If you’re farming/processing/selling/transporting marijuana and don’t already know that you’re subject to Internal Revenue Code Section 280e, fire your accountant as soon as possible. Oregon’s defiance of the Controlled Substances Act has done a decent job of shielding marijuana growers from handcuffs, but it can do nothing to stop an audit, or that monster increase of your tax rate if you’re in the marijuana business.
For hemp farmers and handlers, however, the issue may not be so, well, clear-cut. Many people – and even a few accounting professionals – believe hemp is exempt from the Internal Revenue Code’s rule that forbids businesses from deducting ordinary and necessary business expenses if they traffic in a controlled substance. This is because the Agricultural Act of 2014 (aka “the Farm Bill”) legalized the production of hemp for research purposes nationwide, but only in those states that choose to develop a hemp-production pilot program under a higher-learning institution or state department of agriculture.
While this seems to bode well for the future acceptance of hemp/cannabis as a run-of-the-mill a crop – as opposed to the dangerously and irredeemably addictive drug the Congress deemed it to be in 1970 – it still doesn’t change that hemp is a schedule 1 controlled substance. It also doesn’t change federal tax law. The Farm Bill merely legalized hemp growing notwithstanding the Controlled Substances Act. This means, essentially, that the Farm Bill explicitly refused to repeal the Controlled Substances Act with respect to any of its verbiage, including the list of drugs under schedule 1.
Another reason to doubt that the IRS would be more forgiving with respect to hemp farmers and their tax deductions is a recent 9th Circuit Court of Appeals decision that explicitly placed CBD – an extract derived from industrial hemp – in the crosshairs of the Controlled Substances Act. This decision evaluated whether or not the DEA stepped out of line in clarifying their rules with respect to CBD by stating that CBD was a schedule 1 controlled substance. As most predicted, because CBD is derived from cannabis, the court had no choice but to respect the fact that the DEA was within its authority to double-down on its interpretation of the CSA, even though CBD offers none of the “high” you’d experience with marijuana.
That being said, the IRS has hardly provided tax lawyers or CPAs detailed guidance with respect to how the IRS would treat a hemp farmer who wanted to deduct, say, payments on a tractor versus the cost of seeds or nutrients for the soil. Under 280e, even marijuana cultivators can deduct the Cost of Goods Sold (COGS), and most cannabis attorneys and 280e accountants have taken advantage of this allowance through a labyrinth of entities designed to incur business expenses that the “280e company” (the company actually producing/selling the marijuana) cannot.
Additionally, while you would be likely courting an audit if you grow hemp and attempt to deduct all business expenses, you may also be inviting unwanted IRS scrutiny if you attempt to place every possible “ordinary and necessary business expense” on the balance sheet of a property company, leasing company, or asset-holding company in an effort to skirt a higher tax rate.
The one true salvation for hemp farmers will come in the form of a legislative fix that ceases the federal confusion between “marihuana” and hemp, a product once so integral to society that some landowners in the 17th and 18th century American colonies were required to grow it. There is some cause for hope that the Congress will exempt hemp from the CSA, but for now, tread lightly and keep a 280e expert at the ready.