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This Post suggests some specific changes relating to the reporting and collection of Cannabis Cultivation Tax (“CCT”) and Cannabis Excise Tax (“CET”). California’s shortfall in cannabis tax revenue is not because California’s underground market did not pay CCT and CET taxes. The individuals involved in California’s underground cannabis industry pay little if any, taxes of any sort.

Many of those individuals involved in California’s underground cannabis market who were potential taxpayers did not pay CCT because California made it too difficult for them to migrate into the legal commercial cannabis market. Many closed up shop. Many others decided to stay in the underground as long as possible. Many cultivators have continued struggling to cope with the regulatory labyrinth California created.


Some cannabis cultivators believed they had paid CCT. Unfortunately, they did not. In 2018 unscrupulous distributors regularly purchased cannabis from cultivators under contracts that stated the distributor would be responsible for paying the CCT to CDTFA, but the CCT wasn’t reported or paid over to CDTFA.


It is our opinion that a significant portion of California’s lost 2018 cannabis tax revenue is missing because California did not receive its full share of the cannabis tax revenue “collected” on “legal” sales of cannabis.

Before we discuss three black holes into which a portion of California’s cannabis tax revenue disappeared, I want to mention for the reader one of my mother’s admonitions, No sense crying about spilled milk.”

California will not collect a substantial portion of any lost 2018 cannabis tax revenue. Governor Newsom needs to ask the Internal Revenue Service what percentage of delinquent income taxes are collected and at what cost?


We will describe in the balance of this Post three small black holes into which we believe a significant portion of California’s 2018 cannabis tax revenue disappeared. We have separately suggested some tax reporting changes to CDTFA will patch some of the holes in California’s cannabis tax bucket. As we have indicated in comments in other Posts, California needs to make it as easy as possible for cultivators to move cannabis into the regulated commercial market. CDTFA needs to focus on making it easy for distributors to fully and accurately collect, report and pay-over CCT and CET. California must not waste significant energy trying to collect tax revenue that CDTFA has already let slip away.


We believe the proper points of focus for CDTFA, our three small black tax-eating holes, are:

(1) the collection, reporting and paying over of CET to distributors by dispensaries;

(2) the collection, reporting and remittance of CET to CDTFA by distributors; and

(3) the collection, reporting and payment of CCT by manufacturers and distributors.


We have already written about the record-keeping and reporting deficiencies relating to the taxes dispensaries collect for various taxing agencies. We will not repeat those comments in this Post.

We will, however, emphasize the importance that a dispensary physically segregate the tax money it collects for taxing agencies from the general funds of the dispensary. It is not enough for a dispensary to prepare and maintain accurate records of the taxes it collects. These funds are money held in trust for a third-party and kept in a segregated account. Besides, dispensaries must make all tax payments from these segregated funds in a manner that is readily verifiable by the respective taxing agencies. Any transfers of funds between the dispensary’s general account and the segregated tax account should be made valid and should be made solely to correct record-keeping errors. Trust me does not for taxing agencies.


The dispensary black hole is, in reality, a thousand or so small black holes. The distributor black hole is a lower number of significantly larger black holes. A distributor is a dispensary on steroids for collecting, accounting for, and remitting CET to CDTFA. CET will represent 20+% of the money a distributor receives from dispensaries. The CET that a distributor collects from dispensaries are funds these dispensaries collected from consumers. Dispensaries collect CET as an agent for the State of California. These funds are trust funds in the hands of dispensaries. When such funds are paid over to a distributor by a dispensary, the funds remain trust funds.


A dispensary that follows our advice on best practices will keep tax funds segregated from the dispensary’s general funds. Well-advised distributors will develop the same methods as well-advised dispensaries. A distributor is appointed by statute under California law as the agent for the State of California entrusted with the collection of CET from dispensaries and remittance of these funds to CDTFA. These funds are trust funds that dispensaries transfer to distributors. Distributors hold these funds in trust for the State of California. As soon as CDTFA gets its act together, CDTFA will expressly require distributors to treat these funds as trust funds.


Distributors have a much more severe problem for record-keeping and reporting than dispensaries. A distributor must address an issue that does not confront a dispensary. A distributor has the additional problem of being sure it collects the proper amount of CET from a dispensary. A dispensary generally collects three different taxes. If a dispensary keeps all of the taxes it collects segregated, the dispensary will very likely not fall into difficulties in connection with these taxes. A dispensary will be protected for CET if it keeps t funds segregated; provided that it can account for all of the CET it paid to distributors.


A distributor generally collects CET solely from dispensaries, although some local jurisdictions are attempting to impose taxes on distributors. A distributor is responsible for collecting the proper amount of CET in instances in which it collects CET. A distributor is, however, responsible for paying over to CDTFA the full amount of the CET it was supposed to collect even if it did not receive the total amount. Of course, if a distributor collects excess CET, the excess amount it collects belongs to the State of California, not the distributor.


Not all transfers of cannabis by a distributor in exchange for money will involve the collection of CET. A distributor may transfer cannabis to another distributor that assumes the CET liability associated with the cannabis product. A distributor also may perform services on a fee for service basis. A distributor acts at great peril if it fails to maintain its record-keeping for various types of transactions carefully as well as maintain as segregated funds any CET it collects. CDTFA will resolve all questions in its favor.


Distributors are also involved in the third black hole into which some of California’s cannabis tax revenue has disappeared. Distributors are responsible for collecting CCT from cultivators and paying the CCT over to CDTFA. Distributors can, and the State of California erroneously assumed distributors would, expressly assume this liability and pay cultivators a net amount. Unscrupulous distributors have taken advantage of the naivety of cultivators. Distributors have taken advantage of cultivators throughout California by purchasing cannabis product according to contracts that provide the distributor will be responsible for the CCT. It is our opinion a significant portion of the CCT associated with cannabis transferred into regulated cannabis commerce in California in 2018 did not get paid over to CDTFA.


We have made and will continue to make suggestions to CDTFA relating to procedures, information, and forms that we believe will assist CDTFA in collecting the CET and CCT. We think BCC, CDTFA, CDFA, and the CDPH will serve California better if they focus on helping those involved in California underground cannabis who want to become wholly legal. Taxpaying members of California commercial cannabis industry come into the regulated industry rather than catering to those who have become involved in cannabis in California solely because of the perceived opportunity to make a quick buck.