Voters in four states and Washington, DC, have approved marijuana legalization. But the drug remains illegal under federal law, creating all sorts of legal hurdles that state-legal marijuana businesses have to overcome.
The federal government is taxing marijuana businesses to death
One of those hurdles is federal taxes. Due to a section of the tax code known as 280E, many state-legal marijuana businesses have to pay taxes on basic expenses like rent, employee salaries, and utility bills — unlike other legal businesses, which are allowed to deduct these types of expenses.
For some businesses, this can drive their effective tax rates to 70 to 90 percent of their profits, which is enough to force many shops out of business. In comparison, other types of businesses can expect effective tax rates closer to around 30 percent.
The New York Times’s Jack Healy reported on one medical marijuana business in Seattle that paid nearly 87 percent of its profits to federal taxes:
In Seattle, John Davis earned $53,369 in profits last year from his medical marijuana dispensary, the Northwest Patient Resource Center. Because he complied with all of the tax rules prohibiting deductions, he said, he ended up owing $46,340 in taxes.
“It’s basically a dagger at the throat of the entire legal cannabis industry,” Steve DeAngelo, co-founder of California-based medical marijuana dispensary Harborside Health Center, told me.
Section 280E was originally meant for criminals, not state-legal businesses
This is the kind of drug trafficking 280E originally intended to go after. (Alonso Rochin / AFP via Getty Images)
Section 280E was originally passed in 1982 to prevent drug dealers from deducting expenses related to the trafficking of schedule 1 or 2 substances, including marijuana, from their federal taxes. It was in part inspired by a Minneapolis drug dealer who ran up deductions for expenses related to his dealing, including the cost of gas, trips to other cities, and even rent on his apartment, which he classified as his place of business.
But in recent years the IRS has used section 280E to go after state-legal marijuana businesses, since they technically deal in a schedule 1 substance, the federal government’s strictest classification for an illegal drug. The move has netted the US millions in extra revenue from pot shops and growers, but it’s also forced some state-legal marijuana businesses to shut down.
DeAngelo of Harborside Health Center worries that section 280E could actually help illicit drug traffickers. To cope with the tax burden of 280E, many marijuana businesses raise their prices. But raising prices could make legally sold pot more expensive than illegally sold pot, giving consumers more incentive to buy from illicit drug dealers. So by treating businesses that are legal under state law like criminals, the federal government may be giving more leverage to actual criminals in the pot market.
Some businesses are trying to get around 280E — and calling for change
Grover Norquist attended a press conference calling for 280E reform. (Win McNamee / Getty Images News)
Pot shops have tried to mitigate the cost of 280E by hiring attorneys and accountants to help them restructure their businesses to include more expenses in limited deductible categories. As marijuana business attorney Henry Wykowski explained, businesses are still able to deduct the cost of goods sold, including — in a bizarre twist — the actual marijuana bought wholesale from growers, and some services unrelated to marijuana sales, such as massages, psychotherapy, and social activities.
“The impact of intense federal enforcement actions is felt most by the smaller, less well-funded dispensaries,” said DeAngelo of Harborside Health Center. While smaller dispensaries closed, DeAngelo said Harborside was able to stay open because it had “the financial resources to hire the best legal talent available.”
The National Cannabis Industry Association, legal pot's lobbying arm, has called on Congress to exempt marijuana businesses operating legally under state law from 280E. They've been joined by a bipartisan cast of political players, including conservative Grover Norquist, head of Americans for Tax Reform.
Advocates acknowledge that the chances of reform passing are slim, particularly in the upcoming Republican-controlled Congress. Taylor West, deputy director of the National Cannabis Industry Association, said changes to 280E will most likely need to come through a broader tax reform bill. The goal, she said, is to make sure legislators understand this isn't necessarily about supporting legalization.
“This is not about how you feel about marijuana one way or the other. This is about simple fairness,” West said. Businesses “are saying, ‘We will pay taxes. We just want to pay fair taxes.’”
