Marijuana Merchants Owe Taxes Even When They Take a Loss


Northern Lights Cannabis Co.

As we have noted here several times in the last few years, Section 280E of the Internal Revenue Code bars state-licensed marijuana merchants from deducting business expenses on their tax returns. USA Today reports that disallowing those deductions can result in an effective tax rate ranging from 70 percent to 100 percent. Needless to say, that handicap makes it hard to stay in business.

USA Today describes the predicament of Mitch Woolhiser, proprietor of Northern Lights Cannabis Co., a dispensary in Edgewater, Colorado, who last year owed $20,000 in federal income tax even though he did not turn a profit. "It's almost like they want us to fail," he says. Well, yes, it is exactly like that, if "they" refers to the members of Congress who enacted Section 280E in 1982 as way of sticking it to drug dealers. Woolhiser still qualifies as one of those under federal law, even though he is licensed by Colorado to sell marijuana.

Counterintuitively, cannabusinesses are allowed to deduct the "cost of goods sold," which includes whatever they spend to grow or purchase marijuana. The upshot, as I explained in Reason last year, is that a can of coffee in the break room may not be deductible, but a jar of Lemon Diesel buds on the shelf is. I say "may not" because marijuana merchants can try to deduct a portion of their business expenses, including big-ticket items such as rent, utilities, and wages, by attributing them to activities other than supplying cannabis. But that tactic, which is used mainly by medical marijuana dispensaries that provide ancillary services to patients, is complicated and open to challenge.

The IRS is not known for flexibility in dealing with state-legal cannabusinesses, but it does not have the discretion simply to ignore Section 280E. USA Today quotes a 2010 IRS letter to members of Congress who wanted it to stop enforcing Section 280E in states that have legalized marijuana for medical or recreational use. "The result you seek would require the Congress to amend either the Internal Revenue Code or the Controlled Substance Act," the IRS said. That is not quite true, since the executive branch has the power to reclassify marijuana under the Controlled Substances Act without new legislation from Congress. Section 280E applies only to substances in Schedule I or II, so moving marijuana to Schedule III or lower would make it much easier for cannabusinesses to pay their tax bills.