Impact Of 280e On MSO Income

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This brief article shows the impact of 280E on the net income after taxes for 11 of the largest, vertically integrated, publicly held MSO companies. These 11 were selected because of their size and the fact that they disclosed the dollar impact of 280E on their taxes in their audited financial reports for the year ended December 31, 2021.

Biden Provides Catalyst

MSO stocks were setting new 52-week lows on almost a daily basis prior to 3:00pm on October 9th when President Biden announced a major change in the Administration’s cannabis policy. Particular attention was paid to his call for an immediate review by the Secretary of Health and Human Services of marijuana’s Schedule 1 drug status.

Investors hope marijuana will be descheduled and 280E will be removed. The onerousness of 280E has often been cited as the primary reason why MSO lack profitability and cash flow.

The president’s speech sparked an immediate sharp increase in MSO stock prices and volumes. Most MSO stocks were trading near 52-week lows prior to the speech, but most closed up 30-50% for the day.

280E

In 1982 Congress created Section 280E of the Internal Revenue Code, IRC, which significantly limited the business expenses that a cannabis company could deduct. It 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.”

The DEA has categorized marijuana as a Schedule 1 substance alongside, heroin, ecstasy and LSD enabling the IRS to apply 280E to cannabis companies. Numerous expenses that are normally deducted for federal tax purposes by companies are denied for cannabis companies. The list of expenses that cannot be deducted include advertising, marketing, bad debts, board meeting expenses, business association dues, vehicle expenses, charitable deductions, legal fees, office supplies, payroll processing, payroll taxes for employees (including Social Security, Medicare and unemployment taxes), parking, tolls, sales staff salaries and wages, equipment and repairs, furniture and fixtures, rent, home office expenses, insurance premiums, shipping costs, computer software and equipment, utilities, website, workers compensation, and many more things.

The negative impact of 280E is exacerbated by state taxation laws. Most states rely on company tax filings with the IRS; therefore, the negative impact of 280E is magnified. Cannabis companies pay higher federal and state taxes because of the existence of 280E.

The Data

The following exhibit shows the net income after taxes “NIAT” of 11 MSOs for their most recent fiscal year ended 2021. Earnings per share “EPS” are also shown and were calculated based on the weighted average number of fully diluted shares reported in the audited financial statements.

280e Impact

SEDAR

As revealed in the exhibit, only three of the 11 MSOs: Green Thumb (OTCQX:GTBIF), Trulieve (OTCQX:TCNNF), and TerrAscend (OTCQX:TRSSF) reported positive net income after taxes for 2021. Green Thumb’s net income of $75.4M was over four times larger than Trulieve, which reported net income of $18.0M million. TerrAscend had the lowest net income of the three at $9.6M.

The 11 MSOs combined had a net loss after taxes of $712.6M in 2021. The largest loss was reported by Cresco Labs (OTCQX:CRLBF) -$319.6, because it took impairment charges of $305.9M in 2021. The second largest loss was reported by Columbia Care (OTCQX:CCHWF) -$143.1M. Interestingly, Cresco is supposed to acquire Columbia Care in Q4 2022.

Ascend Wellness (OTCQX:AAWH) reported the 3rd largest loss -$122.7M. It was followed by Curaleaf (OTCPK:CURLF) with a loss of -$102.7M.

Actual Reported Cost of 280E

The additional taxes reported because of 280E are shown in the exhibit as “280E Cost.” The cost of 280E in 2021 ranged from a low of $12.732M million at Goodness Growth (OTCQX:GDNSF) to a high of $102.128 M at Curaleaf (OTCPK:CURLF). In total, the 11 companies in the exhibit reported $452,224M in additional taxes because of 280E. Even without 280E these companies would have reported a combined loss, but it would have been $260.404M or 36.5% lower than what they reported.

Impact of 280E on 11 MSOs

The exhibit shows what the net income after taxes would have been for each of the 11 cannabis companies without 280E. Ayr Wellness (OTCQX:AYRWF) and Verano (OTCQX:VRNOF) are the only two that would go from reporting losses to reporting gains in 2021 if 280E did not exist.

The largest potential improvement in the dollar amount of net income after taxes would be for Curaleaf and Trulieve. Curaleaf’s 2021 income would go from a reported net loss after taxes of $102.7 million to a net loss of only $603,000, while Trulieve’s net income would soar from $18.0M to $103.7M. In the absence of 280E, Green Thumb would have reported net income of $116.3M, which would have been the largest net income among the 11 MSOs.

Of the 11 MSOs included in this study, six (6) that lost money in 2021 would have also lost money even if 280E did not exist. Those six MSOs are Curaleaf, Cresco, Columbia Care, Planet13 (PLNTF), Ascend Wellness, and Goodness Growth.

Conclusion

President Biden has given hope to forlorn MSO investors by encouraging an expeditious review of cannabis as a scheduled drug. It is arguably one of the greatest roadblocks to MSO profitability, free cash flow, and rising stock prices.

Investors, however, need to understand that even if 280E did not exist, six of the 11 largest MSOs companies would have still reported after tax losses for 2021. It is clear that removal of 280E will not magically turned the largest, vertically integrated cannabis companies into hugely profitable enterprises in 2021, but it is bound to help MSO stock prices.

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