California Provides Tax Relief for Cannabis Businesses

By Tim Long, Counsel

Dec 9, 2019

With the passing of Assembly Bill 37 (AB 37), legal cannabis businesses can now take advantage of more state tax deductions in California.

On October 12, 2019, Governor Newsom signed AB 37 into law, thereby eliminating California's conformity with Internal Revenue Code (IRC) Section 280E for licensed cannabis businesses subject to the Personal Income Tax Law (PIT Law). 

For those unfamiliar with 280E, Section 280 of the IRC forbids businesses from deducting otherwise ordinary business expenses from gross income associated with the “trafficking” of Schedule I or II substances, as defined by the Controlled Substances Act. The IRS applies Section 280E to state-legal cannabis businesses, which means that marijuana growers, processors and sellers are unable to deduct certain expenses from their taxes that businesses in other sectors can write off. The only deductions that cannabis businesses can make are cost of goods sold.

Until Oct 12, California policy reflected this federal approach. Now, the state tax code will deviate from IRS policy when it comes to 280E, allowing licensed state cannabis firms to take deductions just like any other business.

AB 37 is effective for taxable years beginning on or after January 1, 2020 and before January 1, 2025. The new law is reflected in Section 17209 of the California Revenue and Taxation Code. According to the bill, the objectives of the new law are:

  • To provide tax equity to the cannabis industry.
  • To exempt commercial cannabis activity by a licensee from Section 280E of the Internal Revenue Code, relating to expenditures in connection with the illegal sale of drugs, in order to allow cannabis businesses to claim deductions and credits available to other legal businesses in the state.
  • To provide commercial cannabis licensees the ability to claim ordinary business deductions from taxable income in the same manner that other state businesses do for state purposes.
  • To align the Personal Income Tax Law with the Corporation Tax Law in relation to deductions under Section 280E of the Internal Revenue Code.

Previously, taxpayers operating under the PIT Law, including individuals operating sole proprietorships, partnerships and their partners, PIT investors in S-corporations, and LLCs treated as partnerships and their members, could not benefit from ordinary and necessary business expense deductions, other than cost of goods sold, with respect to their cannabis businesses. Now, businesses licensed under California’s Medicinal and Adult-Use Cannabis Regulation and Safety Act who are subject to the PIT Law can deduct those ordinary and necessary business expenses from their state taxes. Unlicensed businesses subject to the PIT Law remain bound by IRC Section 280E and cannot deduct ordinary and necessary business expenses. 

Cannabis businesses operating under California’s corporate tax law have not been subject to IRC Section 280E and may continue to deduct both costs of goods sold and ordinary and necessary business expenses. 

Federal restrictions, including Section 280E, continue to create obstacles for legal cannabis businesses, but state laws such as California AB 37 should provide some relief in the meantime.

Click here for more information on AB 37.

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