Cannabis, legalization and taxes: The debate continues

A look back to 2013 marijuana tax law

By Richard Drew

 

On your mark, get set … WAIT!

 

Potential business interests in Washington, waiting for the legislature to promulgate the rules and regulations under which said businesses will be allowed to grow, distribute or sell cannabis, gained some direction from state representatives on May 14, 2013.

 

Washington announced its draft rules and fees for gaining a license akin to a liquor license for potential Cannabis investors. The state, after passage of law by voters in the fall of 2012, has until the end of 2013 to finalize the rules. However, the legalization of Cannabis for recreational or medicinal uses has a significant caveat when it comes to business interests.

 

The growing, selling and distribution of Cannabis continues to be a violation of Federal law. Why is this significant when the Federal government seemingly has taken a hands-off approach to the criminality of Cannabis interests in Washington and Colorado?

Taxes!

 

While the announcement of the rules for licensing may be cheered by businesses in Washington and Colorado, potential investors should take a closer look. While the Feds don’t seem eager to prosecute such entities criminally, they have an Ace up their sleeves in the Internal Revenue Service. The specific provision is found in the IRS Code, Sec. 280E.

 

Simply put, any business found to have broken Federal law loses any and all business deductions when filing its tax returns. Thus, the normal expenses a business would deduct from its taxable income in any year – rent, power, salaries, inventory costs to name a few – would be disallowed by the IRS.

 

Take a simplified calculation, based on a potential cannabusinesses in Washington that earns $1,000,000 in 2014. Normally, say, that business pays $100,000 in salaries, rent is $75,000 a year, and seed and operational costs are another $125,000.

 

Taxable income, just from these numbers, is reduced immediately from that $1 million to $700,000. At a taxable rate of 39 percent, that means the business would owe $273,000 – leaving a net profit of $427,000.

 

Due to the 280E violation, however, that tax bill is actually $390,000. The difference is significant. Businesses in California already have been hit by the IRS, and are in the process of appealing rulings from the tax court.

 

“You better take that into account,” said Nicholas Paleveda, CEO of National Pension Partners, speaking to a group of lawyers the week of May 20. “It’s like a really big B&O [business and occupation] tax. And you will be audited.”

 

For those businesses whose business plans can account for the potential tax implications of a Cannabis enterprise, the Washington draft rules are out.

 

Under the proposed guidelines issued by the Washington State Liquor Control Board, licenses to grow, process and sell the marijuana would each cost $1,000 per year, in addition to a $250 application fee. Growers and processors cannot double as retailers. Exactly how many retail licenses will be issued by the state remains uncertain. Those licenses will be issued on a county by county basis.

 

In counties with more qualified applicants than there are licenses available, a lottery system will be held to see which businesses are granted the licenses. By contrast, no limits are expected to be set on the number of grower and processor licenses, nor on the size of those operations. The draft rules do say that Cannabis must be grown indoors, and tested for contaminants and potency.

 

The proposed rules “create a very tightly controlled and regulated market but at the same time allow for reasonable access for small and large businesses to participate,” said Mikhail Carpenter, a spokesman for the Liquor Control Board, in a statement. “We’ve been working on this for eight months and we’re still working on it, but it’s the first time that people get to see what it’s going to look like.”

 

These rules are only a draft at this point, and could be tweaked before the end of 2013.

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