section 199A deduction at the individual level.) Until tested, there is no way to know how it will apply in the situations. Until then, business owners should consult with a tax professional to obtain guidance on the issue. At the very least, if I.R.C. § 280E is ultimately held to limit I.R.C. § 199A, professional guidance and/or disclosure of the issue on the front-end may minimize applicable penalties. See, e.g., Treas. Reg. § 1.6664-4 (setting forth reasonable cause defense to accuracy-related penalties for good faith reliance on a professional).
Cannabusinesses must keep abreast of developments in tax law that are unique to their industry and must plan to minimize their disparate tax treatment.
[1] Letter from AICPA, Request for Immediate Guidance Regarding IRC Section 199A – Deduction for Qualified Business Income of Pass-Through Entities (Pub. L. No. 115-97, Sec. 11011) (February 21, 2018), available at: https://www.aicpa.org/content/dam/aicpa/advocacy/tax/downloadabledocuments/20180221-aicpa-sec-99a-qbi-comment-letter-faq.pdf.
