12/21/2011 1:00 AM ET|
What's killing pot sellers: Taxes
Federal law bars any business that sells medical marijuana from taking tax deductions. And while a dispensary may be able to hurdle that barrier, criminal ones also await.
Nearly 200 years ago, Supreme Court Chief Justice John Marshall put it simply, "The power to tax is the power to destroy."
President Barack Obama and his Justice Department have adopted that maxim. In an attempt to destroy medical marijuana, they're using the U.S. tax code to put state-authorized weed dispensaries out of business.
Way back in 1982, Congress enacted tax code Section 280E to deny all tax deductions to an individual trafficking in controlled substances that are prohibited under federal law or under the law of the state in which the taxpayer conducts business. Marijuana falls under the federal Controlled Substances Act and therefore is within the scope of the deduction disallowance.
Despite multiple state laws that now allow the sale and use of marijuana for medical purposes, the U.S. Supreme Court concluded in 2001 in United States vs. Oakland (Calif.) Cannabis Buyers' Cooperative that no exception to controlled-substances law exists for medical marijuana.
If you sell marijuana, you get no expense deductions to offset your sales revenue. A marijuana dispensary is taxed on gross revenue rather than net income.
Say a dispensary generates $100,000 in gross sales. The cost of the product could be $60,000, with salaries, rent and other operating expenses reaching an additional $30,000. That would give the business a pretax profit of $10,000, which at the lowest corporate rate of 15% would create a federal tax liability of $1,500. That would leave an after-tax profit of $8,500.
But not under current federal law, Smoke Breath. The Internal Revenue Service would deny all deductions and apply the tax rate to gross sales rather than to net income. At the 15% rate, that would generate a $15,000 tax, more than the $10,000 the business had left after expenses.
The federal tax alone confiscates more than 100% of the profit, and you couldn't make it up with volume. In fact, the actual corporate tax on $100,000 would be $22,250, $12,250 more than the hypothetical company had left after expenses. That's a tax rate that would make even Warren Buffett blush -- 222.5%!
It's already happening. For instance, the Harborside Health Center, an Oakland medical-marijuana dispensary, was hit in October with a $2.4 million bill for back taxes from the IRS.
No place to sell, either
If you thought the IRS was tough on dispensaries, wait until you hear what else the feds have waiting for them. How about a California order to shut down in 45 days or face federal criminal charges and forfeiture of all their property, even if operating legally under state law? The federal asset-forfeiture rule applies even to landlords renting space to dispensaries, the U.S. government contends.
Such actions could include forced evictions that may be prohibited by state law. The issue would be argued in a state court, before a state judge, under state rules. The judge would be asked to balance the property rights of the landlord against the contract rights of the dispensary to occupy the leased premises.
Say a dispensary successfully fights off eviction. The federal law still would forfeit the property to the U.S. government, which would become the dispensary's landlord.
And don't forget the criminal charges, with added penalties for selling drugs within 1,000 feet of schools, parks and playgrounds.
What's a dealer to do?
The solution to the tax issue is relatively easy. A dispensary would need to qualify as a tax-exempt organization. If it was organized and operated exclusively for a qualifying charitable or scientific purpose, it would avoid tax on any profits. The denial of all business tax deductions wouldn't be an issue.
The key here is the purpose and operation of the organization. "Nonprofit" doesn't mean you don't make any money. It just means your objective was not to make a profit. Many qualified nonprofit organizations generate substantial positive cash flow and pay healthy compensation to their management teams. Forbes magazine reported that the average top pay for the 10 largest nonprofit U.S. charities was $566,693 a year.
The bottom line is that, with an attorney's help in setting up the dispensary's organizational structure, the tax issue could disappear.
The criminal issues are another matter. An organization can be convicted of a federal crime even if its actions were legal under state law. Besides the going-to-jail part, the criminal conviction would probably jeopardize any tax-exempt status.
Short of the feds deferring to state law, perhaps the only solution would be to create dispensaries as quasi-state organizations. As part of the state government, they would be exempt from federal taxation. More importantly, the criminal issues should also disappear.
Another solution: Congress could just change the law. Surveys indicate that about 50% of Americans favor legalization of marijuana and that more than 70% want it legal for doctors to prescribe marijuana to reduce pain and suffering. What do you think?
Jeff Schnepper is the author of the best-selling book "How to Pay Zero Taxes," which is in its 30th edition. He is a former professor of taxation, accounting and finance. Schnepper now has a full-time tax planning and legal practice in Cherry Hill, N.J. Click here to find Schnepper's most recent articles.
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