Up in Smoke: How Taxing Cannabis Has Proven Difficult for the IRS

Dec 12, 2019

Twenty years ago, 31% of U.S. adults supported marijuana legalization. In 2018, nearly 62% of adults favored legalization – including 74% of millennials. Thirty-three states have already established some form of regulated marijuana production and sale. With recreational and medical marijuana legalization gaining momentum across the United States, there has been an increased focus on one of the biggest issues facing the movement: How to ensure tax compliance on an item that is legal at the state level but still deemed illegal at the federal level?

Implementing and collecting an excise tax on the sale of any good is typically not a complicated process, however, the opposite is true when it comes to the collection of taxes levied on the sale of marijuana.The production, sale, possession, and use of marijuana has remained illegal under federal law, despite the nationwide domino effect of legalization and shifting attitudes among voters. The effects of this legal paradox extend into the banking industry, where marijuana manufacturers and dispensaries effectively lack the power to make deposits with any bank – virtually anywhere. This leads to dispensaries conducting transactions with cash only – starting to see the problem here? The result is that marijuana businesses in states with legal marijuana, along with financial institutions, run the risk of breaking federal banking laws by processing credit card transactions or accepting cash from the businesses. Because of the federal illegality of marijuana, some dispensaries across the country pay taxes in bags of cash transported in bulletproof vehicles. Some states, like Colorado, allow marijuana credit co-ops to exist to provide financial services to licensed marijuana companies in the state, which are regulated by the State Commissioner of Financial Services, but not all states are afforded this option. In the meantime, those left without regulated banking options make it difficult for agencies to audit and verify bank records and bank statements to verify compliance.

Unbanked taxpayers present unique challenges for the IRS. First, cash-only businesses are more prone to underreport income and evade taxes. Second, the process of accepting cash payments places a burden on the IRS, which must provide secure receipt facilities, deploy specialized machinery to count bills and detect forgeries, and employ the services of multiple staffers to ensure process integrity. Finally, in nascent industries such as the marijuana business, there exists widespread misinformation about obligations to calculate, file, and pay taxes. In September, the House of Representatives passed a standalone marijuana reform bill which would protect banks that service the marijuana industry from being penalized by federal regulators.

The IRS requires that gross income be reported from whatever source it is derived. Therefore, income generated from marijuana sales, even though it is classified as an illegal substance, must be reported for federal tax purposes.This brings up an important decision for growers and dispensaries: Do they risk tax evasion if they do not report their income, or do they risk criminal prosecution if they do? If they do choose to report the income and take the prosecution risk, deductions are minimal and, therefore, their tax bills are quite high.

Although states who have legalized marijuana have a better handle on the collection of marijuana sales tax, they face new compliance challenges. In our next piece, we will explore how inefficient and disjointed legacy systems, outdated and unsupported Information Technology (IT) systems, and paper only processes, in conjunction with hundreds of Excel spreadsheets, can muddy up a state revenue agencies ability to effectively and efficiently track marijuana sales and ensure tax compliance.



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Category: Blog, marijuana tax