Cannabis tax lawyer
Sweat equity: it’s complicated

When our lawyers set up legal structures for cannabis companies, the choice of legal entity is one of the most important things we must consider. Many cannabis businesses use limited liability companies. For tax purposes, an LLC is typically treated as a partnership or as a disregarded entity. In both of these cases, the tax liabilities pass through to the partner/members. However, an LLC may check-the-box to be taxed as a corporation. In that instance, the LLC is subject to tax, whereas its partner/members do not pay tax. Once an LLC is formed, the next important decision is how to fund the LLC.

In this two-part series, we will outline some of the tax traps and opportunities in the initial funding of your LLC. Part I will discuss opportunities in capitalizing your businesses with equity and creating an ownership relationship with the business. Part II will discuss opportunities and risks in funding a cannabis business using debt and creating a debtor/creditor relationship with the business.

The Benefits of Contributing Property. Generally, the contribution of “property” in exchange for a membership interest is tax-free. Members often contribute cash, land, and equipment to a cannabis business in exchange for an interest in a partnership/LLC. This is a classic tax-free contribution. What is often overlooked is that intellectual property may be property for purposes of a contribution. Industrial processes, formulae, designs and “know-how” in the right circumstances are considered property and can be contributed to a partnership tax free. However, this approach should only be taken with careful consideration, analysis and documentation.

The most straight-forward contribution is a contribution of cash in exchange for a member interest in a Partnership/LLC. A member may contribute cash in exchange for a membership interest in an LLC. Such a contribution is typically tax free under federal partnership tax law. If an LLC elects to be taxed as a C corporation, a member may contribute cash in exchange for a deemed “stock interest”. Again, such contribution is typically tax-free. Many companies start with extremely small cash contributions, like $1.00 for each member. However, there is some risk there to equity holders, since some courts have pierced the corporate veil against undercapitalized entities. Nonetheless, there is no minimum amount of cash required to form a valid partnership or corporation for tax purposes. In determining the appropriate dollar amount of contribution, a cannabis business’s founders should use common sense and good business judgement.

Sweat Equity may be Painful but is not Prohibited. Investors often can bring valuable experience and “know-how” to a cannabis business and want to contribute such “know-how” in exchange for an ownership interest in the LLC. In general, a mere promise to contribute services in exchange for a membership interest is subject to tax. This is generally considered a “capital interest” in the partnership. Capital interests are defined by the IRS as ownership interests where the member has a right immediately following the contribution, to its share of the liquidation value of the partnership/LLC. To illustrate, imagine one member contributed $1,000,000 in cash to a new company, and the other member agrees to do all the work for the company, and they split the LLC up 50/50. Even if the business doesn’t generate any revenue, the member contributing sweat equity is going to be on the hook for $500,000 on that year’s tax returns. This is because if the LLC liquidated the next day, that member would be entitled to receive the $500,000 as a liquidating distribution. Although the guidance in this area can be complex, it is based on a simple, maxim – “You can’t get something for nothing (in tax)”

One way to get around this is for a member to receive a “profit interest” instead of a a standard equity interest. A profit interest is defined as an interest where the new member would not receive any value if the partnership were to be immediately liquidated after the contribution. Note however, that this treatment has some strict limitations and requires careful drafting of an operating agreement.

In capitalizing a cannabis business, founders all bring different skills and resources to the new venture. All founders should carefully consider the mechanics of offering equity interests to each new member. As we will discuss in Part II, the use of debt financing brings additional, flexibility, risks and opportunities to funding a new cannabis venture.

Cannabis tax lawyer
New tax law will impact cannabis businesses

Our cannabis business lawyers are often called on to help clients choose the most effective legal entity for operating their cannabis business. In making this choice, we consider many factors, including the tax impact to investors. See Cannabis Companies and Phantom Income and How To Open A Cannabis Business: For-Profit vs. Not-for-Profit, that is the Question.

Our  cannabis clients usually choose to operate as a limited liability corporation (“LLC”). For federal tax purposes, a LLC with more than one member is treated as a partnership unless the LLC elects to be taxed as a corporation.  Accordingly, any change to partnership tax law applies to LLCs as well.

One important consideration for LLC Partners/Members is identifying who is authorized to represent the partnership in the event of an IRS audit. Under current law, Partners/Members appoint a Tax-Matters-Partner or “TMP.” Though the TMP is the contact point for dealing with the IRS, the TMP function is ministerial.

