Currently eight states regulate recreational adult-use cannabis1 and twenty-eight states and Washington D.C. allow the use of medically prescribed cannabis.2 The legalization of both recreational and medically prescribed cannabis led to nearly $9 billion in sales in 2017 along with a corresponding tax windfall in many of these states. As the legal cannabis industry grows at an exponential pace, cannabis businesses should be aware of the various tax implications facing the industry.
Type: Client Alerts
State Income Tax and Internal Revenue Code (IRC) Section 280E
For federal income tax purposes, IRC Section 280E prohibits deductions for expenses incurred by operating “any trade or business…that consists of trafficking controlled substances (within the meaning of schedule I and II of the Controlled Substances Act).”3 Marijuana is a Schedule I controlled substance, and the IRS uses section 280E to disallow cannabis businesses from deducting ordinary and necessary business expenses.
For state income tax purposes, most states use federal taxable income as a starting point to determine state taxable income. Absent any modifications by the state, states would also disallow the deduction of ordinary and necessary business expenses based on conformity to IRC Section 280E. However, some states such as Colorado, allow any type of cannabis businesses to take a deduction for ordinary and necessary businesses expenses through the use of a state adjustment. California, on the other hand, took a middle-of-the-road approach and only allows deduction for cannabis businesses filing a corporate franchise tax return by virtue of its IRC conformity provisions. As a result, a California cannabis business that operates as a sole proprietorship and is taxed as a partnership may not deduct ordinary business expenses due to conformity to IRC Section 280E.
Sales and Use Tax
Generally states impose sales and use taxes on the sale of tangible personal property, unless an applicable exemption applies. In California cannabis sales are subject to sales and use tax, but the state provides an exemption for medicinal cannabis if customers provide valid, state-issued medical marijuana identification cards (MMID).4 In contrast, Colorado generally taxes both medical and recreational cannabis, but provides for a lower tax rate for medical cannabis.
Many states allow localities to impose sales and use taxes in addition to the state sales and use tax. In California local tax rates are generally capped but the state allows for an enhanced cap for local sales tax imposed on cannabis products.5 For example, Berkeley is capped at a 2 percent sales and use tax rate for non-cannabis products but, at one point, imposed a 10 percent sales and use tax rate on cannabis products.
Cannabis businesses may also be subject to other taxes, such as an excise tax. Excise taxes are generally taxes imposed on the cannabis business but are passed through to the end customer. For example, Washington imposes an excise tax of 37 percent on all taxable sales of marijuana; California imposes a 15 percent excise tax on retail purchasers of cannabis and cannabis products; and Colorado imposes a 15 percent excise tax on the first sale or transfer of marijuana from a retail marijuana cultivation facility to a retail marijuana store or a facility that manufactures marijuana products. California also imposes a cultivation tax on growers based on the weight of the raw cannabis plant.
As the industry continues to grow at a rapid pace so will the taxes that follow the increasing dollars. While states and localities are eager to cash in on the newly legitimized industry, they often lack the resources and knowledge to properly administer the laws and regulations. Cannabis businesses should carefully consider engaging tax counsel to not only ensure the proper administration of the tax rules but also to help with the interpretation of the ever evolving cannabis laws in these states.
- Alaska, California, Colorado, Maine, Massachusetts, Nevada, Oregon, and Washington have passed laws regulating recreational marijuana. Vermont and Washington, D.C. allow adults to possess and grow limited amounts of marijuana but do not allow or regulate sales.
- These states include Alaska, Arizona, Arkansas, California, Colorado, Connecticut, Delaware, Florida, Hawaii, Illinois, Maine, Massachusetts, Maryland, Michigan, Minnesota, Montana, Nevada, New Hampshire, New Jersey, New Mexico, New York, North Dakota, Oregon, Pennsylvania, Rhode Island, Vermont, Washington, West Virginia, as well as Washington D.C.
- 26 U.S.C. § 280E.
- See Cal. Rev. & Tax. Code § 34011(f).
- Cal. Rev. & Tax. Code § 7251.1 Higher local rates are achieved by separate propositions enacted by the localities; see also Cal. Rev. & Tax. Code § 34021.5
Client Alert 2018-144