The new federal tax law that went into effect in January this year doesn’t have much in store in the way of surprises. For state-legal cannabis businesses, the federal tax law will have about the same impact it has always had: a huge one.
But with recreational legalization about to open up in California, the largest legal cannabis market in the country already, investors and entrepreneurs are eager to get in the game.
But few who imagine setting up a cannabis business fully understand how hard the federal tax law can be on startups. And although Trump has vowed to slash taxes for the wealthiest individuals and corporations, those cuts aren’t likely to impact the taxes cannabis companies are already paying.
Federal Tax Law Already Makes Taxes on Cannabis Businesses Very High
In the first place, weed taxes vary state by state. And they seem hard to get right. Every state who has legalized cannabis has revised their tax laws and regulation codes for 2017.
Here’s a breakdown of the recent major changes on a per-state basis. But when it comes to federal tax law, businesses in each state face the same rates. And it’s this law that makes taxes on cannabis businesses so high.
Back in 1982, Congress easily passed a measure adding Section 280E to the U.S. tax code. Essentially, the law prohibited any business that “trafficked in controlled substances” from taking advantage of the many deductions and credits available to every other business.
These included things like overhead costs, employee-related expenses, the usual business stuff.
As a result of all those breaks, designed to support small business owners, a typical company could expect to pay a roughly 30 percent tax rate.
Without them, however, companies, like state-legal marijuana businesses, paid an effective rate as high as 70 percent.
Many point to the contradiction regarding legalization. If marijuana is still federally prohibited as a “Schedule I” controlled substance, why do companies still have to pay the federal government taxes?
The argument from the IRS claims that just because a business is illegal doesn’t mean it shouldn’t pay federal taxes. After all, states allow them to operate and receive their own cut. Suffice to say, these sky high tax rates make it difficult to keep a legal cannabis company afloat.
Tiny Change in Federal Tax Law Could Have Big Consequences For Cannabis Businesses
There is, however, one small change to the federal tax law that could have a big effect on many legal cannabis businesses.
The change in the tax code impacts cannabis businesses that register as a limited liability corporation or LLC. If an LLC has more than one member, it’s considered a partnership.
So, partnerships account for most legal cannabis businesses. And the new federal tax law effects these entities dramatically. Up until now, the IRS collected tax directly from each member in the LLC.
However, the new tax law will require the IRS to collect the tax directly from the partnership. The Canna Law Group describes this as “one-stop-shopping” for the IRS to collect tax from cannabis companies.
Furthermore, the new law requires partnership LLCs to select a “partnership representative.” The PR is the only person who can deal with the IRS. They’ve also got quite a bit of authority when it comes to deciding how much tax each member of the partnership pays if there’s an audit.
The issue is further complicated by the fact that the PR doesn’t have to be a member of the LLC. Overall, these small quirks in the new federal tax law could create issues for companies down the road. If you own a cannabis business, this is something to consider closely.
The Major Takeaways
For 2017, there’s not much new in the way of actually implemented tax law. At the state level, of course, it’s a different story.
Uncle Sam is going to get his cut, whether you like it or not. Legal cannabis companies have to pay:
- a 15% excise tax applied to the gross total of all retail sales
- a cultivation tax of $9.25 per dry-weight ounce of cannabis flower and $2.75 for the same of amount of leaves
- a use tax, unless you obtain a resale receipt from the company that sold you the cannabis for resale.
Ultimately, any new tax laws are likely to make things more expensive for your company. And the costs will likely have to be covered by the consumers themselves.