PROCEED WITH CAUTION: NAVIGATING CALIFORNIA’S HIGHLY REGULATED CANNABIS SUPPLY CHAIN – PART 3Jared Younker
BY: DAVE MINER: LinkedIn
TAXES! Local, State, & Federal
In California, there is wide agreement that the state got off to a slow start with legal cannabis primarily because of the high tax burden imposed on the industry. Another concern in California is that the high level of taxation levied on the legal market is helping the Black Market thrive. This report will spell out basic tax rates and considerations from a local, state, and federal standpoint and provide some high-level recommendations and tools you can use to make sure you know what you are getting into AND how to ensure you stay on the right side of the law regarding collection and payment of ALL of your required taxes. (Disclaimer: I am not an accountant. It is advisable that you seek out the professional services of a tax professional in the cannabis industry for any detailed questions on taxes and to assist with the preparation of required financial reports and tax documents.)
The bonanza predicted by experts has yet to pan out for the Golden State. Based on the high rates of taxation imposed on the industry, California legal cannabis revenues actually fell in 2018! Many blame high taxes for the slow start. “While “state officials estimated there would be as many as 6,000 cannabis shops licensed in the first few years,” the Los Angeles Times reported last week, “the state Bureau of Cannabis Control has issued just 547 temporary and annual licenses to marijuana retail stores and dispensaries.” The New York Times notes that legal cannabis sales totaled $2.5 billion in 2018, which is about $500 million less than in 2017, before the first recreational shops opened. Marijuana tax collections amounted to $234 million at the end of September, which suggests the total for 2018 will be less than half what officials predicted and less than a third of the $1 billion annual haul they were expecting within a few years.” (Sullum, 2019)
Black Market Dominance:
“Legalization is off to a ragged start, due to black-market sellers siphoning off customers who don’t want to pay high taxes, he (Cooper) said. Assemblyman Jim Cooper, D-Elk Grove, worked for three decades in the Sacramento County Sheriff’s Department, where his duties included undercover narcotics work.” (Brannon, 2018)
In addition to lower prices, in some regions, illegal shops outnumber legal retail dispensaries. “The illicit market outnumbers us by five to one, “Kenny Morrison, President of the California Cannabis Manufacturers Association said. “You can go to a random city and find four legal stores and 20 illegal stores. What’s worse, those four legal stores are charging two and three times the price of the illegal stores.” (Kaskey, 2018)
“The bottom line is that there’s always been a robust illicit market in California — and it’s still there,” said Tom Adams of BDS Analytics, which tracks the cannabis market. “Regulators ignored that and thought they could go straight into an incredibly strict and high-tax environment.” (Fuller, 2019)
Rates vary by geography as well as by which type of cannabis business you run. For example, Cultivation taxes in California City are only $7/square foot while Grover Beach levies a whopping $25/square foot*. Below is an illustrative chart to give you an idea on how tax rates vary by business type (City of LA rates used in this example):
* Grover Beach Cultivation and Nurseries Taxes: $25 per sq ft on the first 5,000 sq ft and $10 per sq ft on the remainder. (Margolin & Lawrence, Attorneys at Law, 2018)
Link for an updated list of tax rates in all 58 counties and 482 municipalities in California: CA City-County Tax Rates
A Tax Guide for Cannabis Businesses may be found on the California Department of Tax and Fee Administration (CDTFA) website which also provides tabs for each business type as well as additional state tax guidance. (CA.gov, California Department of Tax and Fee Administration, 2018)
The State of California charges a 15% Excise Tax on top of the typical 9% Sales Tax. Excise Taxes are baked into the retail price of every product for sale in a legal retail business. Excise Taxes are collected from the Retail Businesses and paid by Distributors. If you are a Distributor, be aware that your privileged position in the middle of the Cannabis Supply Chain comes at the cost of burdensome tax collection and payment obligations. Here’s the summary:
Federal taxes will vary depending on your revenue. The big issue with Federal Taxes is Section 280E. 280E while allowing normal deductions for Cost of Goods Sold (COGS), disallows normal deductions for “Other Expenses”. This can make a huge difference in your Effective Tax Rate at the Federal Level, and thus your Net Income. See the example below:
|For a non-cannabis business, tax is based on the net income of $300,000, therefore the federal tax obligation is $105,000, resulting in a net income after taxes of $195,000 and an effective tax rate of 35%.
For a legal cannabis business, tax is based on the gross profit of $700,000, therefore the federal tax obligation is $245,000, resulting in a net income after taxes of $55,000 and an effective tax rate of 82%.
The legal cannabis company ends up paying an additional $140,000 in taxes, which reduces its overall net income by the same amount, creating a significant disadvantage.
Other helpful links:
Stay tuned for Part 4 of our series: Licensing – Local & State
Dave Miner writes on behalf of Cannabiz Trusted Advisors