The widespread legalization of recreational marijuana has sparked a thriving and highly profitable marijuana industry in several states. A notable report from Arcview Market Research and BDS Analytics projects that California will achieve $7 billion in annual cannabis sales by 2024. Expectations for states such as Colorado are similarly optimistic, with enthusiasts claiming that the industry will contribute greatly to the local economy and tax revenue.
Unfortunately, when it comes to filing taxes, marijuana business entities can suffer greatly from complications at both the state and federal level.
How marijuana taxation works at the state level
A greater push for cannabis-related tax revenue has exerted significant pressure on today’s emerging marijuana businesses. As with any agricultural or retail endeavor, marijuana dispensaries and producers are required to accurately report and pay taxes on income generated from sales and related services.
For states in which recreational marijuana is legal, customers pay sales taxes when purchasing cannabis products. Many states assess sales taxes exceeding 10%, while Washington imposes a hefty rate of 37%.
In some states, transactions between cultivators and distributors are also taxed, as are transactions between distributors and retailers. Most states permit the collection of additional sales taxes at the local level.
State-based tax collection can be further complicated by differences between recreational and medicinal marijuana. In California, for example, excise taxes do not apply when patients receive medicinal cannabis for free. This stipulation only applies, however, if cannabis products are provided to users with valid Medical Marijuana Identification Cards.
Legalized marijuana and federal tax concerns
State taxes assessed on marijuana transactions are complex enough as is, but they’re only the beginning. At the federal level, tax concerns are far trickier.
While marijuana is legal for medical purposes in 33 states and for recreational use in 11, cannabis remains a federally banned substance. This means that every marijuana business currently operating in the United States faces a difficult quandary: is it preferable to avoid reporting cannabis-generated income and risk tax evasion? Or should income be reported, even if it leads to an elevated risk of criminal prosecution?
The complications don’t end there. Many businesses ultimately choose to report cannabis-related income to the IRS.But due to the substance’s continued illegal status, they are unable to qualify for deductions available in other industries. Elevated federal taxes, when combined with state-based expenses, make it increasingly difficult for marijuana businesses to get by, even in a time of high demand.
Accounting presents another notable concern. Because marijuana remains banned at the federal level, FDIC banks are unable to open checking accounts for the many businesses now involved in this booming industry. Banks that voluntarily choose to work with cannabis-based businesses risk being shut down by the federal government, and few are willing to take on such a significant risk.
Being unable to open checking accounts, most marijuana businesses continue to operate in cash. Likewise, many are forced to use cash to pay federal taxes.
How can marijuana businesses navigate state and federal tax laws?
Tax concerns should be addressed proactively when planning for and opening a marijuana business. Likewise, existing businesses should regularly assess financial practices to weigh the opposing risks of tax evasion and criminal prosecution.
In general, most businesses prefer to remain in the clear with the IRS. After all, the agency’s stance on cannabis taxation is crystal clear, as evidenced by this edict from an official memo: “Though a medical marijuana business is illegal under federal law, it remains obligated to pay federal income tax on its taxable income.”
The IRS can be extremely aggressive in its efforts to address tax liabilities, regardless of the legality of the business that owes back taxes. For this reason, marijuana businesses should be prepared not only to report on federally illegal income and pay necessary taxes (in cash, if necessary), but also, to deal with the very real possibility of suffering an audit. Meanwhile, accurate collection and record-keeping are just as critical at the state level.
Ongoing complications with marijuana tax law
There’s no perfect solution to these problems yet—nor will there be until this issue is properly addressed at the federal level. Until then, marijuana businesses should seek legal counsel. In many cases, strong advocacy will be required to fend off potential issues with the IRS and other federal agencies.
In today’s complicated marijuana tax environment, due diligence is critical. Efforts to remain fully compliant will ultimately pay off in reduced interference from both the IRS and state-based tax agencies. Don’t hesitate to seek support to keep tax-related risks to a minimum.
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