Can Cannabis Outgrow the Cash Economy?

As the SAFE Banking Act Makes Its Way to Congress, We Recap the Challenges of 280E

BY MIKEL WEISSER

It’s been the bane of marijuana businessmen since well before the days of fancy accountants parsing massive dispensary industry profits. Cash. Can’t do without it, can’t put it in the bank.

And how do you explain it to the IRS?

Once upon a time marijuana entrepreneurs understood they were operating as criminals. Hiding the cash from “ill-gotten gains” was a necessity. How does one explain the stacks of hundreds in grimy rubber bands with no record of legal employment?

But starting in the 1990s, with the creation of state medical marijuana programs, and the legally recognized businesses the new laws created, many in the new business sector thought the cannabis industry would pay its taxes like any other business – add up your gross, subtract your expenses, pay taxes on your income. And that’s where it gets complicated.

A Product of the Drug-War-Driven 80s

Keep in mind, whether or not cannabis is federally legal, the IRS still expects businesses to pay taxes on income. As Slate’s Will Yakowicz points out, “The Internal Revenue Service has written specific rules for every profession and activity, legal and illegal.” IRS Tax Code Section 280E, devised during the drug-war-driven 80s, disallows all the normal business expenses a company would routinely take while filing their taxes if the businesses profits are derived from a federally controlled substance.

Section 280E reads:

“No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances (within the meaning of schedule I and II of the Controlled Substances Act) which is prohibited by Federal law or the law of any State in which such trade or business is conducted.”

The section originated during the Reagan Administration’s “War on Drugs:” During a 1981 court case a “cocaine trafficker asserted his right under federal tax law to deduct ordinary business expenses. In 1982, Congress created 280E to prevent other drug dealers from following suit.” The Treasury Dept. first gave banks limited permission to do business with legal cannabis operations in 2014.  That year there were 51 banks approved.

Tax Rates as High as 90%

By 2017 there are over 300, about 3% of our country’s 11,954 federally regulated banks and credit unions. However, back in January of 2015, the IRS released Memo. 201504011,  further restricting what types of costs could be allocated to COGS (Cost Of Goods Sold), reducing companies’ ability to adjust their federal tax rates.

The impact of disallowing normal deductions can be enormous. As Tiffany Wu, of the Cannabis Law Blog, notes, “There are differing opinions on the level of tax rates imposed on marijuana companies – from 40% to 70% to as high as 90% – all of which are higher than the 35% corporate tax rate paid by most other businesses in the United States.”

Marijuana tax attorney James Thorburn notes the singular struggle 280E has caused the industry: “It is not being applied to any other industry that we know of.” Property rental, employee salaries, advertising, utilities, equipment, raw materials, subcontractor costs, and so on? None of it, no expenses deducted.

Awash in Dollar Bills

Though more recent rulings have allowed some dispensaries to deduct the COGS, even bookkeeping costs, and of course, the purchase, care and maintenance of the cannabis itself can be questioned, the interpretation of the code typically falls on the IRS investigator on the case and, as a group, they have not been friendly.

The federal prohibition on cannabis and cannabis revenue leads to a second, even more perplexing, problem: Federally ensured banks can’t do business with companies that earn their income from marijuana since cannabis is a federally controlled substance.

This leads the industry to be awash in dollar bills and complex schemes to somehow get the money recorded and deposited somewhere. Many marijuana-touching enterprises have faced sudden closings of their bank accounts when the bank determined the client was a cannabis entrepreneur.

NORML chapters around the country and other political organizations focusing on cannabis issues frequently suffer the same discrimination. Even ancillary businesses like accountants, equipment manufacturers, security and marketing firms can be considered “marijuana businesses” and lose their banking services overnight.

“Massive Issues of Public Safety, Money Laundering, and Tax Evasion”

In a country that is adding new cannabis states faster than corn pops, the 280E obstacle is no longer exclusively the problem of a handful of little “laboratories of democracy” testing out new business structures. It is rapidly becoming an American banking crisis.

Following their 2016 legalization vote, California State Treasurer John Chiang created a 16-member task force to address the 280E problem. “If you don’t create some type of resolution, we’re going to have massive issues in regards to public safety, in regards to money laundering, tax evasion.”

With legalization coming to California, the potential for an in-state multi-billion-dollar industry is only hampered by the federally imposed banking restriction. Unhindered, Chiang believes the industry could generate as much as a billion dollars a year in state taxes.

“We want to be able to bank in a more professional manner like other businesses do,” says Jeff Hatley, Sacramento testing facility operator. Hatley, a biochemist whose testing facility tests a variety of products besides cannabis, has already been through the 280E ringer with closed accounts and the security headaches of a cash-heavy operation.

Banking in a More Professional Manner

Elsewhere The Cannabist’s Richard Baca notes, that in Colorado, absolute legalization has been in place for 4yrs and sales, thought of as “legal under state law,” have been approved by the state for the past three years. Colorado cannabis businesses pocketed over $1.3 billion in 2016 alone. By 2019, cannabis cash accounted for over five billion dollars of the state economy.

Yet James Thorburn believes the IRS presses Colorado cannabis businesses harder now than they did before. With national legal cannabis sales expected to reach $20 billion by 2020, a more understanding approach would be expected if not an entire new section of the tax code.

Nichole Snow, executive director of the Massachusetts Patient Advocacy Alliance, adds, “If the businesses have more access to banking, it would be a lot easier to apply to become a dispensary and then deliver medicine to the patients, who may not carry cash all the time.”

“People with guns and masks saying, ‘Give me all your cash.’”

