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California Cannabis & Hemp Industries 

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IRC § 280E Analysis / R&D Tax Credit Eligibility

 

Does Section 280E Apply to state individual income tax?

No beginning on or after January 1, 2020, and before January 1, 2025 under AB 37, the California state tax code will depart from Internal Revenue Service policy when it comes to 280E, allowing licensed state cannabis firms to take deductions just like other business.

 

This bill, for each taxable year beginning on or after January 1, 2020, and before January 1, 2025, would specifically provide in the Personal Income Tax Law for nonconformity to that federal law disallowing a deduction or credit for business expenses of a trade or business whose activities consist of trafficking specified controlled substances only for commercial cannabis activity, as defined under the Medicinal and Adult-Use Cannabis Regulation and Safety Act ("MAUCRSA"), by a licensee under MAUCRSA, thus allowing deduction of business expenses paid or incurred during the taxable year in carrying on that commercial cannabis activity under the Personal Income Tax Law.

 

Section 17209 is added to the Revenue and Taxation Code, to read:

(a) For each taxable year beginning on or after January 1, 2020, and before January 1, 2025, Section 280E of the Internal Revenue Code, relating to expenditures in connection with the illegal sale of drugs, shall not apply to the carrying on of any trade or business that is commercial cannabis activity by a licensee.

(b) For purposes of this section, “commercial cannabis activity” and “licensee” shall have the same meanings as set forth in Division 10 (commencing with Section 26000) of the Business and Professions Code.

  • (k) “Commercial cannabis activity” includes the cultivation, possession, manufacture, distribution, processing, storing, laboratory testing, packaging, labeling, transportation, delivery, or sale of cannabis and cannabis products as provided for in this division.

  • (z) “Licensee” means any person holding a license under this division, regardless of whether the license held is an A-license or an M-license, and includes the holder of a testing laboratory license.

    • (a) “A-license” means a state license issued under this division for cannabis or cannabis products that are intended for adults who are 21 years of age and older and who do not possess a physician’s recommendation.

    • (b) “A-licensee” means any person holding a license under this division for cannabis or cannabis products that are intended for adults who are 21 years of age and older and who do not possess a physician’s recommendation.

    • (ae) “M-license” means a state license issued under this division for commercial cannabis activity involving medicinal cannabis.

    • (af) “M-licensee” means any person holding a license under this division for commercial cannabis activity involving medicinal cannabis.

(c) This section shall remain in effect only until December 1, 2025, and as of that date is repealed

 

Previously, California Personal Income Tax Law (PITL) conformed to IRC § 280E (RTC § 17201), and marijuana growers, processors and sellers were unable to deduct expenses from their taxes that businesses in any other sector would be able to write off under federal income tax law. However, both state and federal law generally allow PITL taxpayers subject to denial of deductions under IRC § 280E to deduct their cost of goods sold. Although the deduction for cost of goods sold is prohibited by RTC § 17282 to PITL taxpayers who are convicted of criminal profiteering activities or drug trafficking activities.

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Does Section 280E apply to state corporate income tax?

No. California’s corporation tax law does not conform to the Internal Revenue Code, meaning the automatic denial of deductions under IRC Section 280E does not apply. 

 

Because the California Corporation Tax Law (CTL) does not conform to IRC § 280E, cost of goods sold and business expenses may generally be deducted by a CTL taxpayer in the trade or business of medical marijuana. However, similar to the exception under the PITL stated above, the deduction for cost of goods sold is prohibited to CTL taxpayers who are convicted of criminal profiteering activities or drug trafficking activities (RTC § 24436.1).

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An entity taxed as a corporation under the CTL that is involved in commercial cannabis activities is allowed to deduct its necessary and ordinary business expenses (RTC § 24343) and cost of goods sold (RTC § 24271), assuming the entity has adequate records to substantiate these items.

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But as mentioned above, state law (RTC § 24436.1) provides that no deductions (including deductions for cost of goods sold) are allowed to any taxpayer on any of his or her gross income directly derived from any illegal activity, but only if the taxpayer was determined to be engaged in criminal profiteering, as defined in Section 186.2 of the Penal Code or in an act or omission of criminal activity enumerated in RTC § 24436.1(a). Any such activity includes drug trafficking.

