Cannabis Cost Goods Sold Calculations
Cannabis Cost Goods Sold Calculations is not a deduction but actually, an adjustment is taken into account in arriving at gross income. Regulation §1.61-3(a) provides, “gross income” means “…the total sales, less the cost of goods sold.” Although IRC §280E disallows any deduction for a marijuana seller’s ordinary and necessary business expenses, the legislative history fails to include the cost of goods sold in this rule. The literature suggests that Constitutional concerns of the Sixteenth Amendment, which taxes ‘incomes’, are the reason for this exclusion.
In the Senate hearings prior to passing IRC §280E, discussion suggested including the cost of goods sold in the ‘disallowed’ expenses for drug traffickers. However, the feeling that this could create a constitutional issue leading to court challenges (and delays) prevailed, and cost of goods sold remained an available adjustment to drug traffickers.
Although the Service has not issued regulations related to IRC §280E, the Service allows the adjustment for Cost of Goods Sold (COGS) on the tax returns of businesses engaged in drug trafficking. On November 24, 2010, U.S. Representatives Fortney Pete Stark, Barney Frank, Jared Polis, Linda Sanchez, Raul Grijalva, and Sam Farr wrote to the office of the Chief Counsel of the IRS, asking the service to create guidance for regulations related to deductions for state-licensed marijuana businesses.
The Chief Counsel’s Office replied to the Congressman on December 16, 2010, stating that the IRS is unable to issue regulations for IRC §280E since neither the Controlled Substances Act nor IRC §280E makes the exception for medical marijuana. Further, the Chief Counsel places blame on Congress to change either IRC §280E or the Controlled Substances Act.
Cost Method for Cost of Goods Sold
A business must use an inventory method of accounting whenever “the production, purchase or sale of goods is an income-producing factor. Under an inventory method, costs related to producing, acquiring, storing, and handling goods are not currently deductible. These costs must be included in the costs of inventory and deducted when inventory is sold. In the typical business, tax professionals look to minimize current income by taking deductions during the current period. IRC §263A does not magically transform otherwise disallowed costs under IRC §280E into allowed capitalized costs, although the tax professional should look to maximize the number of deductions which can be justifiably capitalized. Much billable work exists for tax and accounting professionals who possess the skills to wade through client inventory records and classify expenses to maximize the cost of goods sold deduction and support the conclusions at an examination.
Generally, the current year inventory costs are added to the beginning of the year inventory amount and reduced by the costs of inventory on hand at the end of the year to calculate costs of goods sold for the year.
Section 471 and methods required by Section 263A provide that marketing, advertising and selling expenses are “not required” to be treated as inventory costs. Under Reg. §1.471–11, 6(a), taxpayers must include as inventoriable costs all direct (e.g., the cost of inventory and delivery, and the cost of materials and labor for manufactured inventory) and indirect production costs (e.g., rent and utilities related to inventory).