Key Takeaways
The U.S. Department of the Treasury has previewed forthcoming guidance addressing Section 280E of the Internal Revenue Code in light of federal rescheduling. For cannabis businesses licensed in Oregon and Washington, the anticipated guidance signals two significant developments:
- A taxpayer-favorable transition rule that may apply relief across the full taxable year that includes the effective date of a final order; and
- An activity-based application of Section 280E that may require apportionment between trafficking activities and non-trafficking activities, including between medical and adult-use sales.
What This Could Mean for Oregon and Washington Licensees
Oregon and Washington have integrated medical and adult-use licensing regimes, which allow retailers to sell to both medical patients and adult-use consumers and allow producers and processors to supply both channels under integrated compliance structures. If the IRS adopts the anticipated approach:
- Retroactive transition relief: A rule applying relief for the entire taxable year that includes the final order’s effective date could simplify compliance and reduce the risk of mid-year accounting complexity. Taxpayers should assess whether their taxable year-end falls before or after the final order’s effective date and model potential full-year outcomes.
- Activity-based allocation and apportionment: An allocation and apportionment requirement could focus 280E disallowance on activities related to non-medical sales and could require separating expenses associated with exempt activities from those subject to 280E. For retailers, this could mean determining the extent to which expenses relate to medical versus adult-use sales if the federal treatment of one category changes as a result of rescheduling. It is also possible the IRS will rely on a single-factor sales apportionment methodology.
Practical Challenges for Producers and Processors
An allocation requirement may be particularly problematic for producers and processors that lack direct visibility into end-customers. Unlike retailers, producers and processors sell to retailers without sufficient information to make an informed allocation calculation. Producer/processors should consider:
- Establishing reasonable, consistent allocation methodologies could be critical, potentially leveraging product categories, purchase orders, contract terms, or customer certifications where available.
- Documenting and maintaining contemporaneous records supporting assumptions could be essential to withstand IRS scrutiny, especially where end-use customer data is incomplete.
Potential Action Items
- Inventory activities: Map business lines to identify which activities may remain subject to 280E and which may not.
- Prepare allocation frameworks: Develop reasonable, supportable methods to apportion expenses between trafficking and non-trafficking activities, and—where relevant—between medical and adult-use channels.
- Enhance data collection: For producers and processors, evaluate options to improve downstream insight, including contractual representations, SKU/channel tagging, or periodic customer attestations.
- Model scenarios: Run tax models for the taxable year that includes the final order’s effective date to quantify potential benefits of full-year relief and the impact of apportionment.
- Monitor developments: Track the final order’s effective date and the IRS’s final guidance to align implementation timelines, internal controls, and tax return positions.
Next Steps for Cannabis Businesses
The anticipated guidance offers the prospect of meaningful certainty and, potentially, favorable timing for relief. At the same time, an apportionment regime would place a premium on defensible methodologies and robust recordkeeping. Cannabis businesses should begin preparing now so they can promptly operationalize final IRS rules once issued.
For questions about how these developments may affect your operations, please contact a member of our cannabis team.
This article is provided for informational purposes only—it does not constitute legal advice and does not create an attorney-client relationship between the firm and the reader. Readers should consult legal counsel before taking action relating to the subject matter of this article.
