The green rush is not the gold rush
The California gold rush started two hundred years ago in Northern California and made the great State it is. Today, California has another gold rush but called the “green rush” with nuggets that are as good as gold. California is on the verge of having the largest cannabis industry in the world, and much wealth is derived from it. Much can be said about cannabis, but few investors or entrepreneurs think that they have a partner in their endeavors, called Uncle Sam and he wants his share of the wealth from these nuggets.
AUTHOR: William Fowler
UNCLE SAM AND HIS 70% EFFECTIVE TAX RATE
The Green Rush entrepreneur or investor thought they were on easy street, with pocket full of cash, until they filed a federal tax return for 2018. They discover, through the federal audit, that they are critically wounded with an effective overall federal tax rate of 70% or more. Additionally, there is the possibility of fines, penalties, interest, etc. that they would be subject to, if it is found there is participation in a money-laundering scheme with the illegal product called cannabis. If it is determined that they cannot prove of operating completely legal, then the IRS is capable and legally required to audit several years “before” they even started the plant-touching business! Remember, with the Internal Revenue Service, the burden of proof shifts to the taxpayer…so the entrepreneur must “prove” everything is legal within the cannabis touching business.
LET’S DO THE MATH
The California entrepreneur is only receiving thirty cents on the dollar, considering they are paying a 70% effective tax rate and the remaining thirty cent profits goes to paying friends or
investors their hefty return on investment. The cannabis entrepreneur discovers, they cannot even file under the federal bankruptcy laws since it is a federally illegal substance. Entrepreneurs, unfortunately, considered, too late, that they should have participated in the “black market,” because, no worries there, no federal tax, nor watchful State agencies.
Take note, that there are some legal cannabis companies “White Market” participating in the “Grey Market,” whereas they find themselves having difficulty in competing with the ever-changing legal market, federal taxation, and price drops, so these “legal” cannabis companies end up selling some of their cannabis in the “Black Market.”
Now the California Black Market is Under Scrutiny
The California Black Market is much larger than the legal market, as much as three times greater. All this cash is flowing somewhere, and now federal agencies are closing in on these Underground thieves. The Underground bandits are not just individuals in these cannabis plant touching businesses but within the local and State agencies. It is no secret that local agencies have been on the “take” for years, look no further than Calexico, California for an example, whereas the FBI investigations found Calexico officials were paid $35,000 for obtaining a cannabis license. Additionally, there are law enforcement officers that look the other way when paid cash when his neighbor has a grow right next door.
Let us not forget the State agencies themselves are in questionable alliances, for example, in Las Vegas, Nevada, the State taxing authority was not handing out lucrative cannabis distribution licenses to legally approved cannabis businesses, they were providing the licenses to only alcohol distribution companies. Is it any wonder that Las Vegas law enforcement resorted to a crack-down to stop all cannabis delivery companies so the alcohol industry would have a monopoly on
all distribution? This makes sense. Furthermore, the most alcohol sold in the state of Nevada, is Las Vegas. Isn’t it convenient that the alcohol industry has a near monopoly on Nevada cannabis distribution?
Let us not forget the great State of California, whereas the Department of Justice has been investigating Weedmaps for all the participants in the Illegal Market so the Department of Justice can shut them down with the help of the Internal Revenue Service. All the names of the individual businesses on Weedmaps will be information that that Internal Revenue Service will use to go after the underground businesses advertising on Weedmaps. Additionally, the Inspector General is recommending to the Internal Revenue Service to use all the names within the State Cannabis Departments to identify those companies dealing with cannabis.
The federal law enforcement agencies will clean up the illegal market, just like in Nevada so the large corporations will have a monopoly on cannabis. Recently, as of January 2022, LA County considers fining unlicensed cannabis operators $30K per day. Why did this take so long? Isn’t this a great example of the “Black Market” continuing without regulation…. until now?
California’s’ Department of Food & Agriculture had stated in 2018 that the limit put on outside grows is only one acre, but as of January 1, 2023, there is no stated limit to outside grows. What does this mean? One can surmise, that by January 1, 2023, that California’s illegal market will have better enforcement and the small legal cannabis operators will go out of business because of IRS’s unrealistic 280E ramification of a 70% effective tax rate. Accordingly, large corporations will come in 2023 with bundles of cash to grow on multiple acres, buy up small cannabis farms that are going bankrupt, and even buy larger companies that are having financial difficulties and investor woes. Of course, the IRS in 2021 has even said they would like to see banking rules loosen
up, so the IRS does not have to put all their cannabis derived cash into warehouses. Hence, the banks will be open, as soon as 2022 for cannabis businesses and capital will flow for corporations and savvy investors picking up great deals in the cannabis sector in the years 2022 and 2023.
One can easily surmise that the federal government will change the Schedule I classification of cannabis in or around January 1, 2023, or soon thereafter and eliminate the taxing effects of 280E. When this happens, large corporations in California will be operating just like the alcohol industry which has predominate control on the cannabis distribution in Nevada. Obviously, Uncle Sam will be happy with all the legal money coming in from the large corporations that pay Uncle Sam’s salary. The Internal Revenue Service does not need to spend time and resources on enforcement of cannabis, like the prohibition period when dealing with alcohol and the likes of Al Capone. History does repeat itself and investors should be mindful of this.
What should cannabis companies do to safeguard their investments
Hire professionals that know the workings of the Internal Revenue Service and how to structure a cannabis business the right way*, not “fly by the seat of your pants.” Unfortunately, there have been many cannabis companies formed by unsophisticated individuals that have no idea on how to run a business, much less what to do with the 280E ramifications. Most new businesses fail, 80% or more due to the lack of business acumen, much less any knowledge of IRC 280E
Keep meticulous accounting records, even more so than a regular business. The IRS will already have your business name in its system to “red flag” you because of the days when it was illegal. Now that your business is legal, still be wary that your business name will pop up for review, just be conscious of this, do not get lackadaisical because you think the days of 280E are over.
Remember you have a partner in your business, its Uncle Sam and he is not forgetful.
*Note: see https://www.wkfowlerconsulting.com/ or NACVA for classes on business strategic structuring and achieving more value for a Cannabis Dispensary or other cannabis businesses.