The Taxman Cometh (for the cannabis industry)

[dropcap class=”kp-dropcap”]T[/dropcap]he month of April is famous for both the cannabis holiday of April 20 as well as the tax deadline of April 15 and it seems that we should look a bit more at the significance behind the latter. Cannabis is certainly a curious industry when it comes to the levying of taxes. On the one hand it is seen as a goldmine by some local cities and counties, who may believe that it could solve empty budgets and economic blight. But there’s a fundamental problem—if taxes are set too high on regulated sales of a substance still widely available on the illicit market, then consumers will avoid regulated channels and revert to buying off of the street. So it’s a curious relationship that many cannabis policy reform activists often find themselves in, supporting permissive social policies while also pushing for low government intervention and extremely low limits on taxes set on regulated cannabis sales. Social progressives often find themselves morphing into libertarians, while fiscal conservatives find themselves forming common cause with hippie farmers. Strange bedfellows sharing the same (taxable) joint.

In California, retail sales of medical cannabis sold by collectives were determined by the Board of Equalization to be a taxable activity and there has been a variety of city and county-specific additional local taxes on retail sales adopted by voters from Sacramento to Palm Springs. Due to a quirk added to California’s constitution adopted 20 years ago, governments are not allowed to collect any funds from businesses beyond what it actually costs to regulate and administrate the business activity. According to Proposition 218’s provisions, any funds collected above this level would be defined as a tax and not just a fee. Taxes in California must be approved by the voters in a ballot measure, which is the path taken by these several cities with local taxes. Expect to see more cities place cannabis tax ballot measures on this November’s ballot. However, if these localities are seeking to eliminate criminal, illicit sales and encourage good, licensed operators in their communities then any taxes must be set as low as possible. It’s a fine line that must be set and hopefully voters will be smart enough to vote down counterproductive ballot measures with excessive tax rates.

Like so many other problems, the biggest tax problem for the cannabis industry comes back to the federal government and a 33-year-old law which is now screaming for deletion. Section 280E of the Internal Revenue Code disallows standard business operations for any federal taxes filed by businesses engaged in the trafficking of controlled substances. Even though these commercial activities may be legal under state law, these are still federally illegal substances and law-abiding businesses are therefore effectively liable for 70 to 80 percent taxation rates. Ironically the cost of goods sold (i.e. the production costs of the medical cannabis) may be deducted but not items related to the sales of the federally illegal drug: Storefront facilities, staff wages, security investments and other typical tax deductions that any other businesses would be allowed to deduct. Solving Section 280E must be done by Congress but less than 10 percent of our House Representatives and none of our Senators have authored or joined as co-authors on 280E reform bills. In addition to tracking cannabis policy at our state capitol in Sacramento, California’s cannabis industry needs to look to its representation in our nation’s Capitol and send champions like Garden Grove Mayor Bao Nguyen and other progressive, tax-savvy fresh voices to Washington DC.