Taxes are screwing the weed industry
Jim Parco may be one of the most unusual—and most qualified—pot shop owners. A retired Air Force lieutenant colonel, he served on Bill Clinton’s National Security Council in the 1990s. Today, he and his wife own Mesa Organics in Pueblo, Colorado, a recreational cannabis retail store.
In addition to selling legal weed, Parco teaches economics at Colorado College, a private university located in downtown Colorado Springs. He founded one of the world’s first accredited cannabis-oriented university courses, where students learn the history, science, and regulations surrounding the plant. The students’ capstone project involves developing a business plan for forming a new cannabis business, then pitching the idea to Parco as if he would award a state license.
One thing every student learns in his course: they better prepare to pay taxes out the ass.
“This is why cannabis is legal,” Parco told Rooster over the phone. “Because state and local governments are making a killing right now.”
How to Make a Killing (If You’re the Government)
By law, licensed marijuana businesses cannot make tax deductions. This is due to 280E, a section of the tax code prohibiting anyone from deducting expenses on income earned from selling Schedule I controlled substances like cannabis. Even in Colorado, where voters approved a regulated marijuana market, state law still classifies marijuana as Schedule I—right alongside other drugs like heroin.
Any other business, including those that sell alcohol, tobacco, or pharmaceuticals, can make deductions. These deductions include any business-related expense, such as paying for employees, transportation, insurance, equipment, or—ironically enough—tax accountants.
For many companies, tax deductions are the key to generating profits and keeping the company in business, since overhead costs often exceed sales, especially for newer businesses.
“We’re effectively paying a 100 percent tax rate,” Parco continued.
What exactly does that mean, a 100 percent tax rate? Parco gave, by his own admission, an incredibly simplified example. Let’s say a pot shop makes $100,000 in sales. Tax code calculates the tax by revenue minus cost of goods sold. If this same shop spent $80,000 buying plant material to make dabs, and another $60,000 on the labor and equipment to process those dabs, cost of goods sold equals $140,000.
Under 280E, this hypothetical business just lost $40,000 and will still pay all taxes on $100,000 in sales. Other businesses would net a profit because of deductions; in this example, the pot shop may now go bankrupt.
“When it’s all said and done, there’s no money left. There’s no profit,” Parco explained. “Everybody’s looking at the sales, and everyone thinks cannabis is making all of this money. Yes, there are a lot of sales, and the state and local governments are making a ton on taxes. But the business owners? They’re not making anything.”
Parco recognizes exceptions to the rule. Some cannabis businesses are doing incredibly well, he said, because they scaled and expanded. These successful businesses, however, remain rare. Most licensed weed companies are lucky if they just break even.
“During the gold rush, it was never the prospectors making all of the money,” said Parco. “It was the people selling the picks and shovels. In cannabis, it’s the people selling [empty] vape cartridges. People selling grow supplies. People selling manufacturing equipment. Those are the businesses to be in right now, because their sales are going through the roof. And they get all the benefits of being a business through the IRS.”
The tax code affects everyone, not just business owners. Parco said this unfair taxation system could ripple throughout the nation’s economy. Investors may be pouring billions of dollars into this fledgling industry, but returns on those investments could prove disastrously dismal under 280E.
“Until 280E goes away, and tax policy changes,” he said, “I think we’re going to see a [financial] correction in the marijuana industry. I wouldn’t be surprised to see some very big losses.”
But What About Hemp?
Last month, President Trump signed the 2018 farm bill, federally legalizing hemp. Hemp is marijuana’s sibling, a variant of the cannabis plant that produces negligible amounts of THC, the chemical in marijuana that gets us high. As of this month, the farm bill removed hemp from the Controlled Substances Act, the federal law that classifies marijuana as a Schedule I drug.
According to tax experts, Americans and the IRS can treat hemp like any other legal commodity. “You shouldn’t have any issues making normal business deductions” with hemp, said Jordan Cornelius. Cornelius owns Cornelius CPA, a tax accounting firm that specializes in cannabis.
Business deductions for hemp may be obvious for anyone growing the plant for purely industrial purposes, such as for making textiles, rope, animal feed, or hempcrete. But what about deductions for businesses that grow hemp to make medicinal products?
Right now, most of the hemp grown in the US goes toward CBD extraction. CBD is another chemical in cannabis known for its medicinal properties, but unlike THC, it doesn’t get people intoxicated. Recently, the DEA reclassified FDA-approved—and only FDA-approved—CBD products with less than 0.1 percent THC as Schedule V, the same category as codeine cough syrup. Only Epidiolex meets the DEA’s criteria, which received FDA approval last year.
Cornelius said, ultimately, the IRS will decide if CBD companies can make tax deductions, but he remains optimistic. “In the event that I’m sourcing CBD from hemp-based plant material, and that product was grown legally under the 2018 farm bill, it doesn’t seem like much of a stretch,” he said.