By Beau Whitney, Chief Economist at Whitney Economics.
- We begin with the assumption that an increase In US corporate tax rates, from 21% to 28%, is coming.
- Because of a relatively obscure IRS regulation known as 280E, this increase in federal tax rates would push effective tax rates for cannabis operators to more than 70%.
- Without reform of 280E, forced consolidation will be one unintended consequence that hurts smaller, minority-owned and women-owned cannabis retailers.
- This is a watershed moment for the US cannabis industry.
A Corporate Tax Increase Is Coming
Raising taxes in the middle of a pandemic-induced recession is obviously not a straightforward task. If tax increases are focused too narrowly, they will not achieve their revenue objectives. However, if tax increases are not focused enough, they can have significantly negative impacts that result in unintended outcomes. The proposed corporate tax increase coming from Washington D.C. will negatively impact the cannabis industry, which has earned a good reputation for generating tax revenue and creating jobs.
Because Of An Obscure IRS Tax Code, This Corporate Tax Increase Will Damage Smaller Cannabis Operators
Although cannabis is medically legal in 37 states, with 15 of these states also allowing sales for adult-use purposes, it is still a schedule 1 drug. It is deemed illegal by the federal government. Despite the nation’s strong embrace of cannabis at the state level, cannabis retailers are subjected to a punitive federal business tax called IRC 280E. Our analysis indicates that the proposed corporate tax increases (from 21% to 28%) would increase business taxes on cannabis operators by $6.8 billion over 5 years. This amount is estimated to add an additional $140,000 in federal tax payments, per cannabis retailer, per year for the same time period. By adding an additional $140,000 in federal taxes, cannabis operators face the daunting task of spending nearly two full months-worth of revenue just to cover federal taxes. Lower margins result in slower growth, lower employment, lower wages, fewer benefits and decreased tax revenues.
Why is 280E So Damaging to Cannabis Retailers?
280E does not allow for deductions of cannabis expenses (other than cost of goods sold) on the federal taxes, thereby increasing the effective tax rates for most cannabis businesses. The current average effective tax rate for cannabis retailers is in the range of 50% - 60%. When combined with the corporate tax increase of 28%, the effective tax rate for cannabis retailers swells to greater than 70%, potentially crippling the ability to operate small, women or bipoc cannabis businesses.
Is the Intention to Tax Cannabis Businesses At 70%?
In a scenario where the corporate tax rate is increased and 280E is not reformed, US cannabis operators would pay an effective tax rate of 70%, which would be the highest tax rate in the world. According to data from the Tax Federation*, a 70% effective tax rate is more than 20% higher than the highest national corporate tax rates in the world, including Norway, Finland and New Zealand. Interestingly, France, Netherlands and Sweden are all cutting corporate taxes in 2021 as a tool to drive economic stimulus.
Standard Deductions Not Allowed by IRS on Federal Filings Under 280E
- Wages and Salaries
- Commissions and Payments to Independent Contractors
- Health and Other Insurance Premiums
- Security Services
- Marketing and Advertising Costs
- State and Local Taxes and Fees
- Legal, Accounting and other Professional Expenses
- Rent and Home Office Expense
- Interest Paid on Business Loans
A taxpayer hit by 280E pays tax on “phantom income” whereby a taxpayer’s taxable income is greater than its actual income, because of the deductions that 280E denies.
Why 280E Reform Is Necessary
Record sales and tax revenues were generated in 2020, which was a positive, but operators in the cannabis retail sector struggled to survive. In 2020, 7,500 cannabis retail operations generated an average of $2.4 million in revenue. Even without the proposed tax increase, over the next five years, cannabis operators will pay an average of $2.2 billion in additional taxes relative to similar legal businesses. With high taxes and low margins, most cannabis operators are already struggling to pay for labor, taxes and product acquisition costs. Benefits, rent and debt service are often a monthly struggle. In a period of high unemployment due to covid-19 displacement, our analysis shows that current federal taxes are suppressing the hire of more than 30,000 individuals into the cannabis industry. The hire of this new group would generate approximately $1.1B in annual wages.
- The cannabis industry is already experiencing what you would expect any industry to experience if it was being taxed far too heavily.
- While other industries are receiving tax holidays or deferments, taxes on cannabis businesses continue to increase.
- In 2020, many states designated cannabis operators to be essential businesses. Despite this fact, they are still not taxed equally.
- Cannabis operators are struggling with how to justify their essential business designations while being required to pay high, punitive taxes.
Cannabis Has Demonstrated Its Viability Despite Punitive Taxes
Cannabis retailers have contributed $7.3 billion in taxes to state coffers since 2014. In 2020, they added 79,000 jobs to the economy and generated $44 billion - $51 billion in economic activity. Cannabis has more than proven itself to be a viable industry, and will flourish if given the political and regulatory support it needs to sustain it in its nascent stages.
Why Legislators Have A Unique Opportunity For Reform
Senators Schumer (D-NY), Booker (D-NJ) and Wyden (D-OR) have announced that cannabis reform is a legislative priority in the U.S. Senate. With such high visibility, a tax hike combined with an already punitive tax policy seems contradictory. It would take the legs out from cannabis retailers, which is one of the fastest-growing industries in the U.S. Strong bi-partisan public support exists in the public for cannabis reform.
The next few months will be telling. This is a watershed moment for the cannabis industry and cannabis tax policy.
About the Author.
Beau Whitney is the founder and Chief Economist at Portland, Oregon-based Whitney Economics, a global leader in cannabis and hemp business data, consulting and economic research.
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