Cannabis businesses are constantly searching for relief from Section 280E’s crushing tax burden. With effective tax rates that can exceed 70%, it’s no wonder that any promised solution gains quick traction in the industry. Enter Section 471(c)—the latest strategy being marketed as a game-changer for cannabis taxation. But before you jump on this bandwagon, let’s examine why this approach may create more problems than it solves.
Section 471(c) allows qualifying small businesses to use simplified accounting methods for inventory. Instead of the complex uniform capitalization rules (UNICAP), businesses with average annual gross receipts of $29 million or less over three years can treat inventory as non-incidental materials and supplies. This effectively allows them to deduct inventory costs when paid rather than when sold—a significant cash flow advantage for traditional businesses. Additionally, the definition of inventory costs is expanded to be far broader.
The provision was designed to reduce compliance burdens for small businesses in conventional industries where detailed inventory accounting creates unnecessary complexity relative to the tax benefits.
Here’s how the strategy is being pitched to cannabis businesses: by reclassifying inventory under 471(c), costs that would normally be part of ordinary business expenses become part of costs of goods sold (COGS). Since Section 280E only allows COGS deductions for controlled substance businesses, this reclassification theoretically converts non-deductible expenses into deductible ones.
Sounds appealing, right? Unfortunately, the reality is far more complicated.
Direct Conflict with 280E’s Framework
Section 280E doesn’t just limit deductions—it fundamentally restructures how trafficking businesses calculate taxable income. The provision specifically allows only COGS while disallowing all other business deductions. Attempting to circumvent this through inventory accounting methods directly contradicts 280E’s comprehensive restrictions.
Courts have consistently interpreted 280E broadly, rejecting creative attempts to work around its limitations. The Olive v. Commissioner case and subsequent decisions demonstrate that courts view 280E as creating a complete framework for taxing controlled substance businesses, not just a simple deduction limitation.
Absence of Legal Support
Perhaps most concerning is the complete lack of legal precedent supporting this strategy. There are no:
Essentially, proponents are asking cannabis businesses to bet their companies on an untested legal theory with no supporting authority.
The way this strategy is being marketed raises additional concerns:
Overly Aggressive Promotion
Some firms are presenting 471(c) as a guaranteed solution rather than acknowledging its experimental nature. Any tax strategy promising to solve 280E problems should be viewed with extreme skepticism—if such solutions existed, they would be widely known and established through case law. Firms touting this strategy stand to make huge revenue gains by promising the benefits, getting paid to meet the reporting requirements, and then even potentially receiving large sums to defend the strategy in court, all while their clients have signed a liability waiver saying they can’t hold the firm responsible when the strategy doesn’t pan out. Read agreements carefully.
Misrepresenting the Benefits
Even if 471(c) worked as theorized, the documentation requirements far exceed a normal bookkeeping requirement. Because this is a change in accounting method, businesses must be able to produce books and records that match the 471(c) accounting. This can create convoluted, misleading financial statements that may not be accepted by other stakeholders, such as investors and banks. The implementation of 471(c) is not as simple as it appears and could result in significant extra accounting costs.
Ignoring Audit Risks
The IRS is acutely aware of this strategy and views it as potentially abusive. Cannabis businesses using 471(c) face significantly higher audit risks and the likelihood of sustained challenges.
Financial Penalties
Failed tax strategies don’t just result in paying the originally owed taxes. Businesses face:
Operational Disruption
IRS examinations consume significant time and resources. Cannabis businesses already operate under intense regulatory scrutiny—adding tax controversy to the mix creates additional operational strain and potential compliance issues. What’s further is that aggressive tax tactics are generally not attractive to potential buyers and can drive down the value of a business looking to be acquired.
Reputation Risk
Being associated with failed aggressive tax strategies can damage relationships with banks, investors, and business partners who are already cautious about cannabis industry risks.
Instead of gambling on questionable strategies, cannabis businesses should focus on legitimate planning opportunities:
Optimize Cost of Goods Sold
Work with qualified accountants to maximize COGS deductions through proper allocation of direct and indirect costs. This includes careful classification of cultivation, extraction, processing, and packaging expenses that legitimately qualify as COGS under 280E.
Strategic Entity Structuring
Entity structures vary significantly when it comes to how they are taxed. Every business is different, and not every structure is a one-size-fits-all, especially in cannabis. Discussing entity structure with a qualified tax accountant can help provide some clarity and even opportunities to further reduce tax burdens.
Protective Refund Claims
File protective refund claims. This is not a guarantee of a refund, however protective refund claims protect the taxpayer’s right to file an amended return in the future if the laws change. For example, if next year the laws change to remove 280E based on its constitutionality, a cannabis business may make the argument that it never should have applied and want to amend prior year returns to collect refunds. Generally, the statute of limitations to amend returns is only three years; however, a protective refund claim leaves that statute open, allowing the taxpayer the opportunity to go back further in this set of circumstances.
State Tax Optimization
Most states don’t impose 280E-equivalent restrictions. Focus planning efforts on state tax strategies while maintaining conservative federal compliance.
Business Process Improvements
Implement systems and procedures that maximize legitimate deductions within 280E’s framework. This includes proper documentation, cost allocation methodologies, and compliance procedures that can withstand IRS scrutiny.
The cannabis industry’s unique tax challenges require sophisticated, conservative planning approaches. While 280E’s burden is real and substantial, the solution isn’t to embrace untested strategies that could create bigger problems down the road.
Successful cannabis businesses focus on:
Section 471(c) may sound like the answer to cannabis businesses’ tax problems, but it’s more likely to create new ones. With no legal support, significant audit risks, and potentially severe penalties, this strategy represents speculation rather than sound tax planning.
Cannabis businesses deserve tax strategies built on solid legal foundations, not experimental theories that could jeopardize everything they’ve worked to build. The industry’s tax challenges are real, but the solutions must be grounded in established law and conservative practice.
If you’re considering the 471(c) strategy or have already implemented it, consult with qualified tax professionals who can provide objective analysis of your risks and alternatives. The cannabis industry has enough regulatory challenges without adding unnecessary tax controversy to the mix.
Remember: in tax planning, boring and defensible usually beats creative and risky. Your business’s long-term success and potential future value depend on strategies that can withstand scrutiny, not just promises of easy savings.
Christine Gervais
Christine Gervais is a licensed CPA, using her skills to help businesses grow and achieve their fullest potential. Christine has a Master’s degree in accounting from Southern New Hampshire University in addition to holding her CPA license for over a decade. Notably, Christine is a nationally recognized speaker providing education to other CPAs on how to best serve clients as well as instruction on a wide variety of topics for business owners on how to maximize success. Christine prides herself on the value she can bring to clients with her extensive tax knowledge and provides strategic, forward-thinking financial strategies to help clients grow. When not behind her desk, you can find Christine spending quality time with her daughter and stepson or tending to the family’s excessively loved farm animals.
