But making money off of legalized pot has turned out to be substantially more complicated because marijuana remains a controlled substance under federal law. A federal tax code amendment passed in 1982 called Section 280E specifically denies tax credits or exemptions to businesses “trafficking” in controlled substances — so the nascent industry taking its first wobbly steps in Colorado and Washington is getting hammered, with some pot outfits forking over as much as 90 percent of their revenue in federal taxes, according to industry analysts.
“When potential marijuana dispensary business owners figure out that their effective federal tax rate will be 60 to 90 percent, it turns them off,” Denver accountant Jordan Cornelius, who works with marijuana businesses, told the law blog Law360. A California accountant added: “You have a lot of organizations that end up failing and closing after two to three years because of the tax burden imposed by 280E.”
The sale and use of marijuana remains illegal under federal law unaffected by fast-changing cultural attitudes that materialize on ballots every election cycle. So far, pro-medical marijuana initiatives have won passage in 20 states, including the District of Columbia, where lobbyists for the National Cannabis Industry Association strut with confidence across Capitol Hill clad in dark suits. (The ballot measure approved Tuesday by District voters does not permit the sale of marijuana, but just the possession and use of limited amounts.) But such confidence belies the sobering reality of what it actually takes for a pot business to turn a profit. And today, experts say tax code 280E is a stealth method of enforcing the Reagan-era war on drugs.
“I believe that the feds extend the drug war through 280E,” Cornelius added in an interview with USA Today. “If [the federal government] can’t put them out of business legally when voters are mandating these businesses to move forward, it’s very easy to put them out of business financially.” Colorado marijuana business owner Mitch Woolhiser agreed: “It’s almost like they want us to fail. Everything I do is aimed at keeping us in business because if I don’t, then [the feds] win. And I’m not going to let them win.”
The IRS hasn’t recently commented on 280E. When reporters ask about it, they’re directed to a 2011 letter the agency wrote to several members of Congress who asked for a repeal of the amendment. The IRS said it had no choice but to tax marijuana businesses more than others. “We lack the authority to publish the guidance that you request,” the letter said. “The result you seek would require the Congress to amend either the Internal Revenue Code or the Controlled Substances Act,” neither of which has happened.
The genesis of the imbroglio is a 1961 Supreme Court decision holding that everyone — even those who make money illegally — had to pay taxes, giving the government free reign to collect taxes on revenue incurred through the sale of illegal narcotics.
Then came along a small time Minneapolis drug dealer named Jeffrey Edmondson. In 1974, he was busted — in all, he moved an estimated 100 pounds of marijuana, 13 ounces of cocaine and 1.1 million amphetamine tablets, court records show. Doing so was no easy matter, and necessitated significant logistical expenses. So after he was cuffed and the taxman came knocking to collect on the illicit income, Edmondson filed a hefty list of deductions.
“In the taxable year 1974, petitioner incurred various expenses in his business of selling controlled substances,” court documents said. “He drove his automobile 29,000 miles, of which two-thirds of such mileage was attributable to business use.” Edmondson wrote off a trips to San Diego, food, entertainment, airfare, telephone calls, rent on his place of business — his apartment — and even $50 for a scale.
This did not go down well with Congress, which vowed to close the Edmondson loophole in 1982 with a tax code amendment sponsored by, incredibly enough, a Colorado senator. This gave birth to 280E: “No deduction or credit shall be allowed for … any trade or business … consist[ing] of trafficking in controlled substances.”
It meant any logistical expense associated with selling the illegal drug — and remember, to the federal government, marijuana is illegal — would no longer be deductible. Illicit business owners couldn’t write off advertising costs, employee salaries or even rent. This has forced marijuana business owners to pay significantly higher taxes.
“A lot of times, instead of paying a tax rate that should be 30 to 40 percent, they are paying rates between 80 or 90 percent,” Cornelius told USA Today. “I even have a client right now that is paying more than 100 percent effective tax rate.”
To say that has been a drag on the industry would be an understatement. “A lot of people think that the marijuana industry is just a license to print money,” a National Cannabis Industry Association spokesman told the newspaper. “And it’s just not the case.”