II. Key Considerations
III. About Freeman Tax Law
Up in Smoke: A Guide to Understanding Tax Issues Related to the Cannabis Industry
Jeffrey S. Freeman, JD, LL.M. and Burton S. Roth, JD
Marijuana related trades and businesses must determine whether and what types of tax they are responsible for collecting when cultivating, processing, selling, and/or dispensing recreational or medical marijuana. This guide provides an overview of the tax issues that relate to marijuana businesses in the United States: federal income tax; state corporate income tax; state excise tax; state sales and use tax; and state property tax.
As a general matter, federal and state income taxes, state sales and use taxes, and state marijuana taxes apply if the state has legalized marijuana in some form (medical and/or recreational). A few states impose a controlled substances tax on marijuana if the state has not legalized marijuana in any form.
It is important to remember that gross income includes income from engaging in activities that are illegal. Such activities would include the earnings from the illegal trafficking in a controlled substance (e.g. marijuana).
Is a Taxpayer Required to Pay Federal Tax on Income Derived From Both Legal and Illegal Sources?
Marijuana trades and businesses are required to pay federal income tax and file federal income tax returns whether operated as a C corporation or pass-through entity, including limited liability companies (LLCs), partnerships, and sole proprietorships. However, marijuana trades and businesses are significantly limited in taking deductions or credits at the federal level.
Deduct This but not That - Internal Revenue Code (IRC) Section 280E
Tax deductions and credits are if a a taxpayer is engaged in a Marijuana trade or business. Internal Revenue Code Section 280E provides that no deduction or credit is allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business consists of trafficking in controlled substances (within the meaning of Schedule I and Schedule II of the Controlled Substances Act) which is prohibited by federal law (e.g., Marijuana/Cannabis) or by the law of any state in which such trade or business is conducted. Trafficking includes growing, distributing, and selling of marijuana or cannabis. As such, a taxpayer carrying on a marijuana trade or business is not permitted a deduction for any expenses incurred in connection with its illicit trade or business.
A taxpayer engaged in the business of trafficking controlled substances, however, is entitled to determine costs of goods sold using the inventory-costing regulations under IRC Section 471. A taxpayer cannot circumvent §280E by treating a disallowed deduction (e.g., salary, depreciation, or rent expense) as an inventoriable cost or as any other type of capitalized cost under the UNICAP rules under §263A.
State Corporate Income Tax Considerations
Most states use federal taxable income as the starting point to determine state taxable income. In addition, most states that have legalized medical and/or recreational marijuana sales do not have specific rules that apply to the computation of corporate income tax for marijuana businesses. This generally means that marijuana businesses organized as corporations use the same computation rules as any other C corporation doing business in their respective states.
Due to the unique interplay of marijuana taxation between the state and federal governments, however, states have begun providing guidance explaining that the credits and deductions not permitted at the federal level (per IRC §280E) may still be available at the state level. Because sales of marijuana are federally illegal, interstate sales of marijuana are prohibited and no apportionment or sourcing is required for corporate income tax purposes. However, marijuana businesses may also be subject to a franchise tax based on net worth or capital stock in addition to the corporate income tax.
Similar considerations may apply when the marijuana business is a sole proprietorship or pass-through entity instead of a C corporation.
EXCISE TAX CONSIDERATIONS
Which Parties Are Responsible For Paying The Excise Taxes on Marijuana?
Most states that have legalized recreational or medical marijuana impose a specific tax, or set of taxes, on marijuana, that are typically referred to as excise taxes.
Marijuana excise taxes may be imposed at various stages: some states impose tax on the cultivation of marijuana; other impose tax on the processing of marijuana; and others impose tax on retail sales of marijuana.
Consequently, marijuana businesses should determine whether they are responsible for collecting, remitting, and/or paying applicable excise taxes. To determine what parties are responsible for excise taxes on marijuana, speak with a tax attorney specializing in these matters.
It is also important to note that many jurisdictions have more than one type of excise tax on marijuana. For example, several states impose an excise tax on both the cultivation of recreational and the retail sale of recreational marijuana.
Marijuana businesses should also be aware that many states differentiate their marijuana taxing structures—including the parties responsible for collecting and remitting tax—based on whether the business sells recreational or medical marijuana.