For tax years beginning in 2018, Congress significantly changed the way the IRS audits partnerships and LLCs taxed as a partnership. Under current law, the IRS must collect tax directly from each Partner/Member. In general, each Partner/Member may defend the audit adjustment as he or she sees fit. The new law requires the IRS collect tax directly from the partnership. In essence, the IRS now has “one-stop-shopping” to collect tax. But there is more. To collect tax from the Partnership/LLC, the new law requires each Partnership/LLC have a “partnership representative.”

There are two significant issues regarding appointment of a partnership representative (“PR”). The first is that the partnership representative (PR) has more power than the TMP. The PR has the sole authority to deal with the IRS and to bind each Partner/Member to the consequences of the PR’s decisions. In other words, the PR ultimately will decide how much tax each Partner/Member will pay as the result of an audit. An odd quirk of the law is that the PR does not even have to be a partner/member of the LLC.

It is important for Partners/Members to choose their PR carefully and in choosing a PR, Partners/Members should consider the following:

  • Who should be the PR?
  • Should election of the PR require a unanimous vote or something less?
  • Should the PR have unlimited authority or should such authority be limited under the partnership agreement or the operating agreement?
  • If the authority of the PR is going to be limited, what will be the scope of the PR’s authority?
  • What will the mechanism be to resolve deadlocks?

These above considerations can and should be addressed when drafting new partnership/operating agreements. Current partnership/operating agreements should be amended, however, the timing on when to do so is dependent on each Partnership/LLC’s specific situation. Because the new law will start applying beginning in 2018, Partnerships/LLC’s have a bit of time to address this issue, however, if you are mending your partnership agreement or operating agreement for other reasons, now is the time to make your PR decisions.

And here is the second issue: the IRS can select your partnership representative if you fail to do so yourself. This portion of the new law is controversial and raises many legal issues, many of which remain unclear. But what is clear is that you can avoid this harsh result by having your partnership/LLC choose its PR in a timely manner. Choosing a PR is one of many tax issues that must be considered when drafting a partnership agreement or operating agreement and as 2018 approaches, this is just one more issue cannabis businesses will need to address.

Another day, another (tax) dollar.

The U.S. Tax Court again addressed IRC §280E in the recent case Canna Care, Inc. v. Commissionerdisallowing all of the California’s dispensary’s “operating deductions” under IRC §280E. Unlike prior cases, the Tax Court in Canna Care does not address the computation of COGS, but rather the deduction of regular business expenses, such as salaries.

Cannabis taxation is not fair.
Cannabis taxation is not fair.

Overall, this case does not change the holdings in CHAMP or Olive. [For those of you that need a quick refresher, CHAMP held that where CHAMP was essentially engaged in two separate businesses, one legal (caregiving) and one illicit (dispensing MMJ), it was entitled to deduct COGs for the caregiving portion of its business; Olive applied CHAMP to less favorable facts, holding that where Olive’s primary business was selling marijuana, and its other services amounted to mere “amenities,” Olive was unable to claim any deduction.] What’s notable about Canna Care is the taxpayer’s direct attack on the application of IRC §280E.

Like the taxpayers under scrutiny in both Olive and CHAMPS, Canna Care was a medical marijuana dispensary. Canna Care was organized as a California mutual benefit corporation, and as such, was considered a non-profit entity under California law. Canna Care took care in emphasizing that it operated at a deficit. However, the Tax Court noted that the officers and directors were paid salaries that “far exceeded the salaries paid to any other employee,” an indicator that Canna Care was perhaps not so altruistically motivated. In addition, the Tax Court noted that corporate funds were used to pay for officer’s automobiles. Importantly, Canna Care highlighted to the Tax Court its involvement with the community including: involvement in cancer and diabetes walks; the hosting of regular meetings for Americans for Safe Access, a medical marijuana advocacy group; and, the offering of prayer and counseling services. Even that community emphasis was not enough to save Canna Care.

Taxpayer advanced three arguments, all of which were rejected by the Tax Court.

First, that medical marijuana is not a Schedule I controlled substance.  The Tax Court indicated that Taxpayer “advanced numerous arguments” as to why medical marijuana should not be considered a Schedule I controlled substance.  The Tax Court did not elucidate any of these arguments and summarily rejected them.

Second, that Canna Care was not “trafficking” for purposes of IRC §280E because its activities were not illegal under the California Compassionate Use Act of 1996.  Taxpayer cited the Cole Memo as well as the 2014 FinCEN Memo as support.  The Tax Court, citing both Olive and CHAMP rejected this argument.  In summary, the Tax Court held that the sale of cannabis is always considered trafficking for purposes of IRC Sec. 280E, even when permitted by state law.