“You make sure that people are really paying their taxes. You know that the money is not being diverted to some kind of criminal enterprise or creates space for tax fraud,” Massachusetts Senator Elizabeth Warren said recently. “And it’s just a plain old safety issue. You don’t want people walking in with guns and masks and saying, ‘Give me all your cash.’”

While cannabis entrepreneurs and their lawyers have fought tirelessly for nearly twenty years to earn respect and equal treatment for the cannabis industry and gained little ground on the tax front, a new wave of pressure is being put on the IRS and their bosses in Congress, to end the federal tax obstacles to the industry and bring it fully into the 21st century American economy. “We’re winning the war, but the federal government is still trying to win battles,” says Thorburn. “They are still using the tax code to destroy companies.”

“We are certain that there’s politics behind this, pushing to make marijuana illegal again,” Thorburn explains. “There are two factions in the federal government: the pro-weed faction and the anti-weed faction. It seems like Treasury Dept. is driven by an anti-marijuana faction.” The tales of the devastation come from every cannabis state. Noted cannabis tax attorney and professor Bob Carp, author of The Marijuana Business Operations Guide, has seen the horror stories. “A lot of dispensary owners would close out their first year of operations, and they weren’t prepared for the tax hit,” Carp explains. “It was a huge surprise. Their liabilities under 280E swallowed up everything.”

John Lord, chief executive officer of one of Colorado’s largest dispensary chains, claims he has been under “continuous audit” as the IRS combs through his records. John Davis, owner of the Northwest Patient Resource Center in Seattle, WA agrees, “I’m taxed on nearly double the amount that my business actually makes.” Davis believes federal legalization is the only way to solve the tax problem once and for all.

An Act of Congress

Starting in the 2017 Congressional legislative session, Elizabeth Warren (D-MA) roared into the US Senate intent on saving weed from its own success. Warren supported her home state of Massachusetts as they passed legalized adult use cannabis. Warren has seen her state struggle with the tax code since the MA medical marijuana law passed in 2012 and is quick to call out the flaws in the current arrangement. “There are a lot of clear advantages for everyone when it comes to allowing marijuana-based businesses to access the banking system,” she insists.

Serving on the Senate Banking Committee, Warren is one of 10 senators, including Vermont Senator Bernie Sanders, who recently filed a letter with the Financial Crimes Enforcement Network (FINCEN) office asking for “new guidance” and the creation of revised tax guidelines for marijuana businesses.

In part, the three-page letter reads:

“The fledgling legal market for marijuana is around $7 billion, a figure that’s dwarfed by the overall US market, most of which remains illegal. This business environment is an invitation to tax fraud, robberies, money laundering, and organized crime … With tens of millions of Americans soon gaining legal access to marijuana under state laws, new guidance is necessary in order to allow banks to enhance the availability of financial services for indirect businesses that service the marijuana industry. This will not only bolster the safety of our communities, but it will also help to spur economic growth across the country.”

Taylor West, deputy director of the National Cannabis Industry Association, has been lobbying Congress to stand up to the IRS for years. “The industry needs a sustainable solution that services the entire industry instead of tinkering around the edges. You don’t have to be fully in favor of legalized marijuana to know that it helps no one to force these businesses outside the banking system.”

The NCIA, which represent more than 1,100 cannabis businesses across the US, leads the fight on Capitol Hill lobby for tax reform. Their 2015 white paper on the issue laid out a strategic approach to changing the tax law.

Nicholas Vita, CEO of Columbia Care, one of the nation’s largest providers of medical marijuana products, cautions however “It’s not just as simple as asking the banks to open their doors,” Vita said. “The industry also needs to develop a set of standards that are acceptable to the banks.”

Document EVERYTHING

Famed Time Magazine cannabis writer Bruce Barcott provides additional advice from Colorado tax attorney Bob Carp for dealing with the pesky provision.  “Most people, even skilled accountants, haven’t worked with it before. They don’t know how to handle it, and before you know it they’re getting audit notices,” Carp warns. “You’re always going to have to render unto Caesar what is Caesar’s. But in some instances, there are ways to substantially minimize a cannabis company’s 280E tax liability.”

Carp offers five simple recommendations for cannabis companies to stay on the right side of the IRS and other financial regulators.

  1. Document Everything. Don’t allow under-the-table sales or tossed receipts: “If you can’t prove to the IRS where your money came in and where it went out, they’re going to assume you’re committing fraud. Then you’re hit with a 20-percent penalty for signing an inaccurate tax return.”
  2. Diversify Operations to Include Allowable Services to Recoup Employee Costs: “As the dispensary owner, you may create a drug counseling business, or a patient advocacy business, that shares the same roof with the dispensary. Now you may demarcate your staff hours to those two different businesses.”
  3. Study the  2007 CHAMPS case: Learn from Wykowski’s textbook example how to apply diversification to reduce tax burden.
  4. Work Out a Formula for Cost of Goods Sold: “For a cultivation facility, your seeds, utilities, payroll, water and other business expenses are all deductible, because everything used in the production of the cannabis can be attributed to cost of goods sold.”
  5. Chart Indirect Costs: Under a separate section of the tax code, IRS 263A, some indirect costs can be deducted. “You’re allowed to capitalize certain indirect costs that can be attributable to your finished product. Capitalize that cost. This is the sort of indirect cost that requires a simple formula. Many of the charges may be small, but they quickly add up and can produce significant savings.”

(Originally published 2017, updated 2019)

Never miss a story. Subscribe today.

Subscribe To Newsletter


By submitting this form, you are consenting to receive marketing emails from: AZ Cannabis News. You can revoke your consent to receive emails at any time by using the SafeUnsubscribe® link, found at the bottom of every email. Emails are serviced by Constant Contact