Everyone wants to avoid paying taxes. All voters want to avoid paying taxes. Politicians are regularly elected based on promises they will reduce taxes. The corollary to reducing taxes is to tax someone else. The political sell is, “We won’t tax you, we won’t tax me, we will tax the guy behind the tree.”
Many long-standing cannabis advocates were surprised by the success of the legalization movement over the past few years. This success should not have been a surprise. The promise of tax revenue from “the guy behind the tree” aka the cannabis industry provided a major impetus for the legalization of cannabis. Over the past few years politicians of all stripes have decided cannabis was not such a terrible drug. As soon as politicians became convinced cannabis is an untapped source of tax revenue, it became clear it was a commodity that could be regulated rather than a dangerous drug.
Proposition 64 would not have passed in California but for the promise of substantial tax revenues. Regardless of all of the other arguments for the legalization cannabis, the promise of tax revenue from “the guy behind the tree” passed Proposition 64.
The idea that taxes can be collected from an unseen taxpayer is a fraud. The financial backers of Proposition 64 perpetrated this fraud on California voters [See IMPLEMENTING PROPOSITION 64: MARIJUANA POLICY IN CALIFORNIA . This fraud was perpetrated by those who saw legalization of cannabis as an opportunity to make money. In this regard California is just another corporate opportunist. There are no taxpayers hidden behind trees. All of the money collected by California’s cannabis businesses whether for business expenses, costs, taxes or profits is collected from cannabis consumers. California cannabis consumers pay directly or indirectly all of the taxes that are paid to governmental agencies by cannabis businesses. All taxes paid by cannabis businesses are paid with money collected from consumers.
The preceding is half of the foundational background for this short article. The other half of this background is the conflict created by Proposition 64 between making profits for investors from California’s cannabis industry and paying taxes to California and local agencies. Business interests sold Proposition 64 on a promise of new tax revenue. Many difficulties have ben encountered in collecting the promised tax revenue. The business interests that sold California voters on Proposition 64 have encountered difficulties making profits.
No one should be surprised that the interests of the investors in California’s cannabis industry conflict with the interests of the State. Higher taxes make it more difficult to make money in California’s cannabis industry. Lower taxes reduce the share of the money flow that goes to governmental agencies. The State of California and those trying to make fortunes in California’s cannabis industry are chasing the same dollars.
The conflict described above was expected by most. However, the arguably excessive taxes on cannabis also produced a more significant expansion of the underground market than many expected. It is obvious to all that both California’s legal and underground cannabis marketplaces have been expanding in recent years.
There is, however, a serious flaw in viewing California’s cannabis industry as divided between a legal industry and an underground industry.
California’s cannabis industry does not consist of a legal cannabis industry and an underground cannabis industry. The businesses that make up California’s cannabis industry fall under a Bell Curve that ranges from wholly compliant with all laws and regulations, including complete tax compliance, to wholly non-compliant with the law. With respect to tax compliance, the vast majority of California’s cannabis businesses fall between excessive fudging and criminal tax evasion if all local, California and federal taxes are taken into account. A similar Bell Curve describes the degree of the compliance of California’s cannabis businesses with regulatory requirements.
There are far more California cannabis businesses than the California market will support. The combination of high tax rates on cannabis businesses and a lack of sophistication relating to business operations make survival difficult for such businesses if they attempt to fully comply with all laws, including full tax compliance. The combination of too many cannabis businesses, high taxes, and limited business sophistication make failure almost inevitable for cannabis businesses that try to be fully compliant with all laws. The solution for most is to cheat to some degree on taxes.
It is almost impossible to make money in California’s cannabis industry without
cheating on tax compliance.
One additional introductory comment relating to this article is required. We developed the tax minimization techniques described in this short article for California’s cannabis industry. These techniques are California specific. Tax minimization principles, however, are general. The application tax minimization principles to the conduct of business in the cannabis space will always be State-specific. The legalization of cannabis has proceeded State by State. As a consequence, the application of the tax minimization principles to the cannabis industry of a State requires a careful examination of both the enabling legislation for the legalization of cannabis in a particular State as well as all of the applicable general laws of the State applicable to comparable business activities.
