When you consider the recent U.S. Farm Bill signed Dec. 20, 2018, tax law is probably not the first thing that comes to mind. A farm bill is passed about every five years that lays out the government’s policies for food and nutrition, agriculture, forestry, and conservation. The farm bill has wide-reaching effects, including school […]
When you consider the recent U.S. Farm Bill signed Dec. 20, 2018, tax law is probably not the first thing that comes to mind. A farm bill is passed about every five years that lays out the government’s policies for food and nutrition, agriculture, forestry, and conservation. The farm bill has wide-reaching effects, including school lunches, food-assistance programs, farm subsidies and loans, milk prices, and agriculture trade. One part of the bill that received much attention is the legalization of industrial hemp, which has spurred on the already booming cannabis industry. Although the farm bill did not change the tax code, the change to the legal status of industrial hemp opened up tax opportunities to those in the hemp industry. Let’s hash out the changes.
A little background on cannabis before we dive into the tax changes. Hemp and marijuana are different varieties of the cannabis plant. Hemp is non-psychoactive and legally must contain 0.3 percent or less THC (the chemical that produces the “high” associated with marijuana). Hemp fibers are a sustainable resource that can be used in a wide variety of applications including fabrics, paper, food, energy, and building materials. Hemp also contains an extractable compound called cannabidiol (CBD), which has risen in popularity for its purported health benefits. Proponents of CBD claim that it offers the anti-anxiety and anti-inflammatory benefits of cannabis, without the associated “high” of marijuana. The pharmaceutical, wellness and alternative medicine, and food and beverage industries are experimenting with CBD and CBD-infused products.
Until passage of the U.S. Farm Bill, hemp was considered a controlled substance under federal law, which meant that for tax purposes, those in the hemp industry, where legal under state law, were treated the same as any illegal drug trafficker and subject to Internal Revenue Code Section 280E. That section disallows deductions and tax credits for businesses that traffic in controlled substances prohibited under federal or state law. Controlled substances are defined as those under Schedules I and II of the Controlled Substances Act. Producers and distributors of illegal controlled substances are limited to only subtracting cost of goods sold when calculating taxable income; no other deductions or credits are permitted.
The farm bill removed hemp and hemp products, including hemp-derived CBD from the federal list of controlled substances monitored by the U.S. Drug Enforcement Administration (DEA). Hemp is now under the purview of the U.S. Department of Agriculture (USDA) while CBD and its associated food and supplement products are subject to regulation by the U.S. Food and Drug Administration (FDA). This is an important distinction because CBD products are still considered illegal by the FDA for use in food and supplements while the FDA conducts further studies to develop regulatory guidelines. States were also given authority to regulate the hemp industry within their borders, leading to a patchwork of local laws and regulating bodies. The industry is rapidly evolving as are the related laws and regulations.
Because hemp cultivation and its related products are no longer considered controlled substances under federal law, producers and sellers are no longer subject to Section 280E as long as hemp is not considered a controlled substance under their state’s laws. In New York state, hemp and hemp-related products are not controlled substances. These businesses are now free to take advantage of the same tax breaks as more traditional businesses, including:
• Tax deductions for all overhead and general and administrative costs.
• Eligibility for federal tax credits, including the research and development credit.
In this expanding industry, hemp cultivators and producers are conducting research on numerous fronts, for example: maximizing crop yield, breeding new varieties, streamlining growing practices tailored to the soil conditions and climate, developing new uses for industrial hemp fibers, devising new methods of harvesting and processing the plant, and developing new hemp-related products. Each of these activities may qualify for the federal research and development (R&D) credit, allowing the business to recoup a portion of its research-related wages, supplies, and contract research costs. For startups, the R&D credit may be used as a reduction of payroll taxes if the business doesn’t yet have taxable income.
The cannabis industry is rapidly changing and will undoubtedly continue to evolve as more uses for the plant are discovered. Of course, as of now, marijuana is still a controlled substance under federal law and is still subject to Section 280E, regardless of state law. However, the 2018 Farm Bill eased the tax burden on industrial hemp and its products, including hemp-derived CBD.
Kristin Kowalski, CPA, is a manager in the tax practice of The Bonadio Group. She serves a variety of tax clients, with a focus on corporations — including S corporations — as well as partnerships. She has expertise in a number of areas, such as the manufacturing industry, multinational companies, state and local taxes, research and development credits, transaction planning, and tax accounting. Contact her at: kkowalski@bonadio.com