How Weed Businesses Pay Their Taxes
With outdated laws and restrictive banking, cannabis companies can expect to have a tough time paying, and affording to pay, taxes.
It doesn’t matter that weed is still illegal federally; under U.S. tax law, you have to pay taxes on all income-generating activities, even if you grow, process, or sell a Schedule I substance. And these rates are much higher for cannabis businesses than for any other. To make matters more difficult, federal law prohibits their use of banking services, so everything has to be paid in cash. Here’s a look at exactly how weed businesses pay their taxes on state and federal levels.
Marijuana Businesses Still Have To Pay Federal Taxes
Back in the ’80s, a cocaine dealer claimed that he could subtract business expenses from his income tax like a legitimate business. In response, Internal Revenue Code 280E came into being. It asserts that you cannot deduct business expenses “in carrying on any trade or business if such trade or business consists of trafficking in controlled substances.”
Today, this law is typically used to penalize weed businesses with heavy taxes. According to New Frontier Data, the federal government collected $2.9 billion in legal marijuana business tax revenue in 2017.
Tax Rates Are Often More Than Half A Business’ Earnings
The typical business pays taxes on their net profits, which is their gross profits minus expenses and the cost of goods sold. They can deduct startup costs, utilities, rent, maintenance, health insurance, marketing and other expenses.
According to the IRS, businesses with a net income of $50,000 pay 25%, ramping up at increments to 38% for $15,000,000. The corporate tax rate goes down to 38% once you hit a net profit of $18,333,333 net profits. Plus, regular companies, especially big corporations, often receive large tax cuts or hire accountants to diminish their tax rate. For instance, Facebook didn’t pay a cent in corporate taxes on its $1 billion dollar profits in 2010.
These rates pale in comparison to the taxes applied to cannabis businesses. According to Tax Code 280E, weed companies cannot subtract most of their expenses from their gross income. They can only deduct the cost of goods sold. This means that you could be looking at a tax rate that’s higher than the profit you made that year.
A marijuana business’ tax rate is almost always more than half of their net income. “70 to 80 is generally what people throw around,” Jennifer Benda, cannabis industry lawyer and partner at Fox Rothschild explained to Green Rush Daily. “I think that includes federal income taxes, excise taxes, state income taxes … all tax burdens.”
Excise taxes are imposed on certain produced goods and vary from state to state. “Many states have an excise tax, usually between the grow and the dispensary which is a tax that has to be paid just basically for producing these items,” added Benda. These go towards compliance departments, for example.
The combination of these taxes, the bulk of which come from the federal government, can drive any business into the red.
How Do Businesses Pay These Taxes? Often, They Don’t.
Considering how new most marijuana businesses are, many can’t afford to pay more than half of their gross profits. Doing so is risky because the government pays close attention to marijuana businesses. A tax evasion charge wouldn’t be hard to come by if you work in legal weed.
But many businesses in the industry do pay their taxes because they want to normalize cannabis. Without paying them, it would seem that post-legalization states are no different than prohibition states.
Paying Weed Taxes Is Expensive, Inconvenient and Dangerous
After calculating your ridiculously high tax rate, you have the added difficulty of getting these funds to the government without online banking. Since banks are federally regulated, they’re subject to federal laws, like the Controlled Substance Act that says that cannabis is illegal. The federal government could charge banks that accept weed money with money laundering.
As a result, there were only 296 banks and 94 credit unions in the U.S. that would work with marijuana companies last year, according to the Financial Crimes Enforcement Network. Most of these only work tangentially with them, and are quick to shut them down for cash deposits.
When tax season comes around, most weed businesses have no choice but to pay in cash. But moving $2.9 billion in cash and checks is not only inconvenient; it’s a safety hazard. Plus, it strains IRS resources, since they have to recount everything.
How Some Cannabis Businesses Get Around Tax Codes
Marijuana has always been an innovative industry, going back to its prohibition roots. This means that tax lawyers have a few suggestions for how to reduce horrifying cannabis tax rates. Keep in mind that state laws vary widely and tax codes are in flux.
One way is to divert expenses to the cost of goods sold. One tax lawyer suggests making sure the business owner is also the inventory manager, then their salary falls under the cost of goods sold, not expenses. Additionally, if you house inventory in a certain percentage of your space, then you can add that percentage of your rent to cost of goods sold.
Another solution is to open non-cannabis companies affiliated with your preexisting business. For instance, marketing or management companies, that can store and advertise the product produced in a grow. These don’t fall under Tax Code 280E. This means that you can deduct expenses when filing your taxes for these separate entities.
Plus, if your cannabis company pays your management company to store your product, you can add that fee to the cost of goods sold.
Selling Weed Isn’t As Lucrative As You Think
Despite the perception that being involved in the cannabis industry means making it big, there are a lot of obstacles for legal weed entrepreneurs. For starters, they have to pay more taxes than the rest of the country, which is much harder due to banking restrictions.
Though weed businesses are booming thanks to huge demand, these entrepreneurs won’t turn as much of a profit in the government reschedules cannabis and changes its tax code.