Many cannabis businesses operate in a legal gray area. This can be frustrating, especially for those who run their companies professionally and have a legitimate interest in staying compliant. To make matters worse, as more states adopt laws legalizing marijuana for both medical and recreational use, the number of tax issues faced by cannabis businesses is also on the rise.
The lack of exemptions and deductions plus levies imposed by both state and county governments are the main cannabis tax issues that make retail prices so high, and cause some customers to shy away from legal, licensed dispensaries. 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.
Tax laws surrounding cannabis are still fairly new to many businesses and there is a lot of uncertainty when it comes to how individual states treat business owners. It’s important to remember that complying with all tax laws can often be tedious and time-consuming. But if you’re operating an audit-tolerant business or otherwise want to stay afloat while paying your fair share, understanding the following tax issues can make all the difference.
What Are The Different Channels Federal Governments Use 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 consistent high demand. Potency-based taxes have an impact on a product's final price, and it forces most 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 pushed cannabis consumers to unknowingly purchase fake cartridges from dubious websites masquerading as authorized vendors. These 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, in order to make them safe for human consumption.
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 frequently receive their weekly payments in cash since cannabis businesses often 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 grounds of withholding information regarding employees. However, most states have unclear cannabis labor laws.
IRS Tax Code 280E Poses A Major Financial Obstacle To Cannabis Cultivators and Manufacturers
Enacted in 1982, IRS tax code 280E prohibits illegal businesses, especially those dealing in narcotics, to file for deductible expenses attributable to costs of production. Three decades later, recreational cannabis consumption is currently legal in at least 15 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.
Conflicting Responsibilities Between State & Federal Levels
Cannabis businesses are booming in states that have legalized the drug, but they face conflicting responsibilities between state and federal levels. On the one hand, they are required to pay high tax burdens to the state government. On the other hand, they are not allowed to deduct those taxes from their federal taxes. This creates a significant financial burden for cannabis businesses.
In addition, local governments are often reluctant to allow cannabis businesses to operate in their jurisdictions. This creates a patchwork of regulations that makes it difficult for cannabis businesses to operate smoothly.
Despite these challenges, many cannabis businesses are still thriving. This is because the demand for cannabis products is high, and the tax revenue that these businesses generate is a major cash cow for state and local governments. In fact, some states and municipalities have even gone so far as to create special tax incentives for cannabis businesses. If you have the option, you’ll definitely want to consider locating in one of these blessed regions.
As the legal landscape continues to evolve, it will be interesting to see how these conflicting responsibilities play out. For now, cannabis businesses will continue to operate in a state of limbo, caught between two very different sets of laws.
How To Prepare Your Business For Cannabis Taxes
Here are some solutions to help business owners navigate these tricky waters:
Set money aside for your taxes
As cannabis business owners, it's important to stay ahead of the tax game. That means preparing for the heavy burden early by setting money aside. The first step is to estimate your tax liability - this will help you figure out how much money you'll need to save up.
Next, don't wait - assume the worst, start saving now, and begin the process of paying estimated quarterly taxes. The longer you wait, the higher the tax burden will be. Keep track of your progress and make sure to file your taxes on time to minimize penalties or interest charges. By following these simple tips, you'll be able to prepare for the heavy tax burden early and keep your business afloat during tough times.
Reduce your tax burden by incorporating
Incorporating your cannabis business can help you reduce your tax burden. By incorporating, you'll pay taxes on your profits at the business level, rather than the individual level. This means you'll save money on your taxes, and you'll also have access to the benefits of a corporation.
Incorporation can help you secure valuable legal rights and protections for your business. By incorporating, you'll be in a stronger position to weather any legal challenges that may come your way. So, if you're interested in protecting your business and reducing your tax burden, incorporation may be the way to go.
Work with a cannabis accountant
One of the best solutions for business owners is to work with a cannabis accountant. This individual or firm can help you navigate the complex tax laws surrounding cannabis businesses, and they can also provide guidance on how to lower your taxes. They can even help you file your taxes correctly, which will reduce the amount of time you have to spend on this task yourself.
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. While we can all hope for changes in the near future, in order to thrive in the current environment, cannabis business owners need to be proactive about the obstacles posed by such a burdensome tax regime.
Get ahead of your tax issues by partnering with Indiva Advisors, LLP. Contact us today to schedule your first consultation.