Posted by William Mehi on 01.23.20
Marijuana’s popularity among American adults is on the rise. Use of the recreational drug is expected to continue to increase, due in part to its changing legalization status in many parts of the country. Less than two decades ago, marijuana was illegal in all 50 states. Recreational marijuana is currently legal for adults in 11 states, and in 2020 with the legalization in Illinois that makes a total of thirty-three U.S. states having broad legislation in place allowing the use of marijuana in some form. Even with the growth in popularity, the U.S. federal government continues to classify cannabis as a Schedule I substance. Many patients, advocates, health professionals and elected officials have sought to reschedule cannabis to reflect its accepted medical value, low abuse potential, and relative safety. Rescheduling can occur either by Congressional action (legislation) or through the DEA's administrative rule making process (petition). De-scheduling marijuana will facilitate medical research, ensure patient access and remove federal prohibitions.
On July 23, Rep. Jarrold Nadler (D-NY) and once presidential candidate Kamala Harris (D-CA) introduced the Marijuana Opportunity Reinvestment and Expungement (MORE) Act, which is arguably the most revolutionary and socially conscious federal marijuana reform bill introduced to date. The MORE Act would completely decriminalize marijuana at the federal level. The MORE Act addresses many of the issues deriving from marijuana prohibition, but it does not offer remedies for every issue. Instead, it takes a somewhat hands-off approach, leaving most regulatory questions up to the individual states.
Basically, the MORE act will allow each individual state to regulate their cannabis industry, but also gives the federal government its’ 5% tax on legal product.
The good news for the cannabis industry would be that once this bill passes and cannabis is removed from the Schedule I substance list federally, companies are going to be able to grow a new community centered small business economy. Up until now canna-businesses have had limited or no access to basic banking services because banks are insured by the Federal Deposit Insurance Corporation (FDIC). Banks worry of potential financial and/or criminal backlash if caught assisting marijuana companies. This bill would allow the cannabis industry access to everything from bank loans and lines of credit, to something as simple as a checking account.
Currently marijuana businesses in the U.S. can be subjected to Section 280E of the tax code. At the federal level, Section 280E of the Internal Revenue Code was passed in 1982 to specifically prohibit the deduction of otherwise ordinary and necessary business expenses from the gross income associated with the trafficking of Schedule I or II controlled substances within the meaning of the Controlled Substances Act. This leaves “plant-touching” cannabis-related businesses unable to deduct non-cost of goods sold business expenses for federal taxes, as marijuana is still considered a Schedule I substance. This burdensome treatment at the federal level must continue to be complied with for federal taxes until a change in federal law in regards to the controlled substances status of marijuana.
Tax incentives at the state level are currently available, and cannabis businesses are now positioning themselves to take advantage of opportunities at the federal level in anticipation of the end of federal prohibition on marijuana. Many states are actively seeking to raise revenue through the encouragement of cannabis-related businesses, and it’s now the time to take advantage of the R&D tax credit at the state level. This is especially the case for cannabis-related businesses that already comply with state regulations and contribute to state tax revenues.
Research and development is a critically important aspect of the cannabis industry’s current and future growth. Cannabis growers conduct research to produce better quality plants, and they experiment to produce better strains of cannabis for introduction to the consumers. Cannabis businesses may collaborate with manufacturers to design and prototype new equipment that can be used in cannabis extraction techniques, or software developers for testing and analysis of new or improved products and their potency. Cannabis retailers on the recreational side often conduct R&D in packaging and consumer studies. Pharmaceutical cannabis companies develop different types of tools, techniques, or processes to support their research when dealing with the aspects of the medicinal marijuana treatments for MS, Epilepsy, Alzheimer's and Cancer. Experiments with indoor versus outdoor environments, lighting, soil, temperature control, watering or processing of the crops are other activities growers already perform and which can qualify for state R&D tax credits.
Cannabis-related businesses conducting research and development activities may qualify for and benefit from R&D tax credits. Potentially eligible costs for state R&D tax credits include wages, cost of supplies, and cost of testing and contract research expenses. As the majority of state R&D tax credits align with the federal R&D tax credit requirements, the activities and associated expenditures of a company can often qualify for state R&D tax credit if the activities meet the same four-part test required for claiming any a Federal R&D tax credit:
Qualified Purpose - The purpose of the research must be to create a new or improved product, process, or formulation, resulting in increased performance, function, reliability or quality.
Technological in Nature – The research must rely on the hard sciences, such as engineering, physics, chemistry, biology or computer science.
Elimination of Uncertainty – Activities must overcome some unknowns, such as uncertainty as to capability, optimal design, or optimal methodology.
Process of Experimentation – Experimentation can be demonstrated through test batches, simulations, systematic trial and error, or other methods of evaluating alternatives to achieve a desired result.
While it is a challenging time for over 28,000 cannabis related businesses across the United States, it’s an even more daunting task to understand both Federal and state income tax laws and state and local government regulations. But with the help of their CPAs and Tax Point Advisors’ National Cannabis Industry Specialization Practice, cannabis businesses across the U.S. have substantial support available to manage and mitigate their income tax liabilities.
Tax Point Advisors provides R&D tax credit study services and other specialty tax services to CPA firms and their clients throughout the U.S. The current opportunity for exploration of R&D tax credits by cannabis-related businesses is at the state level. To learn more about R&D tax credits from the experts at Tax Point Advisors, please call us at (800) 260-4138.