A new federal watchdog report says cannabis businesses owe vastly more in taxes to the federal government and more audits would uncover it.
The owner of Uncle Ike’s cannabis dispensary in Seattle, Ian Eisenberg, sees a lot of would-be entrepreneurs enter the marketplace with lofty visions for how they want their business to look and operate. Eisenberg told The Daily Beast in 2017 that he’d love for his own business to be configured more like a cannabis boutique with stations dedicated to concentrates, big-name growers, edibles, and more. But the exceptional tax burden faced by cannabis businesses compared to any other type of business in the United States makes that all but impossible. “Everything from how the store is laid out to merchandising to inventory management, [the tax code] dictates how the business operates,” Eisenberg said. “It’s more like a 7-Eleven, because it’s all about efficiency.” Due to a section of the U.S. tax code initially written by Congress to strip drug tycoons of illicit proceeds, state-legal cannabis businesses just in the three states of Washington, Oregon, and California faced a collective estimated federal tax burden of an astonishing $475 million when projected over five years. That’s according to the watchdog inspector general for the U.S. Treasury Department, the parent agency of the Internal Revenue Service. While the inspector general is part of the agency itself, that office is responsible for independently evaluating the performance of the Treasury Department and its component agencies, such as the IRS. In other words, the inspector general audited the auditors. In a new report, he describes the exploding cannabis industry in the United States and the obligation of the IRS to enforce federal tax rules, even if they result in legal cannabis businesses being forced to pay as much as 70 percent of their income in taxes while a traditional business may pay closer to 30 percent. Cannabis businesses in the aforementioned three states also had wide-scale problems with misreporting their income or wrongly deducting business expenses for tax purposes where they were not permitted to under the federal tax rules known as 280E, according to the report. These rules state that the federal government simultaneously considers cannabis to be an illegal controlled substance while imposing businesses taxes on anyone who cultivates, processes, or retails it. More than half of nearly 250 cannabis businesses examined by the inspector general in California, Washington, and Oregon, for example, likely would require “adjustments” to their tax forms worth hundreds of millions of dollars if they underwent IRS auditing. Understand, the IRS is in place to make sure that proper revenue is collected for all entities and persons operating within the country. “This forecast represents only a portion of the tax noncompliance related to 280E in that it only included three out of 33 states and the District of Columbia that allow for either medical and/or recreational use of marijuana and does not consider the growth in the industry since tax year 2016,” according to the report. Worse yet, the inspector general found that federal tax enforcers have created virtually no instructions that tax professionals and cannabis businesses can rely upon to understand how to achieve compliance under 280E. “No references to marijuana businesses can be found in IRS publications.” For the purposes of the report, the inspector general created a hypothetical cannabis business with a gross annual income of $500,000. A coffee shop with the same gross income would then calculate the cost of goods sold, as well as business expenses like utilities and rent. This reduces the reported net income of the business on tax forms, and thus, lowers the amount in taxes that the coffee shop owes to the government. Where these calculations would result in a taxable net income of $100,000 for the coffee shop, a cannabis business barred from taking the same deductions under 280E must state its taxable net income as $250,000. As a result, the cannabis business finds itself shelling out $80,000 in taxes to the federal government on $100,000 in net income while the coffee shop would pay vastly less. And all of that occurs before the dizzying array of special taxes that state and local governments have imposed on cannabis businesses as a condition for simply operating. When combined with the fact that many cannabis entrepreneurs don’t know or care to file business taxes with the federal government in the first place, late fines, penalties, and assessments resulting from an audit could be more than enough to sink an entrepreneur permanently. Tax matters have grown so bad for cannabis businesses, in fact, that Oregon Democratic Sen. Jeff Merkely -- with cameras rolling -- accompanied one of his constituents last year as he drove to the Oregon Department of Revenue to deliver $70,000 in cash to cover a state tax bill. In another example, a Seattle-based dispensary called the Northwest Patient Resource Center generated just $53,000 in profits for itself during 2014. It then worked vigorously to comply with all aspects of 280E, but after doing so, it wound up owing $46,000 in taxes. “It hurt, and it hurt bad,” the owner told the New York Times. “Everyone thinks you’re just rolling in dough. That may be the case if you’re not being compliant.” Understand, this is not the drug business that you see on Netflix or on the news. This is a real, legitimate business with its hands tied by antiquated tax code. As states legalize cannabis, Federal tax codes hold these business’ profits hostage. The owner of five dispensary locations in Denver wrote a check to the federal government for $275,000 following the 2014 tax season. In another case from the area, a dispensary owner with gross income of $1.7 million wound up with a tax bill of $866,000, which it sought to renegotiate with the IRS. The report also acknowledges that cannabis entrepreneurs still struggle to locate banking services they need to pay taxes, vendors, landlords, and others electronically like a standard business instead of in dangerously large amounts of hard currency. While the number of banks willing to do business with cannabis companies has grown in recent years to over 700 nationally as of last summer, according to the Financial Crimes Enforcement Network, many financial institutions simply choose not to take the risk or determine it’s too costly and time-consuming. “To the extent that government laws and regulations discourage banking for marijuana businesses (and to the extent they encourage cash-only transactions), they also may indirectly and unintentionally encourage tax noncompliance,” the inspector general concluded. Banks and credit unions that do business with cannabis companies must file a so-called suspicious activity report if they have reason to believe a transaction of $5,000 or greater involves illegal activity or is an attempt to disguise illegal transactions. Those who do business with cannabis companies, as a result, often charge exorbitant fees to entrepreneurs. In one example cited by the inspector general, a California credit union charged an initial fee to cannabis businesses of $10,000, plus $5,000 to $7,500 per month. In another example, a small credit union in Oregon testified to Congress that it had submitted 13,500 suspicious activity reports over two years for 500 cannabis businesses. If you need help with a tax strategy for your cannabis business, then please reach out to us today. |