Marijuana And The Tax Law

TaxConnections Picture - Pot Leaf

It’s unlikely anyone missed the news stories about marijuana sales becoming legal on January 1, 2014 in Colorado. The Huffington Post reported on January 8, 2014 that sales in the first week were about $5 million. That also generated a lot of tax revenue for the state because Proposition AA* that Colorado voters passed in November 2013 allows for a 15% excise tax when unprocessed retail marijuana is sold by a cultivation facility to a retailer AND a 10% sales tax (on top of the normal Colorado sales tax of 2.9%) when the retailer sells the marijuana. That proposition suggested that $70 million would be generated annually with the first $40 million to be used for public school capital construction. Additional revenues would be used to enforce regulations on the retail marijuana industry and the balance for other needs (apparently at the discretion of the legislators).

Recent guidance from the Colorado Department of Revenue (Sales 93) notes that there is a Retail Marijuana Sales Tax Return. Also, there is apparently just one possible exemption, described in “Sales 93” as follows:

“Medical marijuana is exempt from state sales tax for patients that are issued a registry card that has a tax-exempt status notation from the Colorado Department of Public Health and Environment (CDPHE). A person qualifies for the tax-exempt status if, depending on the number of people in the patient’s family, their income is below a certain level. The tax-exempt patient must provide the tax-exempt registry card to the retailer at the time of purchase in order to be exempt from sales tax.” [This appears to be something new because a 2009 opinion from the Colorado Attorney General said it was subject to sales tax.] “Excise 23” explains the 15% excise tax. Medical marijuana is not subject to this tax.

Some observations:

These are high sales tax rates on top of the normal sales tax. Depending on what additional costs the state incurs from the sales, it seems to be a significant source of revenue. A 1/9/14 story in the Wall Street Journal – “Pot Legalization Crimps Funding of Drug Task Forces,” notes that states that legalize marijuana lose funding because some of the seized assets are used by law enforcement.

Are there other items consumers are willing to pay an additional 10% sales tax on? Perhaps the Colorado state sales tax of 2.9% is too low?

Registry card – This card used by a low income patient to obtain a sales tax exemption on medical marijuana is interesting. Generally, it is difficult to target sales tax relief because a vendor doesn’t know if a person is low-income and eligible for tax relief. This is why states typically deliver sales tax relief in overbroad ways, such as by exempting food purchases. Such broad exemptions provide significant relief to high income taxpayers who spend more on food than do lower-income individuals, and likely don’t need a sales tax break. Perhaps this approach works for medicinal marijuana sales as other documentation might exist and these sales are far fewer than food. I think the system would not work for other types of sales, such as food, due to possible abuse and added administrative costs. I think that food should be subject to sales tax with relief provided to low-income individuals via a refundable income tax credit.

Income taxes – Since 1982, federal income tax law has denied operating deductions for a business of selling controlled substances (IRC Section 280E). The business can subtract cost of sales from its revenues, but not operating expenses such as utilities. While most businesses aim to treat expenditures as period costs rather than inventory costs, marijuana retailers would be incentive to treat as many as possible as inventory costs so they can include them in cost of sales under the IRC Section 263A (“unicap”) rules. [For more on this topic, see (1) IRC Section 280E, (2) Olive, 139 TC No. 2 (2012), and (3) “Federal Income Taxation of Medical Marijuana Businesses,” by Professor Roche at the University of Denver law school, August 2013.]

Query: Do the states that have legalized marijuana sales conform to this federal rule?

Query: Will legislation pass to change 280E, such as H.R. 2240 that would make IRC 280E non-applicable in a state where sale of marijuana is legal? Problem there is that then federal law is not treating all federal offenses the sale given that the marijuana is a controlled substance under federal law.

Query: How much will federal and Colorado income tax revenues increase due to sales by Colorado marijuana retailers?

Practitioners – There seems to be an open question of whether a tax practitioner (particularly a licensed CPA or attorney) can assist a marijuana retailer with their tax compliance and planning, given that it is an illegal business, at least under federal law. Is there any ethical violation?

In accordance with Circular 230 Disclosure

Annette Nellen, CPA, Esq., is a professor in and director of San Jose State University’s graduate tax program (MST), teaching courses in tax research, accounting methods, property transactions, state taxation, employment tax, ethics, tax policy, tax reform, and high technology tax issues.

Annette is the immediate past chair of the AICPA Individual Taxation Technical Resource Panel and a current member of the Executive Committee of the Tax Section of the California Bar. Annette is a regular contributor to the AICPA Tax Insider and Corporate Taxation Insider e-newsletters. She is the author of BNA Portfolio #533, Amortization of Intangibles.

Annette has testified before the House Ways & Means Committee, Senate Finance Committee, California Assembly Revenue & Taxation Committee, and tax reform commissions and committees on various aspects of federal and state tax reform.

Prior to joining SJSU, Annette was with Ernst & Young and the IRS.

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One comment

  1. James says:

    This will make Colorado a powerhouse from tax.

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