Marijuana (or Cannabis, or MM). It’s not a new thing, but with the explosion of legal medical marijuana, it’s the new BIG thing. In this article, IRS tax attorney Jeffrey Anton Collins takes a closer look at the taxation issues faced by legal cannabis businesses.
Growers, cultivators, and dispensers expect to make huge profits on the sale of cannabis products. Just like with any other lawful business, distributors expect to pay their fair share of tax on their profits. The fair share of tax – no less, but no more.
Unfortunately, the IRS thinks differently. In some cases, the federal government wants to receive much more than its fair amount of tax on medical marijuana profits. IRS wants the entire pot o’ gold. Here’s how:
Basically, taxable income for businesses begins with revenue (ie: sales). Then, under IRS Code §62(a)(1), businesses can deduct the reasonable, ordinary necessary costs of incurring that revenue. For example, such costs could include product costs, labor, promotional costs, rent, etc. What remains after deducting these §62 expenses is the business net profit. And it is the business’s net profit that gets taxed. Fair enough?
For cannabis distributors, however, the IRS takes a different position. The government has established new rules, referring to a much older federal tax code §280E, which requires:
“No deduction or credit shall be allowed for any amount paid … if such trade or business … consists of trafficking in controlled substances … which is prohibited by Federal law ….”
But This Doesn’t Affect the MM Industry, Right?
Medicinal marijuana businesses have been legalized in many states already. More states are taking the “high” road every year, in legalizing the use of cannabis for medical treatment.
But here’s the problem: The Controlled Substance Act (Title 21 United States Code) lists all drugs considered to be unlawful under federal law. It does not (yet) matter if under state law, where the sale of medicinal marijuana has been decriminalized. This is because federal law (in this case, 21 U.S.C. §812(c)) still lists marijuana as an illegal, Schedule II controlled substance. As we also know, federal laws (here, those laws affecting drugs, taxes, etc.) are not impacted by laws of any state.
So This is What Happens …
Cannabis is still an unlawful drug under federal law. Therefore, tax code §280E says that the business cost of distributing medicinal marijuana is not an allowable business deduction. If cannabis dispensaries are not allowed to write-off their costs of doing business (except for the cost of the product), then those distributors become taxed on their full sales profit – not business net profit.
Here’s an illustration. Distributor sells a $100 order of cannabis, which cost Distributor $50 to purchase. Easily enough, we see that Dispensary has $50 sales profit. Then, Dispensary also incurs $30 of business costs (rent, utilities, labor, etc). From the $100 sale, the business’s net profit is only $20 ($100-$50-$30=$20).
But under the new IRS rules, the U.S. government assesses its tax on the $50 sales profit, resulting in nearly a $20 tax ($50 x 40% assumed tax rate) on the sale. All other “legal” businesses would only pay $8 at the same 40% IRS tax, but only on their $20 net profit. In this case, Distributor’s $20 tax result looks like a 100% federal tax on its $20 business’s net profit.
Plus, it also still has to pay state tax! Over 100% tax? Really?!!
Unfortunately, that result obviously costs marijuana dispensaries much more than its fair share of taxes. This is an unfair result, and must be revisited by the U.S. Tax Court. Related bills are also before Congress.
So Can Cannabis Businesses Fight The IRS?
Yes! In many cases, cultivators, producers, and dispensers of cannabis can fight the IRS against this unfair taxation. This challenge against IRS does not begin with the IRS examination. Instead, it begins with the strategic planning of those business deductions, in anticipation of the IRS audit.
We’re doing it. It can be done. For expert IRS tax attorney representation in Downers Grove and the rest of the Chicago area, get in touch with tax lawyer Jeffrey Anton Collins today!