Dispensaries pay federal taxes just like any other business does. However, there may not be many opportunities for deductions when you have your own dispensary. Many states’ statutes allow for both recreational and medical use, but under federal law, it remains a Schedule I controlled substance. The inherent oxymoron of the situation sets up an incredibly delicate tax environment for dispensaries. Let’s discuss how dispensaries pay federal taxes, further state and local elements and how to manage this tax burden.
How Do Dispensaries Pay Federal Taxes?
Still, according to state law, dispensaries would be considered federal narcotics traffickers. However, they will surely do some significant work for the taxation center. That label brought a huge tax impediment: Section 280E of the Internal Revenue Code. This subsection disallows a business from deducting ordinary and necessary business expenses from its federal income tax returns if it is engaged in the illegal sale of controlled substances.
That translates to a dispensary’s inability to deduct common business expenses—such as rent, salaries, utilities, or cost of goods sold (COGS)—from its federal tax liability. This inflates the difference between its taxable income and that of a traditional business; ergo, it has a tax bill much larger than what is usually seen in business.
Dispensaries are eligible to deduct only some expenses, such as cultivation costs and product-specific security measures, that relate directly to the cost of cannabis itself. This leaves them with a much smaller pool of deductions than other businesses.
In addition, business expenditures are not allowable; hence, dispensary owners are taxed based on gross revenue and not profit. The burden of such taxes will most certainly break a new dispensary, especially with high operating costs.
State Taxes and Additional Fees
Besides the federal taxes, dispensaries also have to reckon with state and local taxes, which are very different from one to another. We break down the other taxes further:
Sales Tax: Most states impose an added sales tax on purchases. The dispensary collects the tax at the point of sale and remits it to the state.
Excise Tax: Some states also impose an excise tax on the sale of cannabis products, which generally focuses on those sold to consumers. This tax is typically levied at the cultivation, processing, or distribution level and finally filters through the various supply chain levels to be reflected in the consumer’s final selling price.
Licensing fees: You will pay annual fees to obtain and maintain your dispensary license. The costs associated with these fees would depend upon the state and the kind of license you were seeking.
The weight of federal, state, and local taxes, combined at every level, is so great that the price point at the retail level for cannabis products reaches stratospheric levels. It may be crippling consumer affordability and therefore pushing at least some customers into the black market, where taxes are not collected.
Why Do Dispensaries Tax So Much?
These are the kinds of things consumers wonder at in a world where dispensaries sometimes tax so hard. As explained above, a significant contributor to this price point is the tax burden it levies upon the dispensaries. Here’s a little more of a breakdown regarding these different factors:
Federal Tax Disadvantage: Since Section 280E does not allow for most business expenses to be deducted, dispensaries are left with a very high taxable income and, therefore, a higher federal tax bill.
State and Local Taxes: Sales and excise taxes add an additional cost to the product, which further inflates its cost to the final consumer.
Cash-Only Transactions: Federal banking law restricts the services banks provide to the cannabis business, meaning that dispensaries hardly work in cash-only transactions. Their inability to access traditional financial services might also prevent them from getting a good deal from suppliers or vendors, causing them to incur a higher final price.
Strategies on How to Manage Taxes Under Section 280E
However, despite the challenges put in place by Section 280E, the dispensaries can look into strategies that will help minimize their tax liabilities.
Maximization of Cost of Goods Sold (COGS): One of the remaining few deductions includes a part of the cost of the cannabis itself. From better deals on inputs to getting the most out of cultivation, companies can further maximize their COGS and cut into their taxable income.
Vertical Integration: Dispensaries control the entire supply chain from cultivation to retail. This position better positions the dispensary to streamline operations and, in effect, reduce the overall costs associated with purchasing the product from a third party and reselling it.
Record Keeping: Keep good records. This provides an audit trail for the IRS and helps ensure all deductions are allowed.
Lobbying Efforts: The cannabis industry is already attempting to lobby for a change in the federal tax code at the Section 280E level. Efforts to lend support to those efforts could keep the door open for potential change down the road.
How Do I Reduce My Federal Income Taxes?
There are a few tax-planning opportunities for dispensaries that can be pursued to minimize their federal income tax liability despite the limitations imposed by Section 280E. Benefits like health insurance and retirement plans may create tax deductions for the dispensary.
Charitable Donations
The dispensaries would be entitled to make charitable donations to qualified organizations and entitle them to reduce their contributions from taxable income. However, it is noteworthy that such contributions must be made in tandem with the federal and state jurisdictions.
Depreciation of the property
While most operating expenses don’t have deductibles, the dispensary is entitled to claim depreciation on the building, equipment, and furniture. This allows the dispensary to spread the cost of these assets out over their useful life, reducing taxable income each year.
Business structure
Most notably, selecting a tax-favorable business structure can be beneficial. Sole proprietorships pay taxes from personal income tax returns, whereas corporations mandate separate corporate income tax. Consulting a tax advisor would help identify the best structure for a given dispensary.
Tax Payment Options for Marijuana Retailers
With dispensaries dealing almost exclusively in cash, taking in that much in tax payments presents a severe logistical problem. Here’s a look at some of the workable options for marijuana retailers:
Estimated Tax Payments: Dispensaries must make estimated tax payments during the year to avoid penalties and interest for underpayment. Payments would be based on the year’s estimated tax liability.
Increase Security: Those large sums of cash will need increased security to protect them from thieves. The amount spent on security is pretty high; however, it might be tax-deductible because it’s part of the business expense.
Advocacy for Reform in the Banking Sector: The cannabis industry supports the push for reforms so that dispensaries can access traditional banking services. This will increase security and hasten smooth tax payments from the business.
Conclusion
The tax situation today is so intricate and more often burdensome. Section 280E not only adds to that state of tax liability but also causes enormous headaches, and the cash-only nature of the business throws in more obstacles. Other loopholes could apply to dispensary companies: COGS maximization, vertical integration, and keeping exceedingly good records.
Effective lobbying will supplement federal tax reform and the search for alternative strategies to save tax dollars through employee benefits and depreciation. Reforms will hopefully come in the future as the legal cannabis industry matures and focuses on creating an equitable tax environment for dispensaries. Furthermore, check out Beem to file your federal and state taxes without any hassle and get the maximum refund.
