Cannabis Business Was a Reseller, Not a Producer, Thus Limiting Costs That Could Be Treated as Costs of Goods Sold

For a cannabis business, it is important to understand if the business is considered a producer, reseller or perhaps a bit of both, since that impacts the calculation of the one thing that such a business can deduct under the restrictions of IRC §280E—cost of goods sold. In the case of Richmond Patients Group v. Commissioner, TC Memo 2020-52[1] the taxpayer attempted to argue it was a producer based on the actions it took. The taxpayer’s position was rejected by the Tax Court.

The issue presents an “Alice in Wonderland” world for many tax professionals—generally a business wants to avoid having costs classified as items that have to be treated as part of cost of goods sold, since such costs are held in inventory until the product is sold. But since §280E bars a deduction for any items except costs of good sold, a cannabis business generally wants to capitalize into inventory as much as the business can.

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Simplified Inventory Election for Small Businesses May Be a Tax Disaster for Marijuana Businesses

An interesting article appeared in Tax Notes Today on February 1, 2019 that raised a question regarding whether a business that is deemed to be trafficking in a federally controlled substance might significantly increase its federal tax if it makes the election added by the Tax Cuts and Jobs Act to escape the provisions of IRC §471(a) and account for its inventory either:

  • By accounting for such inventory as non-incidental materials and supplies pursuant to Reg. §1.162-3, or

  • Conforms to such taxpayer’s method of accounting reflected in an applicable financial statement of the taxpayer with respect to such taxable year or, if the taxpayer does not have any applicable financial statement with respect to such taxable year, the books and records of the taxpayer prepared in accordance with the taxpayer’s accounting procedures.

This election is open to businesses that have average annual gross receipts of $25 million or less for the prior three years (adjusted for inflation) and which is not a tax shelter as defined by IRC §448(a)(3)..

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