[EDITOR’S NOTE — Jewell Lim Esposito is an attorney with 25 years of a tax emphasis in employee benefits, currently at the law firm FisherBroyles LLP.]
If you’ve ever wondered if cannabis (marijuana) shares any similarities with okra, zucchini, oranges and coconut … or even bananas, squash, eggplant and watermelon, I’m here to tell you that there are at least three. They each:
- grow quite well in the Southeast U.S.
- have employees in the business who can sponsor a 401(k) plan
- have to deal with inventory accounting under the Internal Revenue Code.
Let me explain and give you a little background, at least with respect to the latter two, which is where I have legal expertise.
Employees At Cannabis Companies Can Have Access to a 401(k) Plan
In December 2018, President Trump signed the Farm Bill into law. The Farm Bill treats low-THC cannabis products such as hemp and CBD as industrial hemp, rather than as controlled substances under the federal Controlled Substance Act. THC is shorthand for tetrahydrocannabinol, the chemical responsible for most of marijuana’s psychological effects and just one of many compounds found in the resin that glands of the cannabis plant secrete.
There are approximately 300,000 employees in the legal cannabis industry. It’s one of the fastest-growing (ha ha — pun intended) sectors in the U.S. The Internal Revenue Code expressly permits cannabis employees to participate in a retirement plan just like other, non-cannabis employees.
The participation of cannabis employees in 401(k) plans, however, has not been without its issues, particularly when they engage in activities that constitute criminal trafficking federally, despite being cannabis operations that are legal at a state level.
The Trafficking Issue
The real obstacle to implementing 401(k) plans for otherwise legal marijuana producers are the HR consultants, lawyers, banks, accountants, payroll companies, etc. who do not want to deal with “traffickers.”
They wait on the side, watching what the “other guys” are doing before they act. Notwithstanding, here below are some unequivocal truths:
- All cannabis companies are legally able to adopt 401(k) plans. (For more background, see the post on the acknowledgment from the Internal Revenue Service of permissible cost of goods sold adjustments tied to pension and profit sharing plan contributions in “Cannabis and 401(k) Participation”).
- All companies — even cannabis — that participate in a retirement plan are entitled to the federal tax credit of up to $5,500/year for three years for those that start a 401(k) plan. The credit is available under the fairly recent SECURE ACT (Setting Every Community Up for Retirement Enhancement, a bipartisan law designed to aid Americans — including those who work in the cannabis industry — ability to save for retirement).
- U.S. Attorney General William Barr is on record with the stated intent to refrain from pursuing trafficking prosecutions against otherwise legally operating cannabis companies.
The reluctance here from all these various advisers, however understandable, is unfortunate for growers of cannabis and hemp, as they should be entitled to a 401(k) plan … in the same way as growers of okra, bananas, and zucchini can participate in 401(k) plans.
How Cannabis, Hemp And CBD Can Have 401(k) Plans
As already noted, all cannabis companies (whether a cannabis, hemp or CBD producer) are allowed to participate in a 401(k) plan. Yet, advisers have the above reservations with “traffickers.” (For background, the United States Tax Court has defined “trafficking” as the regular buying or selling of marijuana. Californians Helping to Alleviate Medical Problems (CHAMP), Inc., 128 T.C. 173 (2007).) Consequently, any adviser accepting or moving money associated with those traffickers could be considered party to money laundering.
With the Farm Bill as law, however, advisors have clearer path (that is, there is no money laundering whatsoever over which to be concerned) for working with those whom the federal CSA confirms are no longer “traffickers.” The Farm Bill provides a critical component to offer 401(k) plans without hesitation. Essentially, the bill alters the definition of marijuana to exclude the cannabis plant’s buds, leaves and germinating seeds (and products extracted from them, such as CBD) as long as their THC content falls below a threshold of 0.3 percent. These products are now termed “hemp” or “industrial hemp.”
Section 280E Of The Tax Code Does Not Apply To Hemp
Hemp, as newly defined, is now an ordinary agricultural commodity.
Moreover, the deduction limitation of Section 280E of the Internal Revenue Code no longer impacts hemp production. That tax provisions provides:
- No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of the trafficking in controlled substances (within the meaning of schedule I and II of the Controlled Substances Act) which is prohibited by Federal law or the law of any State in which such trade or business is conducted.
Consequently, for hemp growers, there is no bar to claiming normal business deductions (including for 401(k) plan costs).
How Cannabis, Hemp And CBD’s Accounting Practices Are Just Like Those For Banana And Coconut Companies
While hemp and hemp-derived CBD companies get normal business deductions, a cannabis grower must look to Section 471 of the Internal Revenue Code.
That section directs regarding proper inventory capitalization and valuation methods, allocation of expenses, and impact on cost of goods sold. The code requires application of the inventory rules relating to the producer of a product, which includes one engaged in the manufacture or growing of real and tangible personal property (Treas. Reg. § 1.263A-2(a)(1)(i)).
With respect to growing, Treas. Reg. § Sec. 1.263A-4(a)(4)(i) defines a farming business as:
- a trade or business involving the cultivation of land or the raising or harvesting of any agricultural or horticultural commodity. Examples include the trade or business of operating a nursery or sod farm; the raising or harvesting of trees bearing fruit, nuts, or other crops; the raising of ornamental trees (other than evergreen trees that are more than 6 years old at the time they are severed from their roots); and the raising, shearing, feeding, caring for, training, and management of animals.
Treas. Reg. § 1.263A-4(a)(4)(i)(A) defines a plant produced in a farming business as including but not limited to “a fruit, nut, or other crop bearing tree, an ornamental tree, a vine, a bush, sod, and the crop or yield of a plant that will have more than one crop or yield raised by the taxpayer.”
Without going into much more tax and accounting, cannabis — then — is nothing more than just another agricultural-type business, for purposes of the Internal Revenue Code.
Cannabis Is Complex
My desire to author a piece for Southeast Produce Weekly is to help shed a little light on what is most definitely a complex and confusing topic. While cannabis is federally illegal under one set of federal laws (the Controlled Substances Act), those in the cannabis business can have 401(k) plans under other federal laws of the Internal Revenue Code and Employee Retirement Income Security Act.
Moreover, while the tax laws are a challenge, cannabis requires inventory accounting that other agricultural (okra! coconut! squash!) growers do on a daily basis.