WOLF & CO Alerts Massachusetts Passes Income Tax Relief for Cannabis Businesses

Massachusetts Passes Income Tax Relief for Cannabis Businesses

In an overwhelming majority vote of 153-2, the Massachusetts House of Representatives passed a bill aimed at providing sweeping reforms to benefit the cannabis industry and its consumers. A significant tax feature of the bill is a provision to decouple Massachusetts tax laws from federal tax code Section 280E. This change would provide state tax relief to cannabis-related businesses (CRBs).

What is Federal Section 280E?

Section 280E is a federal statute that bars businesses engaged in trafficking a Schedule I or II controlled substance, such as cannabis, from deducting typical business expenses from its gross profit.

These rules apply to state-legal CRBs because cannabis is still a Schedule I substance under federal law. 280E was enacted because of a 1981 court case in which a convicted cocaine trafficker asserted his right under federal tax law to deduct ordinary business expenses. Shortly after, 280E was enacted to prevent other drug dealers from following suit. It states that no deductions should be allowed on any amount “in carrying on any trade or business if such trade or business consists of trafficking in controlled substances.”

This limitation results in a significantly higher effective income tax rate for taxpayers operating a CRB. Below is a simplified model that illustrates the effective tax rate for a CRB compared to a non-CRB. In this scenario, the non-CRB’s taxable income is $150,000, while the CRB is taxed on $350,000, despite having the same costs and expenses.

Non-Cannabis Business Cannabis Business
Gross Revenue $ 1,000,000 $ 1,000,000
Cost of Goods Sold 650,000 650,000
Gross Profit 350,000 350,000
Deductible Business Expenses 200,000
Taxable Income 150,000 350,000
Federal Tax – 21% 31,500 73,500
Massachusetts Tax – 8% 12,000 28,000
Total Taxes $ 43,500 $ 101,500
Effective Tax Rate 29% 68%

As you can see, the effective tax rate for the CRB is 68%. Like most other states, existing Massachusetts tax laws generally follow federal rules in determining allowable business deductions. Therefore, although the Commonwealth legalized cannabis, Massachusetts CRBs are subject to these limitations in determining both federal and state taxes.

Proposed Reform is Good News for Cannabis Businesses

The House bill includes a provision to decouple Massachusetts tax law from federal Section 280E, a move that aligns Massachusetts with approximately 10 other states that allow CRBs to utilize business deductions. Decoupling will allow CRBs to reduce their Massachusetts taxable income by business expenses previously disallowed. This is a welcome relief from Massachusetts state income tax for CRBs as we wait for similar reform at the federal level.

The House also voted to increase the amount of Massachusetts’ 10.75% cannabis excise earmarked for a social equity fund from 15% to 20%. Funds will be used to help social equity applicants launch their CRB.

The House bill follows a Massachusetts Senate approved version in April. Both versions of the bill will enter a conference committee process to align the bills before going to Governor Baker for signature.