Colorado Psychedelics Tax Issues

With the passing of the Natural Medicine Health Act in Colorado, the cultivation, processing, storing, using, transporting, obtaining and ingesting of natural medicines was legalized in Colorado — and this included certain natural psychedelic substances.

But these substances remain illegal controlled substances at the federal level.

Tax issues can arise because of this discrepancy between state and federal law. These issues can become challenging and costly and seasoned legal advice may be required to navigate the potential pitfalls and financial risks.

Federal and state tax laws for psychedelics businesses

Section 280E is a federal tax provision that penalizes “traffickers of Schedule I or II drugs” by disallowing the deduction of “ordinary and necessary” business expenses — such as below-the-line deductions — after reducing gross receipts by the cost of goods sold (COGS).

The main outcome of this provision is that federal income tax liability is calculated based on gross income rather than net income, as in most businesses.

The main substances that have been legalized under the Natural Medicine Health Act are:

• Dimethyltryptamine (DMT)
• Ibogaine (a constituent of
• Mescaline (not from peyote)
• Psilocybin (a constituent of “magic mushrooms”)
• Psilocyn (a constituent of “magic mushrooms”)

These substances are all classified as Schedule I controlled substances (the same as heroin or cocaine) and, as such, businesses involved in the use of these psychedelics in healing centers, manufacturing plants or testing facilities are liable for the federal tax.

In fact, any “plant-touching” psychedelics business in Colorado that is compliant under state law effectively becomes a criminal enterprise “trafficking in a controlled substance” under federal law — and liable for higher tax payments than regular businesses.

Colorado state law, has, however, attempted to soften the blow for psychedelics businesses. Licensed businesses will be able to deduct expenses from their state taxes. This is considered a partial workaround to the federal 280E provision.

Filing tax returns as a psychedelics business

Businesses looking to enter the psychedelics sector should consider how to set up and then regularly assess their federal tax compliance under Section 280E after they are established.

Normal business decisions such as the choice of entity, accounting methods, ownership structure and so on, take on greater implications for psychedelics businesses. Therefore, before you get started, it’s best to consult with a psychedelics industry legal or tax professional about how to proceed.

All decisions made at the start of your venture can have great implications further along the line. Tax rates and tax penalties can quickly eat up profits and place both new and established businesses in financial strife.

Of particular importance to your tax liability is the calculation and substantiation of cost of goods sold. Another important tax consideration for psychedelics businesses is that licensees operating more than one license type or licensed location may be better off conducting each activity and location as a separate trade or business.

Some businesses severely impacted by Section 280E might also be better off establishing a separate primary trade or business that is not “plant touching” — which may permit deductions for certain ordinary and necessary business expenses that would otherwise not be allowed.

Dealing with tax issues

The key to dealing with tax issues is to prevent them from occurring in the first place — with the right legal and accounting advice at the beginning.

Consider your options with psychedelics business formation beforehand and structure your business carefully according to the best advice from a tax perspective.

One of the main risks is a future audit (which should be expected at some point). This can lead to a large federal tax liability upon reassessment of Section 280E adjustments in prior year tax returns. Seek legal assistance advice on this if you are concerned about this risk.

The IRS is still catching up with cannabis businesses about tax issues and is years behind following the flood of cannabis legalizations around the country but that doesn’t mean that psychedelics business owners can take a nap.

The industry is nascent and high on the radar of the authorities, so business owners should expect issues to arise and make the necessary moves now to prevent tax issues or deal with them efficiently if they do arise.

Get the tax advice you need for your psychedelics business…

One of the great challenges for psychedelics businesses in Colorado is complying with federal laws even when operating in compliance with state law.

When it comes to tax, this is a particular challenge that needs addressing with reliable legal and tax  advice. Mistakes with tax issues can be especially costly.

Whether your specialist field is research, development, commercialization or a medical practice involving psychedelics, you can get reliable legal advice and support by calling 866-329-0729 for a consultation with a knowledgeable psychedelics attorney.