Marijuana and Taxes. The legalization of cannabis use and sales is becoming more widespread. What Tax consequences should tax payers be aware of?
We opened a cannabis business in a legalized state, is there anything we should be aware of? Yes! With legalization of cannabis comes a myriad of concerns about health, social and criminal justice impacts, as well as questions about revenue implications. While many states in the U.S. have legalized or decriminalized sales and recreational usage of marijuana, it is still illegal federally, and therefore, cannabis entrepreneurs should be mindful of the tax consequences associated with their business. Cannabis trades and businesses are required to file federal income tax returns and pay federal income tax. These businesses must also file at the state level. However, cannabis trades and businesses are significantly limited in taking deductions or credits at the federal level.
What should we know about section 280E? Specific to Marijuana and Taxes. Section 280E provides that no deduction or credit is allowed for any amount paid or incurred during the taxable year in carrying on any trade or business which consists of trafficking a Schedule I or II controlled substance (cannabis!). In other words, if you are involved in the cannabis business, you must pay taxes on the entirety of your revenue without taking advantage of any business expense deductions that would otherwise be available to reduce tax liability. The purpose of 280E is to preclude drug dealers from taking advantage of deductions allowed to legal enterprises – allowing a deduction would have a similar effect to subsidizing drug dealing.
While section 280E does provide an exception allowing a deduction for the “cost of goods” sold, the IRS has applied this provision very narrowly to cannabis companies. “Cost of goods” are essentially inventory costs.
Is there any other way to take advantage of deductions specific to Marijuana and Taxes? Yes! In CHAMP v. Commissioner the Tax Court held that medical marijuana dispensaries could deduct “ordinary and necessary” business expenses under section 162 in certain circumstances. In CHAMP, Petitioner owned a medical marijuana business, whose dual purposes were to provide caregiving services to members who all had debilitating diseases and to provide members with medical marijuana. The court stated that in passing 280E, Congress intended to disallow deductions attributable to a trade or business of trafficking in controlled substance, not to deny a deduction for all ordinary and necessary business expenses. The court held that CHAMP’s two separate business structure allowed a deduction for those expenses unrelated to the sale of cannabis.
The lesson taxpayers can take from CHAMP is that two distinct business models may allow a taxpayer to circumvent 280E to a degree. While a taxpayer cannot deduct the portion of the expenses allocated to the selling of cannabis, they may be able to deduct other business expenses as long as they are distinct and separate – and not incidental to – the sale of cannabis.
However, taxpayers should note that the Tax Court has been weary of applying CHAMP. In Olive v. Commissioner, the Tax Court struck down Petitioner’s argument that his business was similar to the one in CHAMP, stating that Petitioner had failed to show that one businesses’ activities or services were independent of the dispensing of medical marijuana. Olive established precedent that the Tax Court will hold medicinal marijuana facilities to a strict standard in determining if it actually offers multiple lines of businesses.
How should we expect to be taxed at the state level? As more states move towards the legalization of recreational cannabis, each state must figure out how to establish a legal market and how to approach taxing sales. As of January 2019, seven states had established legal markets with some form of sales tax. These states include Alaska, California, Colorado, Massachusetts, Nevada, Oregon and Washington. Different tax structures implemented include price-based excise taxes, state-level general sales taxes, and weigh-based excise taxes. Maine legalized recreational usage in 2016, but has yet to establish a legal market, although state directors have stated the state is on track to roll out its legal market this year, and tax consequences are sure to follow. Michigan is also in the process of regulating and licensing their legal market. Vermont legalized possession of recreational cannabis in 2018 but has yet to create a legal market. D.C. and New Hampshire also allow the possession and cultivation of cannabis but have not created a legal market. Those interested in opening a business in a state that has established a legal market for the sale of cannabis should look closely at their individual state’s tax structure for more information on what to expect.
We plan on opening a business in California, what should we expect? Currently, California imposes a 15 percent excise tax upon retail purchases of all cannabis and cannabis products, including medicinal marijuana and CBD products containing cannabis (although there are some exceptions for medicinal cannabis sales under Proposition 64. Distributors are required to calculate and collect the amount of excise tax due. As a retailer, you must pay the excise tax to your distributor and collect the cannabis excise tax from your customers. Keep in mind that you are required by law to keep business records that accurately reflect your sales.
We looked at my state tax rates and they’re high! What’s the benefit of taxing cannabis sales so heavily? Implementing effective taxing policies for the sale of cannabis can have a myriad of benefits beyond stimulating the economy. Special excise taxes and high rates may discourage over usage. Furthermore, taxes can raise revenue that can then offset potential social costs of legalization, as well as contribute to education on safe usage. Moreover, as cannabis moves towards decriminalization in many states, revenues can also work to remedy past social costs of criminalization.
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Published by Hannah Karraker