The Tax Cuts and Jobs Act was passed in December 2017. In addition to slashing the corporate tax rate to 21%, a new provision, §199A, was added to the Internal Revenue Code (“IRC”) allowing for a 20% deduction for pass-through entities. Pass-through entities include S Corporations and limited liability companies (“LLC”) among others.
Many state legal marijuana entities are formed as pass-through entities and frequently the choice of entity is the LLC due to its less formal management requirements and its flexibility in financial allocations among members. Since marijuana is a controlled substance under federal law, the federal government considers all marijuana businesses illegal even though these businesses are legal under state law. Furthermore, as a result of numerous cases allowing the deduction of business expenses related to illegal enterprises, Congress passed IRC §280E. Simply stated, this provision prohibits businesses in the marijuana industry from deducting its ordinary business expenses, other than cost of goods sold, resulting in much higher taxes for the owners.
IRC §199A is applied at the shareholder/member level rather than the entity level; therefore, the amount of the deduction for a state legal marijuana business is based upon the entities qualified business income (“QBI”) which would be its income after accounting for the impact of IRC §280E. This will result in a much higher QBI, which is the starting point of the IRC §199A deduction. The following example illustrates the potential for IRC §199A to provide partial relief from IRC §280E.