Experts: Tax rules for cannabis industry ‘inhibit entrepreneurship’ among minorities
After fluctuating a bit earlier in the year, March sales for adult use cannabis in Illinois bounced back to $130 million. Illinois sales of medical cannabis nearly topped $32 million.
Still, all is not well in the state’s legal cannabis industry. Despite the recent high, both adult use and medical cannabis dispensaries will feel the pinch of federal regulations on April 18, the deadline for filing income tax returns.
“Because the IRS still considers the sale of cannabis to be ‘trafficking’, licensed dispensaries can’t take deductions when filing federal income taxes,” said Alice Keane, an assistant professor in Governors State University’s College of Business in University Park.
Keane served in the Illinois attorney general’s office from 2007 to 2016. After medical cannabis was legalized in 2014, she handled administrative review litigation filed by unsuccessful applicants for cultivator and dispensary permits and licenses.
Keane continues to follow the cannabis industry closely. She published an article in a 2019 issue of the Midwest law Journal exploring four rulings that nixed deductions for dispensaries and related side businesses.
Business deductions normally include major expenses like payroll, rent, building depreciation, mortgage interest, business-related equipment, utilities, supplies, vehicle mileage and other expenses.
“For dispensaries, these deductions don’t apply,” said Keane, a resident of Chicago’s Beverly neighborhood. “All these businesses can claim is what they paid for the cannabis they sell.”
Adding insult to injury, because state income taxes are based on income figures supplied to the federal government, dispensaries in Illinois and other states must also pay unusually high state income taxes.
“This is not just higher taxes, this is excessive,” Keane said. “That circumstance could put some smaller concerns out of business and discourage new businesses from entering the market altogether.”
The Cannabis Business Association of Illinois agrees.
“Taxes are one of the huge, overall capital expenditures that
most people don’t understand dispensaries have to incur,” said Pamela Althoff, executive director of the association also known as CANNABIZIL. “What this does is it inhibits entrepreneurship and having the profitability for reinvesting back into the business, which is something typical startups do.”
Dispensaries take yet another hit by having to pay higher insurance premiums for what insurers consider high risk activity.
“That’s because, again, their business is legal in the state, but federally it’s an illicit product,” Althoff said.
CANNABIZIL has attempted to decouple Illinois from the federal tax provision which prohibits legalized businesses from taking normal business deductions, but to no avail.
“We’ve filed bills this session and last session,” said Althoff. “But they’ve not been elevated for consideration.”
So far, 37 states, four U.S. territories and Washington, D.C., have legalized the sale of medical cannabis, according to the National Conference on State Legislators. Eighteen states, two territories and Washington, D.C., have approved adult use cannabis.
Yet the federal government still classifies medical and adult use cannabis as a Schedule 1 drug under the Comprehensive Drug Abuse Prevention and Control Act of 1970.
Besides cannabis, Schedule 1 drugs also include heroin, LSD, ecstasy, quaaludes and peyote. These are considered more dangerous than Schedule 2 drugs which include cocaine, methamphetamine, OxyContin and fentanyl.
Section 280E of the federal tax code prevents businesses that are “trafficking” or selling Schedule 1 drugs from taking typical business deductions.
“Unless you’re a tax accountant for a cannabis business, you probably don’t know about this,” Keane said.
One accountant familiar with 280E is Molly Mayfield. In 2021 she founded Greenflex Financial, an accounting firm specializing in accounting services for cannabis-related businesses throughout Illinois and the United States.
She advises dispensariestodoeverythingthey can to substantiate the cost of goods sold, which for dispensaries is basically what they pay for the cannabis they purchase from growers within their home states. Cost of goods sold is allowed in calculating gross income.
Mayfield is intent on helping the industry address an outsized need for accountability in managing money transactions. She also aims to assist social equity (dispensary) permit applicants who hail from communities historically impacted by the war on drugs.
“It’s going to be 200% harder for these businesses,” Mayfield said. “With social equity, most of the time, that means access to capital is limited.”
Access to capital is exactly what fledgling dispensaries need to withstand exorbitant tax bills, steep startup costs to cover elaborate security systems and other high costs of doing business, said CANNABIZIL’s Althoff.
The state’s 110 cannabis dispensaries have weathered not being able to tax deductions for several years now, but these were heavily financed to begin with, Althoff said.
For prospective dispensary owners holding social equity applications that are still pending and held up due to multiple lawsuits challenging the fairness of Illinois’ dispensary licensing process, long-term survival could prove more precarious.
“I don’t think most of the newer social equity applicants were necessarily aware of a different tax provision,” Althoff said, adding that applicants for existing dispensaries went through a different vetting process.
Besides not having anticipated higher than normal taxes, social equity dispensaries may find it challenging to obtain business loans.
Because federal banks opt not to participate in what the federal government considers trafficking, they will not loan to businesses that sell Schedule 1 drugs. This makes it necessary to approach smaller financial institutions or private investors
That scarcity of financing may be changing, however, according to Mayfield, whose accounting firm also helps businesses locate lenders and manage cash flow.
“There are some nice banking solutions that have been found for cannabis related businesses, but they can be expensive,” she said.
Mayfield describes the role of an accountant serving the cannabis industry as “crucial” as well as “complex.”
Professional and technological skills are needed, she said, for setting up business management software and overseeing transmission of large amounts of data to separate online systems.
These systems can include a dispensary’s accounting system, point of sale system, receipt management system, any qualified financial institutions and money transmitters it may be working with, as well as Metrc, an online sales management system that gives state regulators the means to see a product’s cultivation and sales history.
“One of the special parts in all of this is you have to understand how to get the systems to reconcile and keep the data in sync,” Mayfield said.
Both growers and sellers participate in “seed to sale” monitoring, though growers, which are regulated by the Department of Agriculture, can still take business deductions.
“This industry is heavily regulated, which adds considerably to the cost of doing business,” Althoff said. “Maintaining that accountability and close monitoring can be costly and time consuming.”
Even so, Illinois’ cannabis industry seems to be doing well as far as that goes.
“Illinois has had only one diversion (to unintended users) since 2014,” Althoff said.
Keane seems hopeful that excessive taxes for dispensaries won’t last forever.
“I think Congress will eventually take cannabis off Schedule 1 or take it down to Level 3,” she said. “But who knows when that will be.”