Marijuana Industry Taxation: "Illegal" Income Reporting and Deductions
From growers to buyers, compliance with federal and state tax laws is complicated. Marijuana-related businesses face higher tax rates and tax burdens than other businesses, and business owners face the possibility of criminal and civil prosecution by federal and state tax authorities for failing to comply with all tax laws.
Restrictions placed on medical marijuana dispensaries affect the ability to do business. Therefore, those in the business better know their tax business (or hire someone who does):
Al Capone’s Legacy: The Taxation of “Illegal” Income
The Internal Revenue Code (IRC) requires that everyone file an income tax return if their gross income meets a certain threshold – even if that income was made illegally. As early as 1927, the Supreme Court ruled that income from illegal activities are subject to income tax (see United States v. Sullivan—this was the basis for Al Capone’s conviction for tax evasion when all other attempts to convict him had failed). It has become increasingly difficult to make a living in this trade due to restrictions placed on marijuana-related businesses, such as:
- Business and Membership Structure. All medical marijuana collectives and cooperatives must organize and operate as nonprofit organizations with restrictions outlined by the California State Attorney General’s Office, which include maintaining the proper business licenses, sales tax and seller’s permits, and safeguarding the lawful cultivation and distribution of the product.
- Limitation on Business Deductions. 26 U.S. Code § 280E effectively causes medical marijuana dispensaries to be taxed on their gross, rather than their net income. Section 280E limits business deductions for businesses that consist of trafficking in controlled substances within the meaning of Schedule I and II of the Controlled Substances Act, which includes marijuana. Dispensaries are only allowed to subtract the cost of goods sold from their taxable income. Limitations on business deductions puts dispensaries in the disadvantageous position of having to characterize as inventory items that for most businesses would warrant a current deduction. It in effect raises the tax rate of most medical marijuana dispensaries to over 80%--more than double the tax rate.
- Banking. The inability of marijuana dispensaries to obtain banking services and subsequent problems associated with reporting cash hoard are exacerbated by the high penalties for income and employment taxes paid in cash. Running a cash business also puts marijuana dispensary owners at increased risk of criminal activity and additional expenses are often incurred to pay private security companies.