TAXATION OF
GANJA
At this point we all know of at least one state or jurisdiction that allows for at minimum the use of marijuana for medicinal or recreational use. As of January 8, 2018, the following states have legalized marijuana for recreational use: California, Colorado, Hawaii, Maine, Massachusetts, Nevada, Oregon, and Washington. Even though these states and several other states (when you bring medicinal marijuana into the equation) have relaxed or completely decriminalized the possession of marijuana, the federal government still treats cannabis as a scheduled narcotic. A scheduled narcotic is a drug or other substance that has a high potential for abuse. Marijuana is currently listed as a Schedule I narcotic. In recent years, the United States Congress passed a law, which must be renewed annually, that prohibits the United States Justice Department from interfering with state medical cannabis laws. As of January 4, 2018, the United States Attorney General, Jeff Sessions did not renew this law and therefore, federal prosecutors can pursue marijuana cases in states where marijuana is legal. This is currently an ongoing issue in Congress right now so I will be keeping a close eye out on future legislation or changes within the current legislation. I can tell you this, Congress is not taking this lightly and several states, including Colorado and California are ready to fight as this industry has provided for or has the potential to provide for a surplus of the kind some of these states have never seen. Even before a state decides to legalize marijuana, the taxation of marijuana begins to form. Let’s start with the federal taxation of cannabis. The Internal Revenue Code (Code) governs federal taxation in this country. Generally speaking, gross income is what we are taxed on less any deductions or specific items that are not considered gross income. Gross income according to the Internal Revenue Code “means all income from whatever source derived…” then the Code allows for exceptions to this general rule. So reading it literally, all income from whatever source derived includes both legal and illegal activity. So while our federal government treats the cannabis industry as an illegal activity, certain portions of the Code are applied regardless of the industry in question and that is when the complications begin. All businesses are required to pay federal taxes on their gross income under the Code, even if the income arises out of an illegal activity. The return of capital is not subject to tax. Return of capital occurs when an investor receives a portion of his original investment and these payments are not considered income. So in this context, a business’s gross receipts (or sales) must be reduced by the cost of goods sold (COGS) in order to determine gross income before income tax can be assessed. For a business producing cannabis, COGS is calculated by taking inventories at the beginning of the tax year, adding current year production costs, and finally subtracting year-end inventories. For resellers, COGS is calculated by subtracting year-end inventories from current year purchases. In all other illegal businesses, the taxpayer may deduct all ordinary and necessary business expenses, as long as the expenditures themselves are not illegal under the Code. Still, under Code Section 280E, this section specifically precludes individuals or business trafficking in certain Schedule I and II drugs (recall, marijuana is a Schedule I drug) from claiming those deductions. Under Code Section 280E, taxpayers are prohibited from claiming deductions or credits in the trade or business of illegal trafficking of drugs listed in the Controlled Substances Act. Under this section of the Code businesses are also unable to deduct ordinary and necessary expenses that are not illegal 11
such as salaries, rent, utilities, etc. Recall as discussed above that this section of the Code does allow businesses to recover their investment in cannabis and also allows the reduction of gross receipts by cost of goods sold. After a business satisfies their federal taxation requirement, the state requirements need to be fulfilled as well. Taxation by the states varies from one state to the next, but we will discuss some of the more popular ways the states derive revenue from the cannabis industry. First, sales and use tax which generally speaking is a percentage of the amount of the sale. In some states, medical marijuana is exempt from sales and use tax, in other states it is taxed. Second, some states subject recreational marijuana to an excise tax, cultivation tax, privilege tax, and/or a special sales tax. In addition, cities and counties within the state may also impose a specific taxes on retail marijuana. Finally, states impose fees for sales tax licenses, producer’s licenses, processor’s licenses and seller’s permits. The same way there is a tax return required to be filed with the federal government, states also impose some taxation reporting requirements, such as retail sales tax returns, retail marijuana sales tax returns, and state personal and corporate tax returns. Any non-compliance on your part would result in heavy penalties and fines, as well as the potential for loss of license or permits. If you make a decision to join this industry in any capacity, just ensure that you obtain professional advice from organizations and personnel who specialize in this industry. The cannabis industry is growing and firms are finding new opportunities to serve this industry as more states slowly legalize marijuana. Cannabis dispensaries and recreational stores are currently about a $3 billion a year industry. This industry is known to have the highest percentage of companies with seven figures of revenue in Year 1. If you are thinking about diving into this industry that’s great I would love to welcome you, but this industry is constantly changing and evolving so you must always stay on top of all legislation including state regulations and federal regulations. That is where having an attorney or advisor to consult on state and federal changes comes in. My recommendation for anyone who decides to enter this industry is to remain compliant. Compliance includes paying and remitting all taxes on all levels, including city, county, state, and federal. Being compliant allows you to continue to make money and that is the whole point. If you don’t remember anything from this article, remember this one thing: All income from all sources derived, generally speaking is gross income regardless of the legality of the business. Jeneria Rhodes Contributing Writer J. T. Maxwell, CIA, EA, CFE, CPA, Esq. is the CEO of BayShore Tax & Consulting Group. The firm specializes in full accounting, business consulting, tax preparation and planning, tax resolution, and our newest division, cannabis accounting, where we specialize in providing accounting, tax, and advisory solutions to cannabis businesses.
