Marijuana dispensaries must file federal income tax returns and pay income tax the same as any other business—except that dispensaries are not allowed to deduct their operating expenses because they are considered drug traffickers under federal law.
Marijuana dispensaries must pay federal income taxes by filing one of the following tax returns:
- Schedule C: For sole proprietors and single-member limited liability companies (LLCs)
- Form 1120: For corporations to report income, losses, deductions, and credits
- Form 1120S: For corporations who make the S election and pass income and losses through to their shareholders
- Partnership/LLC – Form 1065: For partnerships and LLCs; income and losses passed through to the shareholders
Key takeaways
- Marijuana dispensaries must pay federal income taxes by filing a tax return the same as any other business, except operating expenses are not deductible
- Cost of goods sold (COGS) is the only deduction allowed for marijuana dispensaries; no other deductions for operating expenses are permitted.
- Nondeductible operating expenses mean marijuana dispensaries face a very high effective tax rate compared to other retailers.
- Taxpayers without a bank account can use prepaid cards, checks, and money orders for IRS payments.
- Cash transactions of $10,000 or more require special informational reporting on IRS Form 8300.
Disallowed Operating Deductions
While most businesses get to deduct all ordinary and necessary expenses, the IRS does not allow any deductions for businesses trafficking in controlled substances. Marijuana is listed as a controlled substance—and the sale of a controlled substance is generally considered trafficking Some marijuana affiliated businesses may deduct operating expenses. Hemp retailers who do not sell any other cannabis products may also deduct operating expenses. The low level of tetrahydrocannabinol (THC) content in hemp is not high enough to meet the definition of controlled substance. .
To discourage unlawful activity, the IRS code includes specific provisions to punish businesses that profit from illegal sources. One of these provisions prohibits marijuana retailers from deducting ordinary and necessary business expenses. Marijuana dispensaries are also not permitted to deduct state and local taxes or payments made to charities Marijuana retailers are prohibited from being organized as charities. Exceptions have been made for caregiving organizations where marijuana distribution has been ancillary to the service of care. .
Other examples of nondeductible expenses are listed below:
- Advertising
- Depreciation
- Office supplies
- Rent for general office space
- Legal fees
- Insurance
- Other ordinary and necessary expenses of operating the dispensary
Allowable COGS Deductions
The previous list are examples of operating expenses, which are nondeductible. However, marijuana dispensaries are allowed to deduct the COGS. COGS for a dispensary is simply what they pay for the products they sell, including any inbound shipping costs.
The table below categorizes the expenses according to their deductibility.
Deductible COGS | Non-deductible Expenses |
|---|---|
Merchandise purchases | Rent for general office space |
Inbound shipping | Advertising |
Utilities | |
Transportation | |
Legal fees | |
Accounting fees | |
Other ordinary and necessary expenses |
Internal revenue code (IRC) 61(a) provides that all sources of income “from whatever source derived” are taxable. This includes illegal income, such as the sale of controlled substances which includes Marijuana.
While IRC 162(a) allows for most businesses to deduct all “ordinary and necessary” expenses, IRC 280E specifically denies any deductions or tax credits for businesses “trafficking in controlled substances” as defined in Schedule I and II of the Controlled Substances Act. Marijuana is included as a Schedule I drug and therefore all ordinary and necessary expenses of the marijuana business are denied.
However, neither Congress nor the IRS has the authority to deny marijuana businesses a deduction for their COGS. The 16th Amendment to the United States Constitution provides the government the authority to “lay and collect taxes on incomes.” Importantly, the Supreme Court has consistently held that income does not include the recovery of capital invested in inventory. Therefore, only the profit from selling goods can be taxed and a COGS deduction must be allowed.
Example Tax Rate of Marijuana Dispensary vs Other Retailers
The example below illustrates the disparity in tax paid by a marijuana dispensary and a typical retailer. The facts shown assume that the revenue and expenses are the same for the two companies, but the taxation is different. As a result of the federal restriction on the deductibility of operating expenses, a typical retailer has a substantial advantage:
- Revenue: $500,000
- Merchandise purchased for resale (COGS): $125,000
- Transportation costs (COGS): $25,000
- Operating expenses: $100,000
- Tax rate: 21%
Marijuana Dispensary | Typical Retailer | |
|---|---|---|
Gross Receipts | 500,000 | 500,000 |
Merchandise Purchased for Resale (COGS) | – 125,000 | –125,000 |
Transportation Costs (COGS) | –25,000 | –25,000 |
Gross Income | 350,000 | 350,000 |
Operating Expenses | non-deductible | –100,000 |
Taxable Income | 350,000 | 250,000 |
Tax Rate | ×21% | ×21% |
Tax | 73,500 | 52,500 |
Effective Tax Rate (Tax/Gross Income) | 21% | 15% |
The marijuana dispensary in the above example paid 21% of its gross income in taxes while an identical legal retail business paid only a 15% effective tax rate.
