Section 280E Tax Provisions and Industrial Hemp
Although tax matters can be both tedious and dull, a solid grasp of them is crucial to the success of a business. In the cannabis world, that includes a working knowledge of the onerous provisions of Section 280E of the Internal Revenue Code (26 U.S. Code § 280E – Expenditures in connection with the illegal sale of drugs).
The fact that marijuana remains an unlawful controlled substance at the federal level means that Section 280E applies to any sales of it, including state-lawful ones. In a nutshell, 280E states that no tax deduction or credit will be allowed for any amount of money paid or incurred during a taxable year for carrying on any trade or business which consists of trafficking in controlled substances. (The provision does not apply to cost of goods sold.) As a simple example, 280E may prevent a state-lawful marijuana business from deducting ordinary business expenses such as rent, payroll, marketing, etc.
This article is not about whether 280E applies to marijuana. Rather, it is about whether it applies to marijuana’s lawful cousin, industrial hemp (Hemp). Although this may seem to be a non-issue by virtue of the fact that Hemp is lawful at the federal level, some commentators have opined that 280E may, in fact, apply to Hemp businesses that engage in commerce. The idea is that the Hemp provisions of the Agricultural Act of 2014 (Farm Act) as set forth in 7 U.S. Code § 5940 (Farm Act) are for “research conducted under an agricultural pilot program or other agricultural or academic research”, not commercial activity in Hemp, such as sales of Hemp products (ie, food and body care, textiles, building material, and cannabinoids). In other words, if a business is acting outside the parameters of the Farm Act, then 280E applies.
That last sentence is undoubtedly true and non-controversial. A business operating outside the parameters of the Farm Act is engaging in unlawful activity. If that activity involves Hemp commerce then 280E applies. The issue is the parameters of the Farm Act. If the parameters are “narrow”, as some suggest, then a large number of Hemp businesses may be operating outside of it and could be subject to the provisions of 280E, even retroactively in the form of a tax audit. But is the scope really that narrow? Fortunately, the best answer is that it is not.
First, the Farm Act creates a lawful sub-class of the plant cannabis sativa l called “industrial hemp”. According to both the language of the statute itself and the recent ruling by the 9th Circuit Court of Appeals in the HIA v DEA case the Farm Act preempts any contrary provisions of law, including the Controlled Substances Act. This means that industrial hemp is lawful. As a starting point, cultivating Hemp does not trigger 280E.
Second, the Farm Act specifically authorizes “marketing” Hemp. Congress has doubled down on the Farm Act language and expanded this concept by enacting several consecutive appropriations acts, including the one currently in effect, that expressly bless the “transportation, processing, sale, or use” (emphasis added) of Hemp “within or outside the State in which the industrial hemp is grown or cultivated”. Moreover, in an amicus brief filed in the HIA v. DEA case a bi-partisan group of 28 Members of Congress asserted:
“Congress recognized the need for research and development to investigate market potential of domestic industrial hemp agriculture, including hemp agronomics, the economic impact of hemp-derived cannabinoids such as CBD, diversion controls, and the overall hemp products retail market.” (emphasis added)
Third, states can authorize private actors such as Hemp businesses to participate and even carry out their pilot programs. Licensing a private entity to carry out a state function is common. For example, in my home state of North Carolina (NC) liquor stores are established by government commissions under the control of the Alcohol Beverage Control Association (ABC), a sub-agency of the NC Department of Public Safety. ABC issues a commercial permit to an individual or company at a specific location allowing for the manufacture, importation, bottling, distribution, transportation, or representation of alcoholic beverages. In other words, NC licenses private actors to perform commercial state functions. This type of thing is true in most states in a variety of sectors. The point is that it is proper and within the parameters of the Farm Act for a state’s Hemp pilot program to license state actors to cultivate, process, manufacturer, distribute, and retail Hemp and its products.
In short, trafficking Hemp and its products is well within the parameters of the Farm Act so long as it is done in accordance with a state’s pilot program. To date, no state’s program has been challenged, or even flagged, as being outside the scope of the Farm Act. (The Farm Act does not even provide a mechanism for doing so.) Certainly, the IRS could take the position that 280E applies to certain businesses activities in the Hemp sector, in which case the industry, including the states with pilot programs, should push back. However, so long as a private individual or business is acting within the purview of its state program its activities are federally lawful and not subject to the harsh provisions of 280E.
A version of this article was originally published in the Cannabis Law Report, May 19, 2018. Thanks to Sean Hocking, John Taylor, and the entire CLR group for their excellent journalism about the cannabis industry.