01 Nov 2017 California May Draw Marijuana Taxation Dollars Away from Colorado
In contrast to the federal perspective on marijuana businesses, popular vote has legalized recreational marijuana in four states and the District of Columbia. In addition, medical marijuana is legal in 25 states. States that legalize marijuana often levy heavy excise taxes on marijuana products. These rules vary by state and change over time. Due to the varying nature of state taxation, let’s focus on two states specifically.
In 2012, voters in Colorado passed Amendment 64, which led to legalizing marijuana possession for adults 21 and over as well as commercial cultivation, manufacture, and sale. In California, a voter initiative titled Proposition 64 changed California law to legalize the possession, cultivation, and sale of marijuana. While the changes share the same number, their approaches to legal marijuana taxation are distinct.
Colorado law allows for residents to purchase up to one ounce of any kind of marijuana product while non-residents are limited to purchasing a quarter of an ounce. Taxation of marijuana and marijuana related products are handled on several levels. First, wholesale transfers of marijuana are taxed at a 15% excise tax rate. Then, retail marijuana and marijuana products are subject to a 15% sales tax. Businesses selling marijuana and marijuana accessories should also know that, while marijuana products are exempt from the 2.9% state sales tax, marijuana accessories are still subject to this state sales tax.
While marijuana taxes seem to suffer from higher tax than other industries in Colorado, last minute negotiations in May of 2017 to fix the Colorado budget led lawmakers to increase taxes related to marijuana to the levels outlined above. Perhaps this indicates that the state government has an interest and reliance on the health of the marijuana industry. Analysts also suggest that competition from other legal recreational states could eat into this revenue stream and force Colorado to lower its recreational marijuana taxation rate.
California may evolve into one of the states that draw marijuana taxation dollars away from Colorado. Proposition 64, passed in 2016 legalized no more than one ounce of marijuana or 8 grams of concentrated marijuana for adults 21 or older. Recreational marijuana taxation is first imposed on marijuana cultivators for all harvested marijuana that enters the commercial market. Marijuana flowers are taxed at a fixed rate of $9.25 per dry weight ounce. Marijuana leaves, or what is basically the entirety of the plant outside of the flower, are taxed at $2.75 per dry-weight ounce. Marijuana retailers are required to collect an excise tax from purchasers of marijuana or marijuana products. This is calculated as 15% of the average market price of any retail sale by a marijuana retailer, and is in addition to the sales and use tax imposed by state and local governments.
All commercial cannabis activity requires a license in California. A license issued under California’s Medical and Adult-Use Cannabis Regulation and Safety Act needs to be renewed annually. Generally, the licensed premises cannot be located within a 600-foot radius of a school, day care center, or youth center that is in existence at the time the license is issued. The company and its owners must also be careful to keep clean records. Notably, however, the sale or cultivation of a controlled substance cannot constitute the sole ground for the denial of a license. Perhaps most importantly, however, marijuana retailers and cultivators need to comply with all of their applicable local ordinances, in addition to the Medical and Adult-Use Cannabis Regulation and Safety Act. Unfortunately, none of these state and local rules has resolved the twilight zone of federal regulations.
Federal Income Tax Regulations
Under section 280E of the federal tax code, no deduction or credit is allowed for businesses that traffic in controlled substances that are prohibited by federal law or the law of any state in which such trade or business is conducted. Cannabis is currently a Schedule I controlled substance under federal law. For that reason, section 280E precludes marijuana businesses from deducting their business expenses. Section 280E does not, however, disallow reductions in income for the cost of goods sold. As a result, marijuana businesses may still attempt to capitalize costs into the cost of goods sold.
Regardless, the denial of deductions may cause marijuana businesses to be liable for federal tax on income that significantly exceeds the amount of actual economic income generated by the business. As a result, businesses operating in the cannabis industry may have significantly higher effective tax rates compared to other businesses. Some estimates are that the effective federal tax rate may be as high as 80%. Accordingly, lawmakers in D.C. have been discussing various legislative remedies.
Earlier this year, Congressional representatives introduced the Small Business Tax Equity Act of 2017 in the House. This bill would amend the federal tax code to exempt a trade or business that conducts marijuana sales in compliance with state law from section 280E. If passed, it would allow marijuana businesses to claim tax credits and take deductions for their business expenses like any other business.
As long as the possession, cultivation, and sale of marijuana remains illegal under federal law, a business that deals in marijuana, as well as any person who knowingly facilitates such business activities, is committing a federal crime, irrespective of whether the business or person complies with state and local laws. The U.S. government may enforce such laws at any time, which could result in business assets being seized or the arrest and criminal prosecution of the owners, their agents, employees, and investors. Please consult with an experienced attorney and other appropriate advisors before engaging in any commercial transaction.