The 2023 Budget

Last week, the New York Legislature passed the State’s 2022-2023 Budget. The $220 billion Budget reflects an $8 billion increase over last year’s budget (a more than 3 percent jump). It is also $4 billion more than what the Governor had initially proposed. In fact, it is the largest spending bill ever to have been enacted by Albany.

I suppose the explanation is obvious: bolstered by still unspent Federal stimulus money[i] and better than expected tax revenues, the Governor and the Legislature decided to be especially generous to their constituents during this election year.[ii]


Although the Budget includes the usual categories of expenditures we have come to expect from Albany, it also introduces certain tax-related measures, some of which are certain to be welcomed by the general business community, and a few that may be meaningful to certain industries.

For example, pursuant to an amendment to the Pass-Through Entity Tax,[iii] if an electing S corporation certifies that all its shareholders are New York residents, its tax base for purposes of calculating the tax will be expanded to include non-New York source income on which the resident shareholders are subject to tax in the State. In addition, the Budget enacted a New York City version of this entity-level tax.[iv]

The foregoing measures will enable many New York business owners, across many industries, to further reduce their federal income tax liability by taking greater advantage of the limited SALT cap workaround “approved” by the IRS in 2020 and adopted by New York in 2021.[v]


Of course, as is often the case, the Budget also contains other measures that are more industry specific. Among these is a tax provision that the Legislature hopes will benefit a relatively new industry that Albany[vi] has sought to foster over the last few years: cannabis.

New York on Cannabis

The use of cannabis for medical purposes has been permitted in New York since 2014. Its recreational use was legalized only recently, in March of 2021. The licensing of New York hemp farmers to grow cannabis crops was just authorized in February of this year.

However, New York is hardly alone in adopting such measures – in fact, it is only one of 37 states that allow the medical use of cannabis and one of 18 that allow its nonmedical use by adults.

For better or worse, more states are sure to follow; in fact, according to a recent survey, more than 60 percent of Americans favor the legalization of cannabis for medical and recreational use.[vii]

The Feds

Indeed, just days before the approval of New York’s Budget, the House of Representatives voted to decriminalize marijuana, and Senator Schumer indicated he would be introducing a similar bill in the Senate later this month.[viii]

A couple of months earlier, the House passed a bill that would allow banks to offer various financial services to cannabis businesses.

Unfortunately for the cannabis industry, the House has previously passed other versions of these bills only to watch them wilt away in the Senate.[ix]

Thus, notwithstanding what appears to be growing public support for legalization, cannabis remains illegal under Federal law as a controlled substance.[x]

Section 280E

Its status as such triggers the application of the much-reviled (at least among supporters of the industry) Section 280E of the Code, which effectively increases the cost of operating a cannabis business by a significant amount, even in a state in which it is legal to engage in such a business.

According to Section 280E of the Code:

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.

In other words, in determining its Federal taxable income for a tax year, a cannabis business will not be allowed to deduct the “ordinary and necessary expenses” that it pays or incurs during the tax year in carrying on the business including, for example, compensation for services, rent for the use of property, and even depreciation.[xi]


Over the years, many cannabis businesses have disputed the validity of this “deduction disallowance” rule in the courts, sometimes relying upon principles of Federalism and the Tenth Amendment[xii] to call into question the IRS’s position that Federal law has preempted state law in this matter notwithstanding that local criminal activity has traditionally been the responsibility of the states.

To date, the arguments proffered by cannabis businesses and their owners have not been successful. Consequently, such a business continues to be denied the benefit of a federal tax deduction for what would otherwise be characterized as an “ordinary and necessary” expense[xiii] of the business that would normally be accounted for in determining the federal taxable income of the business.

However, the economic impact of the Federal denial or disallowance of such deductions does not end with the IRS. That’s because most states, including New York, require their business taxpayers to calculate their state income tax liabilities by beginning with their Federal taxable income.

Conformity vs Decoupling

Many years ago, New York revised its income tax laws to achieve close conformity with the Federal system of income taxation. The stated purpose for the revision was to simplify tax return preparation, improve compliance and enforcement, and aid in the interpretation of tax law provisions. In furtherance of this policy of conformity, as the Code is amended by Congress, New York “automatically” adopts the Federal changes.[xiv]

However, New York’s Tax Law does not conform to the Code in all respects. Indeed, there are a number of instances in which New York has chosen not to conform to – where it has “decoupled” from – specific provisions or amendments of the Code.[xv]

By far, the most significant example of New York’s conformity to the Code is found in the State’s computation of a New York taxpayer’s State income tax liability; this begins with the taxpayer’s Federal adjusted gross income, though this amount is then modified by certain New York “additions” and “subtractions” – basically, items for which New York has decided a different tax treatment is appropriate for its own purposes.

The Budget introduces another instance in which New York has decided to decouple from the Federal tax law; specifically, with respect to the disallowance rule of Section 280E of the Code.

Cannabis Under the Budget

The preamble to the Budget legislation includes a statement that it intends to amend the Tax Law “in relation to permitting deductions for commercial cannabis activity (Part PP).”

The full text of the relevant Budget provision is as follows:[xvi]

Section 1. Paragraph (a) of subdivision 9 of section 208 of the Tax Law is amended by adding a new subparagraph 23 to read as follows:

(23) The amount of any federal deduction disallowed pursuant to Section 280E of the Internal Revenue Code related to the production and distribution of adult-use cannabis products, as defined by Article Twenty-C of this Chapter, not used as the basis for any other tax deduction, exemption, or credit and not otherwise required to be added back by paragraph (b) of this subdivision in computing entire net income.