Additionally, several jurisdictions require specified marijuana businesses to collect marijuana excise taxes even though taxes are not actually imposed on these businesses. For example, a recreational marijuana distributor may be required to collect a marijuana excise tax even though that tax is actually imposed on the marijuana cultivator.
Because the imposition of excise taxes on marijuana businesses is extremely state-specific, businesses are encouraged to examine state-by-state information with their tax advisors.
How Does a Marijuana Business Calculate Its Excise Tax Liability?
Once a marijuana business has determined it is responsible for the payment, collection, and/or remittance of excise taxes on marijuana, the business must determine its pertinent tax bases and tax rates.
The bases and rates of recreational and medical marijuana excise taxes vary greatly from state to state. For example, some states impose an excise tax based on the fair market value of the marijuana at wholesale while other states impose a tax based on the sales price of the transaction.
Additionally, some states differentiate taxation based on whether a marijuana business is “affiliated” with another marijuana business in a given transaction. For example, if a marijuana cultivator and a marijuana retailer are affiliated entities, the rate of tax for a transaction between those two parties may be based on a state-determined average market rate for the category of marijuana product(s) sold, while if a marijuana cultivator and a marijuana retailer are unaffiliated entities, the rate of tax may be based on a percentage of the contract price for the marijuana product(s) sold.
For more information on the basis of tax and tax rates on recreational marijuana, speak with your tax advisor.
How Does a Marijuana Business Calculate Its Excise Tax Credits and/or Refunds?
Once a marijuana business has determined the tax base and rates for the marijuana it sells, the business must determine whether the state in which it operates offers tax exemptions, credits and/or refunds for its sales of marijuana. For example, in several states medical marijuana is specifically exempt from excise taxation.
How Does a Marijuana Business File and Pay its Excise Taxes?
Marijuana businesses must follow their state’s requirements for filing and paying excise taxes. Businesses should be aware that many states have specific requirements regarding tax payment—particularly concerning whether electronic payment/remittance is required. Because many marijuana businesses operate on a cash basis, many states provide specific guidance and procedures for marijuana businesses that must remit excise taxes in cash.
SALES TAX CONSIDERATIONS
Is a Marijuana Business Required to Collect and Remit Sales Tax?
Marijuana retailers and/or medical marijuana dispensaries may be subject to sales and use taxes. The first step for these businesses is to determine whether their state imposes sales and use taxes on sales of marijuana.
It is worth noting that some states impose sales tax on medical marijuana; certain states exempt medical marijuana from sales tax; and other states exempt sales of medical marijuana if the purchaser has a state-issued identification card.
If a state does not impose sales tax on marijuana, a retailer or dispensary does not need to collect sales tax upon its sales of marijuana; however, as discussed above, other taxes may apply.
How Does a Marijuana Business Pay Sales Tax on Sales and Purchases of Inventory?
Most states exclude sales-for-resale from sales and use tax. In order to avoid sales tax collection and remittance requirements on sales of inventory for resale, marijuana wholesalers and cultivators may need to accept and retain sale-for-resale exemption certificates when making sales to marijuana dispensaries or marijuana retailers. Additionally, if a retailer or dispensary purchases marijuana from a wholesaler, the retailer or dispensary may be required to present a sale-for-resale exemption certificate, or it may be liable for sales and use taxes on its purchases.
Even if a marijuana wholesaler or marijuana cultivator does not make any taxable sales, a state may require these businesses to register as vendors and/or file “zero returns.”
What Types of Sales are Tax-Exempt or Excluded From the Sales Tax Base?
In addition to certain states exempting sales of medical marijuana from sales tax, certain entities, such as governmental units or charitable organizations, are exempt from sales and use tax in multiple states.
Many states exempt from sales tax manufacturing machinery and equipment, raw ingredients, and other components directly used in manufacturing goods for sale. These exemptions normally are available only to qualified manufacturers. Most states have not explicitly indicated whether marijuana processors or other marijuana businesses are eligible for such exemptions. W
hile most states offer agricultural exemptions for certain purchases by farmers, these agricultural exemptions do not apply to purchases by marijuana cultivators in many states. For more information on agricultural exemptions, see the Bloomberg Tax Sales and Use Tax Navigator, at 25.