 

For this limitation to apply, current law expressly provides that a taxpayer must be found to be engaged in such activity through a final determination in a criminal proceeding, or a proceeding in which the state, county, city and county, city or other political subdivision was a party. 

 

Are State R&D Tax Credits Potentially Eligible for "Plant Touching" (e.g. producers, cultivators, manufacturers, retailers) Cannabis Companies?

Yes, beginning on or after January 1, 2020, and before January 1, 2025, see above.   

 

Are State R&D Tax Credits Potentially Eligible for Industrial Hemp Companies & "Non-Plant Touching" Separate Trade or Businesses (e.g. testing laboratories)?

Yes​, subject to further 280E analysis regarding company activities, structure, and applicable state laws. See California R&D Credit Summary​.

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State Law Background

(1) Hemp State Law Authority & Background​

  • Cal. Food and Agric. Code §81000 to 81010 (2016)

    • Allows for a commercial hemp program overseen by the Industrial Hemp Advisory Board within the California Department of Food and Agriculture.

    • Establishes registration for seed breeders.

    • This division will not become operative unless authorized under federal law.

 

(2) Medical Marijuana State Law Authority & Background

  • Statutory Language (year) - Proposition 215 (1996)  SB 420 (2003)

    • Patient Registry or ID cards - Yes

    • Allows Dispensaries – Yes (cooperatives & collectives)

    • Specifies Conditions - No

    • Recognizes Patients from other states - No

    • State Allows for Retail Sales/Adult Use - Proposition 64 (2016)

  • Are sales of medical marijuana subject to sales tax?

    • Subject to exceptions, yes. Certain sales of medicinal cannabis are exempt from sales and use tax. Effective November 9, 2016, sales and use tax does not apply to retail sales of medical cannabis, medical cannabis concentrate, edible medical cannabis products or topical cannabis when a qualified patient or primary caregiver for a qualified patient provides his or her card issued under the Health and Safety Code and a valid government-issued identification card. See Cal. Rev. & Tax. Code Sec. 34011(g).

    • For reference: California Tax Guide for Cannabis Businesses

  • Is medical marijuana subject to an excise tax?

    • Yes. Effective January 1, 2018, the Cannabis Excise Tax will be imposed upon purchasers of cannabis or cannabis products sold in California at the rate of 15% of the average market price of any retail sale by a cannabis retailer. Retailers are required to collect the excise tax from the purchaser and pay it to the cannabis distributor. Effective January 1, 2018, a Cultivation Tax on the cultivation of cannabis that enters the commercial market is imposed upon cultivators. Cultivators are required to pay the cultivation tax to either a distributor or a manufacturer depending upon the nature of the transaction. The cultivation tax rates are: $9.25 per dry-weight ounce of cannabis flowers, and $2.75 per dry-weight ounce of cannabis leaves. For reference: California Tax Guide for Cannabis Businesses

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(3) Recreational Marijuana State Law Authority & Background​

  • Ballot Measure: Proposition 64: The Adult Use Marijuana Act — Approved Nov. 9, 2016 by 57% of voters

  • Law: Control, Regulate and Tax Adult Use of Marijuana Act

    • State Website: California Cannabis Portal

    • Effective: Nov. 9, 2016 (revised penalties); Jan. 1, 2018 (retail sales); 2023 (restrictions to be lifted on large-scale corporations)

    • California Medical Marijuana Laws: Medical cannabis patients are not subject to the limits of the recreational law and may possess up to 8 oz usable marijuana, and 6 mature or 12 immature plants.

    • Possession and Cultivation Limits: Age: 21+

    • Usable Marijuana: up to 1 oz

    • Plants: up to 6 plants, including the harvest from those 6 plants

    • Hash & Concentrates: up to 8 g (more than 8 g is a misdemeanor)

  • Are sales of recreational marijuana subject to sales tax?

    • Yes, beginning January 1, 2018.

  • Is recreational marijuana subject to an excise tax?

    • Yes. The Cannabis Excise Tax and Cultivation Tax also apply to recreational marijuana.

 

(4)Does the State impose a Stamp Tax or Controlled Substances Tax?

  • No.​

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