High Time for Changing How Pot Is Taxed?

SMITH BRAIN TRUST – “Did you notice the time of day when the Associated Press officially announced Joe Biden as president-elect?” Maryland Smith’s Samuel Handwerger asks. “No?”

“Neither did I,” he says, “but it should have been at 4:20, the unofficial California time for ‘Mary Jane,’ the good stuff, pot, marijuana.”

It’s been a while since Handwerger last “blew some smoke on this issue,” he says. But, with a new administration headed to the White House, and Congress recently passing a certain bill around, he felt it was high time that he lit up the matter again. (And not without a few puns.)

While most Americans were focused on the top job during the November general election, four states also had cannabis on the ballot, voting to make the plant legal for both medical and recreational use. A fifth state, the very Republican red Mississippi, meanwhile, passed legalization for medical use.

The “score card,” he notes, now reads 15 states with legal medical and recreational use, 21 with legal medical use, and 14 holdouts where cannabis is not legal for any reason. In total, that’s 36-14 states in pot’s favor.

Handwerger, an accounting lecturer at the University of Maryland’s Robert H. Smith School of Business and a practicing CPA, says interest in cannabis is twofold.

First, across disciplines, people are watching to see where the industry is heading. Sales for 2020 are expected to exceed $15 billion, a 40% increase from 2019 – proving there are always winners and losers in any market.

Second, in the accounting department and across the field, people are watching to see what will happen with weed in the income tax code. “We’re keeping a close eye on Code Section 280E,” he says.

Section 280E disallows almost all tax deductions for businesses computing their taxable income derived from sales of pot, and this creates an unusually heavy tax burden on growers and dispensaries. This “draconian restriction,” he says, applies to income from trafficking in any Substance I or II drugs. Despite its status as legal in some form or other in more than two-thirds of states, marijuana is still a federally mandated Substance I drug.

Since 1996, when California became the first state to legalize cannabis, there has been a constant clash between business owners and the IRS over the law, with the IRS consistently prevailing. California broke new ground again this year, becoming the first state to “decouple” from the federal 280E code, and allowing business owners to deduct their expenses, making the income on the net and not essentially the gross. The change applies only to the state tax, “but it is a help,” Handwerger says.

The move followed a 2019 IRS win in tax court, in which a dissenting opinion judge proffered that perhaps 280E is unconstitutional – the 16th Amendment allowing only for a net income tax, not a gross. “To be sure, Congress crafted 280E allowing for the cost of the goods sold to be deducted, so as to avoid the taint of being a tax on the gross. But for a dispensary with many other expenses – rent, utilities, salaries and so on – the income tax burden can easily wipe out any profit and create a loss,” Handwerger says. That doesn’t easily reconcile as a tax on the “net,” being precisely what the 16th Amendment seeks to avoid constitutionally.

“The soon-to-be new administration presents another opportunity for relief for the industry,” Handwerger says.

While not showing a keen interest in legalizing the drug, Biden has implied a willingness to consider some leniency – perhaps dropping marijuana from Substance I to Substance II.

Vice President-elect Kamala Harris, on the other hand, sponsored a 2019 bill to deschedule marijuana entirely. “Whether she can influence the president-elect for this preferable move remains to be seen – but it would be the tax fix needed for the industry,” Handwerger says.

For now, he says, the industry “is just holding its breath.”