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AUTHOR: “Jordan Zoot.  “aBIZinaBOX Inc., CPA’s
PUBLISHER:  CANNABIS LAW REPORT

Federal Legalization – Then What? – It is fascinating to step back and observe how the mindset of many in the cannabis industry seems to work. Let’s think through a couple of scenarios and have a peek at the landscape in a post-legalization world. Let’s begin with the following:

 

STATES Act Becomes Law

The STATES Act passes in Congress, the President signs it and it becomes law which means that in the states where cannabis is legal:

Banking system becomes available to cannabis businesses.

IRC Sec. 280E is effectively repealed and cannabis businesses are no longer subject to the broad disallowance of expenses. [This result is dependent on the mark-up and amendments.]

[Note: while we don’t believe that anyone in Congress has proposed it yet, the Federal government could legalize cannabis for medical use [and perhaps for recreational use] and preempt many of the state laws. States could create more restrictive regimes, but could not authorize activities that permitted activities that federal law prohibited. Of course, federal prohibitions are limited by the Constitution. Such actions by the federal will create some very difficult paths because of policy distinctions arising from individual rights, public protections, commercial activities, health and safety, use of resources, etc.]

The Cannabis Trade Federation has published a whitepaper on the STATES Act that you can read here.

The STATES Act is a substantial improvement from the current situation but it does fully address:

Interstate commerce in connection sending cannabis product to [or “thru”] states which have not legalized cannabis.

The status of Indian Reservations and other similarly protected land has not been adequately addressed in the current version of the STATES Act which would subordinate tribal sovereignty to state law. [See The Murky Part of the STATES Act: Tribal Rights]

The substantial likelihood that Congress will enact a Federal Excise Tax on cannabis to both give the Federal government a “slice of the pie” and replace the revenue loss from an elimination of IRC Sec. 280E. A substantial excise tax of say, 20-25% without an exemption for medical use cannabis would create an additional financial disaster for those whose only interest in cannabis is for its benefit as a medicine.

The STATES Act is a “halfway approach that some will celebrate a victory, but many will be left out.” For a number of reasons Congress must direct serious attention to whether a distinction should be made between medical and recreational use of cannabis.

 

Federal Legalization – Then What?

Removal of Cannabis from the Controlled Substances Act [“CSA”]

The broader solution that many advocates seek is either the removal of cannabis from Schedules 1 and 2 of the CSA or preferably the removal of cannabis from the CSA entirely. The removal or rescheduling of cannabis within the CSA could be accomplished via two different paths. The first and more conclusive would be through Congress legislation signed by the President. The second path would be the administrative action by the Drug Enforcement Agency [“DEA”] and its Diversion Control Division. We are not going to attempt to tackle the myriad policy issues of this alternative, but we do have some observations.

Once cannabis is removed from the CSA or rescheduled, cannabis will either become “medicine” or just another agricultural crop in the view of some people. The consequences of either may cause cannabis to lose much of its “special status” and become “just another plant”. However, it should be obvious to everyone that removing or rescheduling cannabis “isn’t that simple”. Cannabis is a drug with a lot of history.

We start our thinking with the question of how will any Federal regulations relating to cannabis be crafted? What agencies will have oversight at the Federal level? Will the mandate for the DEA be changed to oversee another special agricultural legal crop or a medicine? Will Federal legal cannabis be treated as if it is a type prescription drug? Will the FDA become directly involved if cannabis becomes “medicine”? Will the IRS be given a new mandate to oversee and collect a new “Federal Cannabis Excise” tax? We regularly return to the maxim, “Be careful what you ask for because you may get it.”

The legalization of cannabis at the Federal level won’t directly do anything to change the licensing, regulation, or taxation of cannabis at the state level except to the extent it may have some preemptive impact. California’s cannabis regulatory agencies [CalCannabis in particular] must still revise, restructure and streamline their activities. Above all California’s agencies must simplify their licensing regimens. Licensing and reporting complexities are is the single greatest hurdle to reducing California’s flourishing underground cannabis industry.

We have written extensively about the critical need for restructuring and modification of the reporting and collection mechanisms utilized by the California Department of Tax and Fee Administration [“CDTFA”] for sales tax, cannabis cultivation tax [“CCT”] and cannabis excise tax [“CET”].

 

The most critical items include:

Legislation to add “responsible person” provisions for CCT and CET taxes.

Creation of a unique identifier for the reporting and remittance of tax payments from retailers, manufacturers, and cultivators to distributors to streamline the process of reconciling tax reporting and to permit CDTFA to rapidly identify and pursue non-compliant cannabis businesses [ See CCT – CET Collection Mechanics],

Mandate the use of segregated bank accounts [“trust accounts”] for cannabis taxes to better protect and preserve the funds that belong to the people of California [See CCT Collection Best Practices],

 

Federal Legalization – Then What?

We believe that there is a parallel urgent need for cannabis businesses to implement the technology and accounting infrastructure to develop, maintain and archive the records required by the myriad regulators. Our belief is that the single largest cause of the failure of cannabis industry businesses is going to be associated with failure to maintain those records, and remit proper amounts of cannabis taxes in a timely fashion. The CDTFA audit process has the potential to be a bloodbath [ See Key to Success for California Cannabis Businesses – Managing Tax Liabilities]. We have yet to find a dispensary in California that is both properly calculating all of the cannabis taxes and presenting all of the required information on receipts [See Dispensaries Need Accurate Receipts].

Our recent posts have returned to a discussion of accounting/compliance platforms which include accounting software to maintain “books of account” [See Which Set of Books? ], point of sale systems for dispensaries, inventory management software, much more complex software for extractors, and a bridge to agency-level reporting under METRC See QBOnline-Boxstorm-METRC].

We have written a set of seven white papers that are available to the public to review.

Our understanding is that many of our peers charge $5 – $7.5K for the same information.

The subjects covered in the white papers are:

  • Brief Background of Legal Cannabis Regulation in California
  • Cannabis Business-Requirements for Books of Account, Transaction Recording, Method of Accounting and Record Retention for Federal Income Tax and California Cannabis Regulatory Requirements
  • Pass-thru Entities, Wages & Salaries, Non-Employee Compensation, Reasonable Compensation and IRC Sec. 199A Pass-Thru Entity Deduction
  • California Cannabis Distributor Responsibilities
  • A Methodology for Cost and Expense Allocations for IRC Sec.280E
  • California Cannabis Cultivation – Qualification as Farming
  • Inbound Investment Structuring

You can access the whitepapers to view here. We will be posting a procedure for registration to facilitate downloading copies. We have a special program for consultation with our professionals if readers have questions or would like assistance in implementation.

We find ourselves constantly reminding legal cannabis businesses that “legal” came with the conditions of “regulated” and “taxed” as the stimulus for government agencies to act. There is still much to be done to get kinks out of the regulatory and tax regimes. We intend to continue to publish our views and suggestions with respect to policy and operational reform.

At the same time, our experience and expertise are available to a cannabis business in California [and soon New York and Illinois] that would like to capitalize on it for the benefit of their own business.

 

You can take the first step to work with us using the contact form