It’s a huge misconception that the federal government doesn’t receive tax money from state-legal cannabis companies. It doesn’t collect money in the standard way; but the weight of what it does do, certainly affects companies. Different states are starting to help out these companies, by instituting legislation for state level tax deductions in lieu of oppressive federal policy.
How does the federal government tax cannabis?
There are different kinds of taxes that are imposed in different ways. The most standard one for consumers is the sales tax; the amount we see added on at the cash register. Each state (or local location) has a set amount for sales tax. Other taxes, like excise taxes, aren’t seen by the customer, but are a part of the product total. They’re paid by a company somewhere in the supply line, and absorbed into final price. In an industry that involves them, this is where sin taxes are applied.
Right now, cannabis industries are only state-approved. The federal government still holds cannabis as illegal, with the exception of industrial hemp products which were legalized via the 2018 US Farm Bill. This created a new definition for ‘hemp,’ based mainly on the THC content of dry weight plants. Without federally approved products, however, all cannabis taxes go to the state, and not the federal government; since the federal government has no tax structures available for what it considers illegal products/industries.
But that doesn’t mean it doesn’t collect tax money. Think of any regular business, and all the tax write-offs it makes for regular expenses. Think of things like rent, legal fees, banking fees, and other costs that come up along the way, which generally qualify as standard deductions. Most businesses save themselves a lot of money by making deductions for these expenses. A deduction means that the cost is removed from the taxable gross income, making less money that the federal government can take in income tax.
That’s something people might forget in all this. That regardless of whether the federal government says cannabis is legal, it still collects income taxes on every business. If you’re earning income, and its not under the table, the federal government gets a piece; and that includes from marijuana operations.
Not only does the federal government take a piece, but it takes more from a cannabis company, than from a company in an industry not considered illegal. As per Section 280E of federal tax law, the federal government gives itself the right to exclude what it considers ‘traffickers’ of illegal drugs, from making standard deductions for income taxes. Of course, we’re not talking about real drug traffickers. Real traffickers operate in the black market and don’t pay taxes. Which means the US government applies this to companies which are functioning legally on some level, but are involved with substances it deems illegal.
In the world of weed, this accounts for any ‘plant-touching’ enterprise. And it actually means that cannabis companies pay more in taxes, than their fellow business owners in different industries. Kind of a funny turnaround when most expect that the federal government gets nothing at all from state-run weed industries.
How state governments are starting to help cannabis businesses
States want to collect as much cannabis tax money as they can; which we know by the tax structures in place. However, in light of the problems caused by federal cannabis tax collection, many are implementing policies to combat what the federal government takes in tax. This is beneficial to cannabis companies, and does mean states cutting into their own possible tax revenue.
For example, Marijuana Moment recently reported that the New York State Senate passed a bill which would help operators get around the lack of ability to make deductions, at least in New York City. The bill passed the Assembly as well on June 8th, and was passed back to the Senate; with an order for third reading rules. If a company fails, then no taxes are to be made by any government, and this new law seeks to help companies stay in business.
The bill – S7508, is entitled “An act to amend the administrative code of the city of New York, in relation to permitting certain tax deductions related to the sale, production, or distribution of cannabis products.” And “Permits certain tax deductions related to the sale, production, or distribution of cannabis products.”
The bill is a follow-up to a budget bill which Governor Kathy Hochul signed last year, which includes the ability for state-level business tax deductions. Should this particular bill get fully passed, it would amend current state law so that cannabis operators can make deductions “in an amount equal to any federal deduction disallowed by section 280E of the internal revenue code.” Essentially, it would work to make up for the money lost by these companies to the federal government; but would have no impact on the actual federal laws. This bill must pass the Assembly before going to the governor for signature.
Similar actions are taking place in other states. Connecticut likewise has a bill just sent to the governor’s desk – HB 6941. The bill allows “for a taxpayer licensed under the provisions of chapter 420f or 420h, the amount of ordinary and necessary expenses that would be eligible to be claimed as a deduction for federal income tax purposes under Section 162(a) of the Internal Revenue Code but that are disallowed under Section 280E of the Internal Revenue Code because marijuana is a controlled substance under the federal Controlled Substance Act.”
Illinois has HB 3817, which was signed off on by Governor Pritzker on June 7th. This also allows cannabis operators to make deductions at the state level that they cannot at the federal level. It was sent to the governor, approved, and went into effect, all on the same day. In May, New Jersey Governor Phil Murphy signed off on A 3946, which “Decouples State tax provisions from federal prohibition on cannabis business deductions.”
The impact of federal cannabis taxes
If a business cannot make standard deductions, its automatically facing higher costs. This puts cannabis companies in the position of having to think way more intricately about how they structure themselves, and how they run. For example, if rent cannot be written off as a deduction, an enterprise must make sure to rent in a place for which they can financially survive at full cost.
I talk a lot about the drowning tax structures put in place for the cannabis industry by nearly every government; much in the form of sin taxes. Just the sin tax alone can often be as high as 15%-30%, or even more. This inability for federal tax write-offs is the equivalent of another tax put on; and works to more greatly tax this already overtaxed industry.
Whitney Economics operates in the cannabis space as a consulting, data, and research firm. The company works with governments and private industry, at both federal and state levels. It assists in formulating workable strategies, to come up with policies based on sound economics. The company is based out of Portland, Oregon, and recently made headlines regarding the suffocating nature of federal cannabis tax laws.
According to the company, in 2022, $1.8 billion was paid as additional amounts because of Section 280E. It expects the total for 2023 to rise to $2.1 billion. As per the company, barring a company from these deductions can mean the company paying as much as 70% in taxes or more, between all tax structures; both local and federal. Whitney stipulates these high percentages are also related to anti-cannabis regulation, no interstate business, and banking issues within the industry.
According to the company, as few as 24.4% of cannabis enterprises surveyed earned a profit in 2022. This number is already greatly down from the previous year, wherein approximately 42% said they earned a profit. Whitney’s Chief Economist Beau Whitney explained how many industries in the cannabis realm are already close to collapse, just years after the industry started. And that tax reform is the best likely answer. Whitney’s staff believes reform of Section 280E could result in an industry increase of $35.2 billion within 10 years.
Having said all this, there is some push within the federal government to amend Section 280E for the benefit of cannabis enterprises. HR 2643 was reintroduced this year. It’s official title is “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.” In April it was referred to the House Committee on Ways and Means, where it still sits now. Representative Earl Blumenauer, previously introduced the bill in 2019 as HR 1118.
As stated in the text associated with the bill, “This bill exempts a trade or business that conducts marijuana sales in compliance with state law from a provision in the Internal Revenue Code that prohibits business-related tax credits or deductions for expenditures in connection with trafficking in controlled substances.”
Conclusion
Cannabis tax situations are a major imposition to weed industries in both the US and Canada. Canada has even seen fit to go after companies unable to pay their excise taxes. These recent actions on the part of US state governments are a positive for cannabis companies; and might even lead to state government reevaluation of harsh state tax policies. These moves do indicate that states are willing to bend in terms of their tax income revenue, if it can help the industry survive.
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