Outdated Federal Tax Law Impacting Cannabis Industry

By Anakka Hartwell

The operations of a cannabis business are like any other businesses. You have salaries to pay, healthcare, products to buy, insurance, rent, office supplies and all the general costs of running a business.  Fortunately, these costs can be included on both your State and Federal Tax return to reduce Net profit, thereby reducing your tax liability – except, of course, if you are in the Cannabis Industry.

Item 280e in the IRS Tax code does not allow the retail costs of marijuana businesses to be claimed as tax relief. Whether it is health insurance for its employees, payroll, improvement, advertising, or any ordinary business expense normally recognized for a business, nothing can be taken as a deduction on the retail level because it’s considered drug trafficking. On the cultivation side, because it’s considered agriculture, we can take some deductions but again they are limited.

For example, if a retail store in Washington has a gross of 1 million dollars, but spent $500,000 to purchase the inventory it sells and another $400,000 in cost associated with rent, security, insurance, salaries and employee benefits, advertising, legal fees, inventory and tracking software, license fees, utilities, etc., and ultimately end up with $100,000 in profit, the retailer is Federally taxed on the $500,000 in transactions without the ability to deduct costs.

The IRS has tax codes for everything, including Political Bribes both foreign and domestic, embezzlement, prostitution, and drug trafficking.  During the 1930’s the IRS was used as a way to arrest bootleggers (production, possession, transportation and selling of alcohol) in an effort to arrest and control the prohibited substance.  Many bootleggers were arrested and charged on a Federal level for not paying Federal taxes from income derived from the production, transportation and sale of an albeit illegal substance.  Some of these cases went as far as the Supreme Court of the United States with the Court expressing no embarrassment about letting the government share in the profits of an unlawful business, issuing the following ruling:

“We see no reason … why the fact that a business is unlawful should exempt it from paying the taxes that if lawful it would have to pay.” – Justice Oliver Wendell Holmes, United States v. Sullivan, 274 U.S. 259 (1927), unanimous decision.

In the 21st century, having ended the prohibition on Alcohol, followed in the same decade with the prohibition of hemp and cannabis, which is now a Classification 1 drug along with heroin, meth, hydrocodone, and opium, State legal medical and recreational cannabis is taxed under 280e as “income derived from drug trafficking of a controlled substance.”  These antiquated tax laws have been undermining the cannabis industry since the introduction of legal cannabis this century.

However, On March 30, 2017 Senators Ron Wyden (D-OR), Rand Paul (R-KY), Michael Bennet (D-CO) and Patty Murray (D-WA) introduced Senate Bill S-777 which received two readings and was then referred to the Committee on Finance as;

“A BILL To amend the Internal Revenue Code of 1986 to allow deductions and credits relating to expenditures in connection with marijuana sales conducted in compliance with State law. The bill shall be cited as the “Small Business Tax Equity Act of 2017” (follow at https://www.congress.gov/bill/115th-congress/senate-bill/777).

Section 2 of the bill provides:

ALLOWANCE OF DEDUCTIONS AND CREDITS RELATING TO EXPENDITURES IN CONNECTION WITH MARIJUANA SALES CONDUCTED IN COMPLIANCE WITH STATE LAW.

This is great news for struggling cannabis businesses who could owe more taxes than profit earned.  The bill will not be retroactive, but if passed this year the bill will apply to all Federal 2017 tax returns.  There is a cost however.  The bill allows for a Federal Excise tax which scales over time.  Year one will be 10% on top of the sales tax and state excise tax already paid by a consumer, to 20% in 2018, 30% in 2019 and culminating with 40% in 2020.  Let’s break this down and how it will affect the cost of cannabis.

Presently in Washington you can visit any cannabis retailer and buy one gram of cannabis for $20.00.  In addition to that you have a 10% sales tax, and a 30% excise tax.

Product cost $20.00

Sales tax    2.00

Excise tax    7.40

TOTAL                        $29.40

Fed excise tax                 2.00

TOTAL                        $31.40

This is great for the businesses, but not so great for consumers.  On the black market an ounce goes for $200, and a pound (16 ounces) can be picked up for between $1,500 and $2,000.  With 28 grams in an ounce this works out to be a little over $7 a gram.

So where is the incentive for the consumer to pay 4-5 times more at a legal recreational store?  There are several considerations with the most obvious being that it is illegal and you will save the cost of an attorney and the mark on your criminal history for buying on the black market if caught.  Second, by buying at legal state licensed store you are encouraging the Federal Government to remove cannabis from a schedule 1 drug to a nonscheduled legal drug like alcohol and tobacco.  Third you are encouraging the growth of the small business market in your State where the excise tax funds will go to things like education and health services.  Additionally, there are many third party businesses that provide testing, packaging, advertising and more that will pay taxes that add to the community and state economies.

Overall, this is a step in the right direction to end the prohibition on cannabis and the needless incarceration of American citizens for merely possessing and selling minor amounts of cannabis.  Already this year, Ohio Supreme Court Justice O’Neil on his platform has called for the release of all prisoners convicted for minor drug cannabis crimes in Ohio and other states saying that “The cost of incarceration of each prisoner costs the state $24,000 each year, which would give the state an additional 100 million to spend on health care,” along with Canada’s Prime Minister Justin Trudeau’s order to release all cannabis drug offenders from Canadian Jails.  Here in Washington, according to Washington State Department of Corrections there are no prisoners incarcerated due to cannabis possession.   By 2020 the United States shall see the end to needless prohibition on Cannabis and the opening of new business potentials and clean green products in the hemp industry.

Anakka Hartwell
Chairman of the Board THC Inc Transparency Helps Cannabis
CEO CannaCloud Technologies Software – Inventory and Tracking Compliance
Founder CannaGlow Intimacy Products