In 1996, Oregon and California were the first states to pass legislation that legalized marijuana for medical purposes. Today, there are 23 states and the District of Columbia that have laws in place that allow the cultivation and use of marijuana for medicinal purposes -- many other states have decriminalized possession while others are working towards legalization (OH and PA.)
In August 2013, the US Attorney General suggested that the federal government will, for now, allow each state to determine and enforce its own marijuana laws as long as each state is effective in preventing the distribution of marijuana to minors, drugged driving and other illegal activity.
While marijuana remains illegal in the eyes of the federal government, in 2013, however, Colorado became the first state to approve recreational marijuana dispensaries.
In 2014, Colorado’s recreational marijuana business had sales estimated at $288 million and tax revenue of $37 million in this all cash industry. Since marijuana is illegal at the federal level, banks will not do business with these cannabis businesses for fear of violating federal banking laws including money laundering. That is why all transactions and expenses are handled in cash, including rents, salaries, utilities etc. Since all transactions are in cash, there are limited paper trails and no traceable means to determine that all income is being reported or the expense amounts are accurate or reasonable. Colorado is working on a solution and has submitted an application to the government for a state chartered credit union that can transact with these businesses so that they can accept credit cards for payment and write checks to pay bills, as well as, reducing security and corruption risks associated with cash businesses.
The tax implications for the cannabis industry are tricky. The Internal Revenue Code (IRC) bans most deductions and tax credits given to business selling controlled substances, which includes marijuana. The IRC allows marijuana dispensaries to deduct only inventory costs; all other normal and ordinary business expenses will be rejected by the IRS. These disallowances create an effective federal tax rate between 60 and 90 percent for the industry.
When a cannabis business has been called to IRS appeal conferences, the IRS is usually quick to settle the issue because it is in the federal government’s best interest to continue collecting money from the industry.
More regulations and revisions are expected and some are calling for a complete overhaul of tax expensing rules pertaining to this industry. Only time will tell how this will turnout but it seems clear that with tax revenues so high from this industry, the government would want to make this work.