Cannabis-ancillary Businesses Have an Unexpected Upside: Hemp R&D Tax Credits

Tyler Kem, EA
Co-Founder & President

Plant-touching businesses, or businesses “touching” the hemp plant, may be the first kind of business that comes to mind when you think about cannabis. If you’re in a state that legalized marijuana, you’ve probably seen marijuana dispensaries pop up all over town. Consequently, they’re often the most visible part of the cannabis industry. 

For savvy entrepreneurs that want to tap into this nascent industry but hesitate to jump into a public-facing cannabis shop, they should consider some of the financial advantages of investing in a cannabis-ancillary business. The R&D tax credit, popular for decades with American innovators, can now be claimed by business owners in some cannabis-adjacent businesses. 

There are seven or eight cannabis-related businesses that support every retail shop. It’s vitally important, however, for entrepreneurs to understand which businesses qualify for the hemp R&D tax credit before they try to capitalize on this lucrative opportunity.

Industrial Hemp and Medical Marijuana: What’s the Difference?

To take advantage of the hemp R&D tax credit, businesses need to familiarize themselves with the specific requirements outlined by the IRS and the 2018 Farm Bill. This recent legislation expanded hemp cultivation broadly, with Brookings reporting that “It explicitly allows the transfer of hemp-derived products across state lines for commercial or other purposes. It also puts no restrictions on the sale, transport, or possession of hemp-derived products, so long as those items are produced in a manner consistent with the law.”

It’s taken nearly two years for the USDA to finalize government rules for hemp and it continues to refine its approach based on public feedback, but here are the current guidelines for industrial hemp and medical marijuana.

Industrial hemp is the cannabis sativa plant that contains less than 0.3% THC. It is legal in all 50 states and also at the federal level. Usually cultivated outdoors, the entire plant can be used, from root to bud. 

Marijuana is any cannabis sativa plant that exceeds 0.3% THC. Medical marijuana is currently legal in 39 states, but still illegal at the federal level. Shorter and bushier than industrial hemp plants, commercial marijuana is usually grown indoors. 

While the plants look different, the federal government only cares about their THC content. The USDA requires growers to submit samples of their crop to USDA labs to verify that the hemp meets current regulations. Any crop that’s “hot”, or that exceeds the legal amount for THC, must be destroyed by the farmer.

Seeds, leaves, roots, and stems of the industrial hemp plant can be used in a variety of industries including animal bedding, soap, medicine, and food.

Potentially Qualifying Hemp Activities

Because “cannabis-adjacent businesses” is such a broad term, it’s helpful to think about the kinds of activities that could qualify for the tax credit. Just like the original R&D tax credit, qualifying hemp activities need to meet the four-part test. 

  1. Develop or improve a new product, process, formula, or software.
  2. Evaluate feasibility of a new product, process, formula, or software through a process of elimination.
  3. Rely on principles of hard sciences like chemistry, biology, computer science, or engineering.
  4. Use a process of experimentation to eliminate uncertainty.

Applying the four-part test to hemp activities might look like:

  • Building software to track seed-to-sale inventory
  • Improving the extraction process for optimal yields
  • Automating a manual process
  • Designing or improving new storage or extraction facilities
  • Creating childproof bottles or containers
  • Developing POS applications for inventory management or sales
  • Experimenting with the drying or extraction process
  • Improving seed quality, crossbreeding strains, or analyzing genetic traits
  • Creating bio-products like hempcrete, insulation, bioplastic, or biofuel

Identifying Opportunities in the Hemp Industry

Since only industrial hemp was legalized by the 2018 Farm Bill, plant-touching businesses cannot take advantage of the R&D tax credit. Fortunately, manufacturing companies, ag-tech, software developers, accountants, lawyers, and anyone else that serves the hemp industry can claim the credit.

Think of industries usually engaged in research and development, and then put a hemp spin on it. For example, canna-tech businesses, or those that are building mobile or native apps to support a cannabis business, can claim the same credits that a software company in the fintech space claims. Product development for hemp products, like smoking devices or new formulas, could also qualify.

Claiming the Hemp R&D Tax Credit

Research group New Frontier Data projects that the cannabis industry will be worth $30 billion a year by 2025. The hemp R&D tax credit is a tremendous incentive for entrepreneurs to take a chance on this billion dollar industry and get in on the ground floor. 

The IRS will scrutinize hemp R&D claims more than any other type of R&D claim. Providing substantial documentation and partnering with a tax advisory firm that understands the ins and outs of this niche tax law will help new hemp businesses claim thousands to reinvest in their bottom lines. Feel confident about your industrial hemp tax claim when you contact HempTax today.

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