New Jersey (NJ) now joins a growing number of states to decouple from IRS code Section 280E. Internal Revenue Code Section 280E is part of the federal tax code passed by Congress that bars businesses engaged in trafficking a Schedule I (such as cannabis) or Schedule II controlled substance from deducting typical business expenses from its gross profit. The code states:

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 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.

This limitation results in a significantly higher effective income tax rate for taxpayers operating a cannabis business.

A common misconception for new cannabis entrepreneurs is that once a state has legalized cannabis, the state no longer conforms (recognizes) this at the state level. However, the tax code has generally not been amended during the process by which states have legalized the sale of cannabis. This creates an inconsistency until the governing bodies amend their state’s code. As of the publication of this article, 18 states have implemented state-level tax codes that allow legal cannabis businesses to deduct certain business expenses, essentially decoupling from IRC 280E. As the cannabis industry grows and public opinion in favor of legalization increases, additional states are taking this approach. Federal lawmakers have previously discussed the possibility of excluding cannabis businesses from 280E entirely but bill has not yet been passed.

Under the new law, ALL New Jersey cannabis licensees, regardless of business entity type, are permitted to deduct from income all ordinary and necessary expenses incurred in carrying on a licensed cannabis business for tax years beginning on or after January 1, 2023. This change applies to both the Corporation Business Tax (New Jersey’s corporate income tax) in addition to the Gross Income Tax (New Jersey’s personal income tax). While partnerships and sole proprietors operating as cannabis licensees may have already been able to deduct their expenses under current Gross Income Tax regulations, the bill codifies this treatment. Finally, the law also permits C corporations and S corporations to deduct from any income any qualified research or experimental expenditures pursuant to Internal Revenue Code 174, while also allowing these deductions for the very same expenditures that are the subject of a New Jersey Research & Development tax credit.

Federal tax law Section 280E has been a significant barrier to the growth of the New Jersey cannabis industry. The newly-enacted bill provides much tax relief for New Jersey tax purposes and opens the door for New Jersey entrepreneurs, cannabis operators, and social equity groups to leverage opportunities that will allow their businesses to grow and thrive.

For questions about the New Jersey bill or other state taxation issues, please contact Citrin Cooperman's Cannabis Advisory Services Practice or Matthew Martin at mmartin@citrincooperman.com.