Based on the preceding, we decided to describe the tax minimization techniques that we have concluded are most useful in California for our readers that are interested in cannabis outside of California. We are doing so for the benefit of professionals in other States. There is nothing new in this article. We have presented the material summarized in this article in other articles. Some of earlier articles on financial planning and tax minimization topics that may be of interest are: Analysis IRC Sec 280E, Cannabis Inventory Costing Update, Collecting, Reporting & Remitting Tax, and CCT CET – Responsible Persons.
We have developed four techniques for the minimization of the tax cost of engaging in the conduct of business in California’s cannabis industry that are more sophisticated than those techniques that are widely utilized in the industry. These four techniques have not been extensively utilized in California. These techniques have not been widely utilized because they require a level of business sophistication and discipline that is not found in California’s cannabis industry. Stated differently, many of those involved in California’s cannabis industry find it easier and more profitable to cheat one or more governmental agency on taxes than to take the actions that are required to utilize the techniques described below. Of course, the long-term survival in California’s highly competitive cannabis industry will require the adoption of business efficiencies, including the adoption tax minimization techniques.
The four techniques for tax minimization we have developed for use in California’s cannabis industry are:
- The utilization of a Cannabis Cooperative Association (“CCA”). Such an organization can be utilized as a for-profit CCA or as a nonprofit CCA.
- The utilization of an entity that operates like a Cannabis Consumer Cooperative ® (“CCC”)[1] for the retail sale of cannabis. A CCC can engage in business as a for-profit CCC or as a nonprofit CCC.
- The cultivation, processing and sale of cannabis as medical cannabis in order to take advantage of the special provisions of California law, including tax laws, relating to medical cannabis that can be utilized to further minimize the cost of moving cannabis from cultivator to consumer if the cannabis falls under the medical cannabis regime.
- The utilization of the California and federal laws relating to tax-exempt organizations to further reduce tax costs for cannabis businesses. We have been surprised by the failure of the various cannabis Equity Programs to utilize tax-exempt organizations to further the efforts of these programs.
As is noted above, we have developed these four techniques based on California law. As a consequence, the techniques we utilize in California will not apply in other States. The underlying principles on which these four techniques are based can be adapted for use under the laws of other states. Knowledgeable tax planners will be able to determine how these principles can be applied pursuant to the cannabis, tax, business and corporate laws of such States.
The basic principles for the legal minimization of taxes are simple. These basic principles are threefold. First, try to make special taxes, excise taxes, sales taxes, etc., not applicable, or are payable by another taxpayer. Second, minimize effective tax rate through the minimization of taxable transfers and the use of vertical integration. Third, defer as long as possible the payment of taxes on a product or service in those instances in which the particular tax liability cannot be passed on to another taxpayer.
California’s adoption of enabling legislation for the creation of a CCA provides the best example. A CCA is a special form of corporation the California Legislature created to facilitate the engagement in the cultivation of cannabis through the equivalent of an agricultural cooperative. In California cannabis cultivators can take advantage of Schedule F reporting through participation in a CCA. It is likely in many other States the corporate laws that authorize agricultural cooperatives can be utilized by cannabis growers. As a consequence of a quirk in California law, cannabis growers could not conduct business through agricultural cooperatives. Hence special legislation was enacted in California to enable CCAs – the equivalent of an agricultural cooperative for cannabis cultivation.
The use of a CCA allows for the creation of a vertically integrated business structure which in turn facilitates a maximum deferral in the payment of taxes. A CCC can be utilized to neutralize the impact of IRC §280E. The use of a CCA in combination with the CCC facilitates the deferral of the payment of taxes until after the tax money has been collected from cannabis consumers. As is noted above, both CCAs and CCCs can also utilize the laws relating to nonprofit organizations to further minimize the impact of taxes on the conduct of business in California’s cannabis industry.
The corporate laws of most States provide for cooperatives and collectives, although it is unlikely the laws of other states will provide all of the benefits that CCAs provide for California cannabis cultivators. All States are likely to have laws relating to nonprofit organizations similar to California’s nonprofit corporate laws.
[1] Cannabis Consumer Cooperative ® is a registered Service Mark for a financial and regulatory recording-keeping and data management system developed by CANNABACUS ® for the retail sale of cannabis and cannabis products.