Section 2. Subsection (c) of section 612 of the Tax Law is amended by adding a new paragraph 46 to read as follows:

(46)  the amount of any federal deduction disallowed pursuant to section 280E of the Internal Revenue Code related to the production and distribution of adult-use cannabis products, as defined by Article Twenty-C of this Chapter, not used as the basis for any other tax deduction, exemption, or credit and not otherwise required to be added back by subsection (b) of this section in computing New York adjusted gross income.

Section 3. This act shall take effect immediately and apply to taxable years

beginning on and after January 1, 2022.

According to Section 208(9) of the New York Tax Law, to which the above provision refers, the entire net income of a corporation is presumably the same as the entire taxable income which the taxpayer is required to report to the IRS.

However, paragraph (a) “of subdivision 9 of section 208,” provides that “[e]ntire net income shall not include:” and then sets forth a number of revisions that must be made to the taxpayer’s Federal taxable income before determining the taxpayer’s New York income tax liability.

Reduced New York Tax

With the addition of the above-described Budget modifications to the Federal taxable income of a New York cannabis business, such a business will be allowed to deduct its ordinary and necessary business expenses in determining its New York income tax liability.

Moreover, the business will continue to capitalize those expenses that must be accounted for in a product’s COGS for New York tax purposes; it will recover these expenses upon the sale of the product.[xvii]

What’s Next?

By virtue of the changes made by the Budget, New York has now joined a number of other states[xviii] that allow cannabis businesses to deduct their business expenses for purposes of determining their state income tax liability.

Although this development will certainly provide some economic relief to cannabis businesses that operate in high-tax states – like New York, especially following its 2021 tax rate increases for corporations (from a rate of 6.5 percent to 7.25 percent) and individuals (from a top rate of 8.82 percent to new rates ranging from 9.65 to 10.9 percent)[xix] – it remains to be seen what the longer-term economic impact thereof will be.

After all, these same states are also imposing significant sales tax burdens upon their cannabis businesses; in excess of 13 percent in the case of New York, for which a cannabis business will presumably be allowed a state income tax deduction.[xx]

In the end, the federal income tax will continue to represent a huge cost of doing business. Let’s see what happens in the Senate in the coming weeks as it deliberates decriminalization.

Stay tuned.

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The opinions expressed herein are solely those of the author(s) and do not necessarily represent the views of the Firm.

[i] Liberally distributed by Washington in response to the economic downturn caused by the pandemic.

[ii] For example, approximately 2.5 million low- and middle-income homeowners will receive an aggregate $2.2 billion property tax rebate this fall – just before the election.

Then there are the Buffalo Bills and their new stadium about which so much has been written. All I can say is they are the only NFL team representing New York that actually plays in New York.

[iii] New York Tax Law Sec. 861 et seq.

[iv] Probably the first local (as opposed to state) jurisdiction to which the SALT cap workaround has been applied.

[v] IRS Notice 2020-75

More on these changes in a later post.

[vi] And indeed, New York’s representatives in Congress.

[vii] .

Query whether there is a correlation between the desire to “self-medicate” and an increased feeling of impotence. Viscerally, you’d probably agree, but check out this study from Wake Forest:

There are also reports that sales of marijuana and other cannabis-derived products (edibles, for example) skyrocketed during the pandemic.

Speaking for myself, of course, I side with Saruman, the Lord of Isengard, when he says to Gandalf, “your love of the halflings’ leaf has slowed your mind,” and then again, when describing Radagast the Brown as a “foolish fellow,” he says, “It’s his excessive consumption of mushrooms! They’ve addled his brain and yellowed his teeth!”


[ix] Apologies, I couldn’t resist.

[x] Controlled Substances Act (P.L. 91-513), as amended.

[xi] However, it is important to separate business expenses (which are not deductible under IRC Sec. 280E) from the expenses used to figure the cost of goods sold (COGS). If a business manufactures products, or purchases them for resale, it generally must capitalize, and include in its COGS, the direct costs and part of the indirect costs for certain production or resale activities. The COGS is not a “deduction” within the meaning of the Code, but it is subtracted from the gross receipts of the business to determine its gross profit for the year; the costs included in COGS are recovered upon the sale of the product (as opposed to the tax year in which they were paid or incurred). In other words, the disallowance of a deduction under Sec. 280E does not preclude a taxpayer from taking an expense into account in its COGS in determining the taxpayer’s profits from the sale of a product.

It is also important to note that Sec. 280E is not limited to disallowing deductions; other tax benefits are also denied. For example, the Chief Counsel’s Office recently advised that an employer was prohibited under Sec. 280E from entitlement to the IRC Sec. 51 work opportunity tax credit (for which it was otherwise eligible) for wages paid or incurred in carrying on a business of trafficking in marijuana. CCA 202205024.


[xiii] IRC Sec. 162.

[xiv] So called “rolling conformity.”

[xv] For example, New York elected not to conform to parts of the 2017 Tax Cuts and Jobs Act (P.L. 115-97). By decoupling, New York effectively became a “fixed date” conformity jurisdiction; it applies the Federal law as it was prior to the Federal changes.


[xvii] This is the same as the federal rule.


[xix] New York was among just a handful of states that actually increased its tax rates during the pandemic. You may remember that the Legislature was calling for much more in the way of tax hikes.


Query whether, at the end of the day, the principal beneficiaries of legalization will be the tax-collecting states and lower-priced illicit businesses.