Finally, that CHAMP was incorrectly decided.  Canna Care argued that CHAMP really was not involved in two trades or businesses but one.  Canna Care argued that the taxpayer in CHAMP was not allowed to perform “caregiving services” under California Law; therefore, the taxpayer in CHAMP was merely a single entity doing charitable work.  Canna Care argued it was a charitable entity similar to the taxpayer in CHAMP, and therefore was entitled to a full deduction of operating expenses.

The Tax Court disagreed, stating that “CHAMP did not involve a determination as to whether the taxpayer qualified as a caregiver for purposes of California law.”  The Tax Court noted that the critical determination in CHAMP was that taxpayer was engaged in two separate trades or businesses. The Tax Court noted that Canna Care stipulated that it was in the business of distributing medical marijuana. The Tax Court noted that Canna Care received income from the sale of books and T-shirts. However, the evidence presented did not allow the Tax Court to determine what percentage of income was derived from sale of books versus the sale of cannabis. As such, the Tax Court held that Canna Care was engaged only in the sale of medical marijuana.  Therefore all operating expenses were disallowed under IRC § 280E.

The Tax Court did not outline the taxpayer’s numerous arguments in any detail, so it is difficult to dismiss those arguments out of hand. We can safely say, however, that this case clarifies several points.

  • First, the argument that the sale of cannabis is not trafficking for purposes of IRC 280E will be difficult to sustain.
  • Second, CHAMPS and Olive are the current templates in determining whether an expense is deductible under IRC §280E. Good works or community involvement are not sufficient, by themselves, to support a tax deduction outside the application of IRC §280E.  In order to be deductible, such activity must be considered a separate trade or business entered into with a profit motive.
  • Third, the case once again highlights that the essence of a successful IRC §280E argument is the substantiation and development of facts. Because the taxpayer had, in the court’s view, insufficient evidence to carve out two separate trades or businesses, the taxpayer was unable deduct any operating expenses.
  • Finally, so long as IRC § 280E is on the books, the cannabis industry will suffer. The industry would be well-served to support aggressively the passage of the Small Business Tax Equity Act of 2015 or other legislation repealing IRC §280E.  I believe it can, and must, be done.

Until today, the cannabis industry had little to look forward to when discussing IRC §280E and its draconian application. See Marijuana Taxation: 280E Ain’t Getting Better Anytime Soon and Marijuana Taxes: The IRS on Section 280E. Now Washington State producers, processors and retailers have some good news to consider regarding their 2014 tax return: IRC §280E does not apply to the three-tier Washington Marijuana Excise Tax (“MET”) as in effect through June 30, 2015.

Marijuana Tax LawsThis is because on July 31, 2015, the IRS Office of Chief Counsel issued an internal memorandum (“July Memo”) outlining how taxpayer’s should account for the State of Washington MET. The July Memo is not precedential but it does reveal how the IRS views the MET. Though in the July Memo, the IRS is taking an approach that seemingly sidesteps its own analysis offered earlier this year, their conclusion is favorable to Washington producers, processors and retailers and may offer an outline on how other states’ marijuana excise taxes could be treated for federal tax purposes.

It has been a long time since I have been able to put “IRS,” “favorable” and “marijuana” in the same sentence.

IRC §280E prevents a cannabis producer, processor or retailer from deducting costs incurred in conducting a trade or business unless those costs are considered a Cost of Goods Sold (COGS). As a consequence, marijuana businesses are required to determine what expenses are included in COGS. Until this July Memo, the IRS has offered no guidance regarding how any specific state’s marijuana excise tax would be treated for purposes of COGS or IRC §280E.

In the July Memo, the IRS interpreted IRC §164 addressing the deductibility of taxes. Specifically, IRC §164(a) identifies the following six types of federal, state and foreign taxes allowed as a deduction:

  • Real Property Taxes
  • Personal Property Taxes
  • Income and Profit Taxes
  • GST Taxes
  • Environmental Taxes
  • Motor Vehicle Taxes

IRC § 164(a) states that any taxes not described above, are deductible if paid or accrued …”in carrying on a trade or business” and further provides that “[n]otwithstanding the preceding sentence, any tax (not described in the first section) …paid or accrued … in connection with an acquisition or disposition of property, shall be treated … in the case of a disposition, as a reduction in the amount realized on the disposition”

The July Memo states that the MET is imposed “in connection with the disposition of property” and so for federal tax purposes, the amount of gross receipts is reduced by the amount of MET with the same economic consequences as if a deduction were allowed. Significantly, the Memo concludes that the MET is neither a cost to be considered included in COGS nor a deductible expense. Accordingly, IRC §280E and the regulations and guidance regarding COGS do not apply.

