The cannabis industry has been growing rapidly in recent years, but it faces a number of unique challenges when it comes to taxation. Federal tax policy, in particular, is limiting the industry’s growth.
The issue stems from the fact that cannabis is classified as a Schedule I drug under the Federal Controlled Substances Act. This classification means that the sale of cannabis is subject to a special tax, known as the “280E tax.” This tax is applied to all businesses that engage in the trafficking of controlled substances, and it significantly raises the cost of doing business for cannabis companies.
Because cannabis is still illegal at the federal level, even state-licensed businesses can't deduct many normal business expenses from their taxes. This leaves them at a disadvantage compared to businesses in other industries, who can deduct things like equipment, office space, and employee salaries.
Cannabis businesses are also subject to different tax rates than other businesses. For example, in California, cannabis businesses are taxed at a rate of 8.75%, while the state sales tax for other businesses is only 7.25%.
Businesses in the cannabis industry also find themselves in conflict with the IRS due to the unclear labor laws that help employers understand and differentiate employees from independent contractors.
So what is a legal cannabis business supposed to do? Let’s take a closer look at the issues surrounding cannabis taxation and some of the options available to business owners.
Different Channels the US Government Uses To Tax the Cannabis Industry
Customers purchasing edibles, dry flowers, vape oils, and topicals from dispensaries usually pay a sales tax that ranges between 6-10%. Illinois imposes higher taxes on products containing more than 35% THC. This system has negative effects on consumer demand.
Dispensaries usually allocate more inventory to products containing more than 35%THC due to their consistently high demand. Potency-based taxes have an impact on a product's final price and it often forces customers to make purchases from unlicensed vendors that offer items at half the price.
Effect of Potency Taxes on the THC Vape Oil Market
Potency taxes have highly affected the THC vape oil market and have historically pushed cannabis consumers to unknowingly purchase fake cartridges from dubious websites masquerading as authorized vendors. These unregistered products usually contain high amounts of pesticides and heavy metals because the manufacturer did not flush their dry flower properly before turning it into THC oil. Flushing is a cleaning process used to get rid of excess nutrients and pesticides on cannabis plants prior to harvesting, to make them safe for human consumption.
The Double Whammy Of State And Federal Taxes
Cannabis companies in the United States are taxed at a higher rate than most other industries. The top federal tax rate for corporations is 21 percent. However, cannabis companies are subject to a special tax rate of up to 37 percent. This is because – depending on the type of entity - they are classified as "pass-through" businesses, which means that their income is taxed at the personal tax rate of their owners.
State and local taxes can also add to the complexity of the tax landscape for cannabis businesses. In some states, cannabis businesses are subject to sales tax, while in others they are subject to an excise tax. Some states also have different tax rates for medical and recreational cannabis. The patchwork of state and local taxes makes it difficult for businesses to know how much they should be paying in taxes.
The Peril Of Being A Cash Only Business
Cannabis businesses are often forced to operate as cash-only businesses due to the lack of banking access. This is because banks are federally regulated and can be subject to criminal penalties for doing business with cannabis companies. As a result, many cannabis companies are forced to pay their taxes in cash, which can be costly and dangerous. More controls are required to ensure all cash is accounted for, which requires time and money that is not deductible. If cash discrepancies exist, the partners may need to recognize a distribution that didn’t take place.
The Conflict Between Employers & Tax Authorities
A cannabis cultivator may hire extra help during an unusually productive harvest to help with trimming and sorting out material in the drying room. This process usually takes two weeks or less and cultivators assume that the temporary workers are independent contractors. During the working period, the laborers will most likely receive their weekly payments in cash since cannabis businesses cannot deposit money in banks.
Local tax officials are known to make random visits to cannabis businesses to verify financial records and tax compliance. These officials can impose penalties on the cannabis cultivator on the grounds of withholding information regarding employees, yet most states have unclear cannabis labor laws.
IRS Tax Code 280E Poses a Major Financial Obstacle to Cannabis Cultivators and Manufacturers
Enacted in 1982, the IRS tax code 280E prohibits illegal businesses, especially those dealing in narcotics, to file for deductible expenses not attributable to costs of production. Three decades later, recreational cannabis consumption is currently legal in at least 21 states. However, federal tax authorities in decriminalized states still wield this outdated law against licensed cannabis cultivators and processors.
The existence and implementation of IRS tax code 280E forces licensed growers and processors to pay income taxes that are 40-50% higher than other legal businesses in non-cannabis industries due to the non-deductibility of selling, general, and administrative expenses.
Solutions To The Current Cannabis Tax Issues
The exorbitant tax rates are doing more harm than good because unregulated vendors stocking harmful or fake products lure customers away from licensed dispensaries using cheap prices. There are several potential solutions to this problem. One option is for the states to lower the tax rates on cannabis. This would make it more affordable for businesses to operate and would likely increase tax revenue in the long run. Another option is for the federal government to step in and create a uniform tax rate for the cannabis industry. This would level the playing field for all businesses and would make it easier for customers to comparison shop.
With the industry growing rapidly, we NEED a solution to the problem of federal and state taxation issues. One thing that business owners can do is support lobbying and policy organizations that are working to promote fair and equitable cannabis laws that will protect the investment of business owners and alleviate some of the burden. One example of such a group is the National Cannabis Industry Association. (https://thecannabisindustry.org/)
The cannabis industry is still emerging and there is a lot of room for growth
The good news is that as the cannabis industry continues to emerge and there is still a lot of room for growth. This industry is expected to continue to grow at a rapid pace in the coming years. There are many different areas of the cannabis industry, from cultivation and manufacturing to retail and dispensaries. The industry provides a lot of opportunities for entrepreneurs who are looking to start their own businesses, both in the supply chain, or for professional service providers looking to support businesses on the journey to a mature market.
If you are thinking about starting a business in the cannabis industry, there are a few things you should keep in mind. First, you need to make sure that you are in a state that has legalized cannabis (hopefully this is obvious!!!). Second, you need to have a solid business plan. And third, you need to be prepared to face some challenges. The cannabis industry is still emerging and there is a lot of room for growth. With the right preparation, you can start a successful business in this industry.
Partner With Indiva Advisors To Help Solve Your Cannabis Tax Problems
The taxation of cannabis in the United States is a complex and ever-changing landscape. This is due to the fact that the industry is still illegal at the federal level. State and local taxes can also add to the complexity of the tax landscape for cannabis businesses. Many businesses are forced to operate as cash-only businesses due to the lack of banking access.
That’s where Indiva Advisors can help. Our team of professional accountants, CPAs, and tax preparers specialize in assisting cannabis businesses with navigating the tax landscape and ensure compliance with federal, state, and local tax laws.
Contact us today to learn more.