How Does a Marijuana Business Calculate its Sales and Use Tax Liabilities?
After a retailer or dispensary determines whether its sales of marijuana are subject to sales and use tax, it must determine where to source its sales. After a retailer or dispensary determines where its sales of marijuana are sourced, it must determine the sales and use tax rates applicable to such sales in those locations. For applicable sales and use tax rates, speak with your tax advisor.
How Does a Marijuana Business File and Pay its Sales and Use Tax Liabilities?
After a retailer or dispensary has determined the sales and use tax rates applicable to its taxable sales, it must file and remit tax. For filing and payment requirements, each state handles this process differently.
Even if a state does not impose sales tax on sales of marijuana, a state may require marijuana businesses to register as vendors and/or file “zero returns.”
PROPERTY TAX CONSIDERATIONS
Property taxes are generally levied and administered at the local level, although a number of states also authorize a state-level property tax.
States often have special classification and valuation rules pertaining to property used to produce agricultural products; however, some states explicitly exclude property used to produce marijuana from agricultural classifications. Additionally, whether property used in marijuana cultivation qualifies as property used to produce agricultural products may depend on how the plant is grown.
Freeman Tax Law handles both the legal and accounting complexities associated with entering into Voluntary Disclosure Programs. We routinely provide legal representation to those involved in IRS Criminal and Civil tax controversies. Lastly, Freeman Tax Law also has a robust tax compliance practice and offers a full range of accounting and tax preparation services.
Jeffrey S. Freeman, Attorney
Jeffrey S. Freeman has personally represented and counseled hundreds of clients throughout the United States in both civil and criminal tax matters. His approach is to handle complex tax matters efficiently, creatively, and strategically. His goal is to educate his clients about their rights and their options when it comes to resolving their tax issues with the government.
Mr. Freeman has skillfully handled voluntary disclosures to report undisclosed offshore bank accounts (i.e., IRS Offshore Voluntary Disclosure Program (OVDP) and Streamlined Disclosure Programs), representing clients during IRS audits, disclosing previously undisclosed Crypto Currency transactions, and resolving collection matters for delinquent tax liabilities with the U.S. and State governments (i.e.,Offer in Compromise, removal of tax liens and levies, sales tax, and payroll trust fund tax assessments, innocent spouse relief claims and the removal ofpenalties).
Mr. Freeman holds a Masters of Law in Taxation (LL.M.) from Georgetown University Law Center in Washington, D.C. and Juris Doctor (J.D.), Cum Laude,from the Michigan State University College of Law and a Bachelor of Arts in Accounting, with honor, from Michigan State University where he was a member of the Beta Gamma Sigma Business Honor Society and the Phi Kappa Phi Academic Honor Society. Further, he is a member of the Criminal Taxation Section of the American Bar Association and Michigan Bar Association, where he served as a past chair of the Tax Practice and Procedure Committee. In addition to the state courts in Michigan, Jeff is admitted to practice before the United States Federal Court, United States Court of Appeals, U.S. Bankruptcy Court and in the U.S. Tax Court.
With national recognition for his work and commentary, Jeff has appeared on the Frank Beckman Show, Fox News, and has been quoted in the Detroit News, Detroit Free Press, Crain’s Business, and Detroit Business. Over the years, he has authored numerous articles for various professional journals and blogs regularly.
He has been named a “Top Lawyer” by Detroit’s dbusiness magazine and was recently the keynote speaker about the Foreign Account Tax Compliance Act (FATCA) at the American Chamber of Commerce in Shanghai, China among his many public speaking engagements.
Burton S. Roth, Attorney and Former IRS Special Agent
Burton Roth is a criminal tax attorney with over 35 years of experience in resolving both criminal and civil tax controversies with the IRS. He spent 13 years as a Special Agent with the IRS Criminal Investigation Division. He worked on many cases in a supervisory role and trained Special Agents on the intricacies involved in tax fraud cases. His years of government service and legal experience in representing taxpayers have provided him with an intimate understanding of the inner workings of the IRS.