Subchapter S Corporations
As you may expect, the greater Salinas Valley agricultural area is home to many legal marijuana-related businesses. It’s no secret that businesses that touch marijuana, cannabis-based products and any other product containing THC must deal with substantially more rules and regulations as compared to most other businesses. Not the least of which is Internal Revenue Code Section 280E.
Section 280E of the Internal Revenue Code forbids businesses from deducting otherwise ordinary business expenses from income associated with the “trafficking” of marijuana, as defined by the Controlled Substances Act.
As specialists in the tax challenges of the marijuana industry, we’ve been seeing some troubling tax situations as we begin working with new clients in the industry. One area we’ve seen with alarming frequency of late is new clients that have used a Subchapter S corporation in their business structure. Buoyed with a U.S. Tax Court ruling last year, the federal government can essentially double-tax some income of a Subchapter S corporation that is subject to Section 280E.
Given what we have been seeing coming in the door, we thought a quick update about Subchapter S corporations and the marijuana industry would be appropriate as year-end tax planning season approaches.
With the recent court ruling there is not much positive to be seen about a Subchapter S corporation for a marijuana company. In Loughman v. Commissioner the operators of a Colorado marijuana dispensary argued that for a marijuana dispensary operating as an S corporation, Section 280E discriminates against S corporation shareholders by double taxing income when shareholder salary is disallowed because of Section 280E as a deduction from flow-through S corporation income and also included on the shareholder’s individual tax return as W-2 wages. The Tax Court noted that the catch-22 was not discriminatory, but instead applied equally, because Section 280E disallows salaries not attributable to cost of goods sold whether or not the salaries are paid to the shareholder.
One of the harsh realities of operating a S Corporation marijuana business is that Section 280E can often create double taxation for owners who receive payments for services from marijuana companies. It would seem the only way to avoid this is if the owner’s sole responsibility is activities related to the production of inventory. But, any officer/owner’s responsibilities are bound to include some sort of management and oversight. While making an election to be taxed as a C corporation can minimize the cost of double taxation in this situation, it won’t eliminate it.
The Tax Court showed little sympathy for marijuana companies when it comes to the punitive realities of Section 280E. I’ll let the Tax Court’s direct words convey it all.
“To the extent that petitioners believe they received disparate tax treatment as a result of organizing their marijuana business as an S corporation, petitioners were free to operate as any business entity and in other trades. Petitioners chose to operate Palisades as an S corporation in the marijuana business. Petitioners are responsible for the tax consequences of their decision.”
Clearly the Tax Court is taking no Section 280E prisoners anytime soon based on this direct quote from the court decision. If you’re a marijuana business considering a structure that includes a Subchapter S corporation, or already have one, be very sure you investigate your options to turn the table on this double-tax trap.
If you’re in the marijuana, cannabis, CBD or hemp industries and are concerned about tax planning and strategies unique to your industry you should give us a call at Scholl & Company, LLP. We understand the unique challenges and opportunities you face. For a free, no-obligation consultation with one of our cannabis industry tax experts give us a call at (831) 758-5966.