Tax Incentives for Cannabis Companies
By Marshall Varano, Partner, CohnReznick LLP
The recent passage of the 2018 Farm Bill descheduled industrial hemp and its derivatives. This new law, combined with the pending bipartisan bill, the Strengthening the Tenth Amendment Through Entrusting States (STATES) Act, (which if passed would provide similar legal protections for cannabis where legalized), is paving the way for cannabis-related businesses to be treated like other agricultural businesses.
How the Farm Bill Impacts 280E
The impact of Section 280E of the Internal Revenue Code has put cannabis companies at a disadvantage relative to non-cannabis businesses, which can deduct their ordinary and necessary business expenses, and use tax credits.
Passage of the 2018 Farm Bill results in hemp cultivators’ and hemp CBD manufacturers’ no longer being subject to Section 280E beginning with the 2019 tax year. Namely, any part of the cannabis plant containing no more than 0.3% THC in dry weight form is called “industrial hemp” and is no longer scheduled. As such, businesses that traffic in industrial hemp or its derivatives are no longer subject to Section 280E. Cannabis companies that are not hemp businesses remain subject to Section 280E. Hemp businesses for their 2018 tax year returns are subject to Section 280E.
Federal Incentives of Note
Without Section 280E, hemp businesses can begin to take advantage of various federal tax credits and accelerated tax deductions.
- Federal Credits, Solar Investment Tax Credit
Various federal tax credits such as the research and development credit, the work opportunity credit, and the solar investment tax credit each exist, and may be of interest to hemp businesses. For example, one such credit is the 30% federal solar investment tax credit. Besides the 30% tax credit, solar investment can result in reduced energy costs, which could mean additional savings for businesses.
- Federal Tax-incentivized Deductions
Businesses not subject to Section 280E can deduct their ordinary and necessary business expenses instead of just cost of goods sold. Some deductions for tax purposes can even be accelerated, such as the 100% depreciation deduction.
Significant California Tax Code Benefits
Significant California tax code benefits have been available to cannabis companies. Such benefits have included a partial sales and use tax exemption, a partial diesel fuel credit, and a manufacturing and R&D equipment exemption.
- California Partial Sales and Use Tax Exemption
Since 2014, a partial sales and use tax exemption has applied to purchasers that meet certain requirements. It provides an exemption of 5% with respect to acquisitions by such purchasers of qualified farm equipment and machinery that is used at least 50% of the time in producing and harvesting agricultural products. Qualifying equipment may include tools, grow tents, lights, drying racks, and solar or hydroponic equipment.
- California Partial Diesel Fuel Credit
A partial diesel fuel credit applies to purchases of certain types of diesel fuel.
- California Manufacturing and Research & Development Equipment Exemption
A manufacturing and R&D equipment exemption applies to qualifying businesses in the North American Industry Classification System (NAICS) categories 311100–339999, 541711, and 541712 that acquire qualifying property. This exemption provides a reduced 3.3125% sales and use tax rate on such purchases. There are no NAICS codes per se for cannabis activities; however, it would seem reasonable that a hemp-based business involved in manufacturing should be classified by a NAICS code in the manufacturing category.
No application is required to qualify for the reduced tax rate; however, the purchaser must provide the seller with a completed and signed partial exemption certificate to receive the rate. The exemption certificates can be found on the State of California website. The certificate asks for the purchaser’s information and includes a statement that the property purchased is used for a qualifying activity, and that the purchaser is a qualified person.
The cannabis industry is at a crossroads in terms of its taxation. As federal and state tax laws continue to align the treatment of cannabis businesses with non-cannabis businesses, it could be increasingly important for cannabis businesses to understand the tax incentives available to them.
For more information on cannabis tax and compliance issues, visit CohnReznick.com
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