Strategies To Reduce Federal Income Taxes
Even though business deductions are limited to COGS, other opportunities exist for marijuana dispensaries to find tax savings:
- Qualified business income (QBI) deduction: The QBI deduction allows for up to a 20% reduction in qualified business income. This deduction is available to sole proprietorships, partnerships, LLCs, and S corporations (S-corps).
- Tax deferral for qualified opportunity zone (QOZ) investments: The IRS maintains a list of low-income communities where investment is encouraged. If a marijuana business sells a capital asset, such as land, buildings, or machinery, for a gain, it may invest those gains in a fund that contains those low-income properties listed by the IRS. A business that reinvests gains from capital assets into those funds may be able to defer the related tax.
- Exclusion of gain for qualified small business stock: Stockholders in a marijuana dispensary organized as a C corporation (C-corp) may be eligible to exclude gain from the sale of company stock held for more than five years. This benefit is designed to promote small business investment. For gain on the stock sale to be eligible for exclusion, both the stockholder and the business have to meet certain qualifications.
Tax Payment Options for Marijuana Retailers
Banking institutions can be steeply penalized for offering services to customers who engage in illegal activity. As a result, marijuana businesses have difficulty finding traditional banking options, even when it comes to payment processing (see our best cannabis payment processing companies). Not having a bank account complicates the IRS payment process as checks and electronic transfers are eliminated as options.
Without a bank account, the following methods are potential alternatives:
- Money orders
- Cashier’s checks
- Prepaid cards; see our roundup of the best business prepaid cards for options
- IRS retail partners, such as Walmart, Walgreens, and 7-Eleven; visit the IRS’s pay with cash page at least seven days prior to the tax payment due date for instructions.
- In-person payment with an IRS representative at a taxpayer assistance center (TAC); appointment required
Special Reporting for Cash Transactions
Banking restrictions on marijuana dispensaries often result in a high volume of cash transactions. Lump sum cash payments exceeding $10,000 (and received in the course of business) should be reported on IRS Form 8300—and transactions less than 10,000 may still be reported if the cash activity arouses suspicion.
This form is not required when payments are received by check as the financial institution on which the check is written is responsible for the Form 8300 filing. Special rules apply when both cash and checks are used to pay for one transaction that exceeds $10,000.
Form 8300 must be filed within 15 days of cash receipt and should be submitted through the FinCEN Bank Secrecy Act (BSA) E-Filing System or mailed to the IRS. The website for electronic filing and address for postal mailing are provided on the IRS Form 8300 instructions.
Payment Plan Options
If the full balance cannot be paid with the filing of the return, the IRS may accept a payment plan—and you may apply for a plan online or with Form 9465. Online applications require an online account. Setting up an account involves a thorough identity verification process conducted by a third-party IRS partner.
Payment plan options include the following:
- Short-term plans: For taxpayers owing less than $100,000 who can satisfy the balance due within 180 days
- Long-term plans: For taxpayers owing less than $50,000 who can satisfy the balance within 72 months
Businesses taxpayers owing less than $25,000 may also pay monthly over 24 months, but automatic payments from a bank account are required for balances over $10,000—which, as we’ve discussed, is a problem for marijuana dispensaries.
Options for Dealing With Penalty Assessment
When filings or payments are not received in a timely fashion, the IRS may assess penalties. It may consider a penalty abatement if an acceptable argument is presented.
The IRS has noted that reasonable arguments for failure to timely file or pay include the following:
- Fires, natural disasters, or civil disturbances
- Inability to get records
- Death, serious illness, or unavoidable absence of the taxpayer or immediate family
- System issues that delayed a timely electronic filing or payment
Interest assessed on tax due is generally not reduced even if the penalty is abated. However, interest charged on the penalty itself will be abated along with the penalty. Penalty abatement requests should be sent to the address on the notice you received containing the penalty assessment.
Frequently Asked Questions (FAQs)
Operating expenses are generally not allowed. However, U.S. Courts have permitted deductions for operating expenses where the primary income source was healthcare and small amounts of marijuana were provided as part of a care plan. Sale of nonmarijuana products needs to be a legitimate part of the business strategy and not a ruse to allow otherwise nondeductible expenses.
Keep immaculate records and maintain procedures for keeping those records. Doing so will bolster the credibility of your support documentation.
The IRS does not generally abate interest unless it is calculated on a penalty that is removed.
Bottom Line
As long as marijuana maintains its classification as a controlled substance, general operating expenses will remain nondeductible. Until that changes, marijuana businesses should be aware of the filing expectations and tax strategies available for this industry.
