Cannabis Businesses and Passthrough Deduction Availability
TAX NOTES, APRIL 8, 2019
13 Pages Posted: 12 Jun 2019
Date Written: April 8, 2019
Thirty-three states, as well as the District of Columbia, Guam, and Puerto Rico, have legalized the sale of marijuana and the national trends favor expanding legalization. Many experts predict exponential growth for the legal cannabis industry in the coming years, as well as the creation of hundreds of thousands of jobs. Despite legalization and the economic opportunities it creates, cannabis businesses face a tremendous obstacle to success and growth in the form of the federal tax code. The fact that marijuana is legal at the state level, but remains illegal under federal law, creates an inherent tension for cannabis businesses, and federal tax treatment of these businesses exemplifies this tension. While cannabis businesses may be operating legally under the laws of their home state, marijuana’s illegality under federal law has a punitive tax effect because of section 280E. There are specific policy proposals that would eliminate this punitive effect for state-legal cannabis businesses.4 However, until these proposals are adopted, or marijuana is legalized for federal purposes, the tension remains with dramatic effect.
While the application of section 280E imposes a significant tax burden on cannabis businesses by taxing their gross income, owners of cannabis businesses that are operating in passthrough form (partnerships and S corporations) or as sole proprietorships may be able to find some relief in the newly enacted section 199A deduction for qualified business income (QBI).
However, cannabis business owners must overcome multiple hurdles before they can use the section 199A deduction. These hurdles include the application of section 280E itself, the specified service trade or business (SSTB) classification, and the wage and property basis limitations of section 199A. As this article explains, the second and third hurdles do not come into play when the cannabis passthrough owner’s taxable income is below a specific level. The second hurdle arises for medical marijuana sellers, but not for sellers of non-medical (recreational) marijuana. Finally, the third hurdle may be insurmountable for pure retailers, while businesses that produce marijuana may be able to overcome it to some degree.
Keywords: cannabis, marijuana, 280E, tax, 199A, QBI, passthrough deduction
JEL Classification: K34, Z18, K10, M40, M41
Suggested Citation: Suggested Citation