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.
Rod Kight is a lawyer based in Asheville, NC. He is licensed in North Carolina and Oregon and represents legal cannabis businesses. You can contact him by clicking here.
5 comments on “Section 280E Tax Provisions and Industrial Hemp”Add yours →
HIA v. DEA, the HIA’s Petition to Review the DEA Rule making Hemp and CBD illegal under Schedule I under the CSA was denied in an unpublished opinion.
The DEA has clearly set forth all parts of the Cannibis Sativa L plant included hemp and CBD are schedule I under the CSA. The IRC 280E is based upon the sale of illegal drugs under the CSA.
While the Farm Act and spending bill define hemp with a thc content lower then 0.03% and allow for research and development and there is a dispute between Congress and the Executive Branch (“DEA”). The injunctive relief that stopped the prosecution in McIntosh is not available against the IRS under the AIA. Regardless case after case has stated that 280E is based upon the DEA rule making under the CSA.
CBD and Industrial Hemp except the stalk which has no CBD extract are illegal under the CSA, the current Farm Act and State law do not effect the 280E status. Taking the deductions can subject you to retroactive audits, underpayment penalties and seems like a great risk.
Ron- Actually, in the most recent HIA v DEA case the Court’s ruling specifically found that industrial hemp is not a controlled substance: “The Agricultural Act contemplates potential conflict between the Controlled Substances Act and preempts it.” In fact, the reason that the Court denied the HIA’s petition was because the Court found no conflict between the DEA’s “marijuana extract rule” (MER) and the industrial hemp provisions of the 2014 Farm Act since industrial hemp is not a controlled substance. The ruling is fairly sparse, but the arguments before the panel addressed this. Even the DEA’s lawyer admitted that the MER does not apply to industrial hemp. CBD is not a scheduled substance- it is not listed anywhere in the CSA. Thus, it is only controlled when it is derived from marijuana, which has a definition that includes “all parts” of the plant. (The chlorophyl in a marijuana plant has the same legal status with respect to the CSA as CBD.) When CBD is derived from a source- any source- that does not fall within the CSA definition of marijuana then it is lawful since it is not otherwise scheduled. As both Congress and the 9th Circuit have stated, industrial hemp is an exception to the definition of marijuana and is not scheduled. For these reasons, 280E does not apply to income derived from sales of hemp and hemp-derived CBD.
When you say to date no states program has been challenged or flagged it seems you are overlooking the DEA seizing 250 tons of Hemp seeds from the University of Kentucky in 2014 that they were in possession of under the Farm Act. Kentucky sued the DEA and got their seeds back and Congress added the Spending Bill provision to the Farm Act using its Article I powers.
Ron- Thank you for your comment. I appreciate you pointing out the KY case involving importation of seed. My point was that the validity of a state’s program has not been challenged. However, even using your example, KY prevailed.
I was wondering if you ever considered changing the layout of your blog? Its very well written; I love what youve got to say. But maybe you could a little more in the way of content so people could connect with it better. Youve got an awful lot of text for only having 1 or 2 images. Maybe you could space it out better?