Beginning July 1, 2015, HB 2136 reconfigured the MET into a trust-fund tax imposed on the retail purchaser so that taxpayers no longer need to consider the deductibility of the MET for federal tax purposes.

In light of the July Memo, each state’s excise tax should be reviewed to determine the federal tax treatment under IRC §164. Such analysis may prove to be difficult. To encourage the development of the cannabis industry in their state, policymakers should consider restructuring the state’s excise tax in the form of a trust-fund tax to reduce uncertainty regarding the federal tax implications of their marijuana excise tax. 

The Superior Court for Spokane County recently held that Washington’s sales tax does not apply to sales of medical marijuana. Late last month, the Washington Department of Revenue (“DOR”) appealed that decision to the Washington State Court of Appeals.

Background on the Case. Rhonda Duncan operated a medical marijuana dispensary called The Compassionate Kitchen. In 2009, Duncan did not collect sales tax from patients to whom she sold cannabis products. At some point, Duncan paid sales tax on all 2009 transactions involving medical marijuana. But after a 2011 raid by federal authorities, Duncan filed a refund claim with DOR for the sales taxes she previously paid. DOR denied the refund claim and Duncan lost all subsequent appeals in DOR’s Appeals Division. In July of 2014, Duncan filed an appeal with the Board of Tax Appeals (BTA). In October of 2014, the BTA also denied Duncan’s refund claim.

Medical Marijuana and Prescription TaxesThe Issues. The BTA examined whether sales of medical marijuana are exempt from sales tax under RCW 82.08.0281, which exempts from sales tax those “sales of drugs for human use dispensed … to patients pursuant to a prescription.” More specifically, the BTA examined the statute to determine whether a “statement signed by a … physician,” confirming that “the patient may benefit from the medical use of marijuana,” qualifies as a “prescription” as defined by the statute. The statute defines prescription as “an order, formula or recipe issued in any form … by a duly licensed practitioner authorized by the laws of this state to prescribe.”

Duncan presented a highly technical statutory argument to the BTA. Specifically, Duncan claimed that the statute is unambiguous and that the phrase, “authorized by the laws of the state to prescribe” refers not to the actual substance being prescribed (i.e., the cannabis), but instead to the “genus of the person prescribing” (i.e., the physician).

The BTA disagreed with Duncan’s arguments and held that, by its plain meaning, the statute defines a “prescription” as an order issued by a practitioner authorized to prescribe the specific drugs referenced in the order. The BTA determined that Duncan’s reading of the laws ignores the ordinary meaning of the term “prescribe.” The BTA held that “Practitioners do not ‘prescribe a prescription; they prescribe medications,’” and further held that any other reading of the statute is either “circular or vague.”

Even if the statute is ambiguous, the BTA references in its decision Senate Bill 6515’s Final Report from 2004, which modifies the definition of “prescription,” mandating that prescription drugs exempt from sales tax “must be prescribed by a person whose license authorized him or her to prescribe the item or drugs.” Where federal law renders cannabis a Schedule I illegal substance, no physician can lawfully prescribe it. They can only “recommend” it to qualifying patients. The BTA’s basic logic is that where physicians cannot lawfully prescribe cannabis to patients, any sale of cannabis for medical use cannot qualify for a sales tax exemption for prescription drugs under state law. On appeal from the BTA decision, the Spokane Superior Court ultimately disagreed with the DOR and sided with Duncan’s arguments.

What Happens Now?

As a result of the Spokane Superior Court decision, we’re likely to see many medical marijuana businesses try to demand sales tax refunds from DOR for amounts paid throughout the proceeding years. But this is easier said than done.

A seller is entitled only to a refund of tax directly paid to the state.  A seller is not entitled to a refund of tax that it merely collected from its customers. In that case, the purchaser (not the seller) is entitled to a refund. Accordingly, the refund of sales tax collected from medical marijuana patients must be returned to those patients.

A refund claim for excise tax is limited only to amounts paid (for example, tax, interest, and penalty) four years from the beginning of the calendar year in which a refund claim is made, so these claims are also time sensitive. Any refund claim filed with the Washington State Department of Revenue must also be substantiated to the satisfaction of the Department. The DOR will deny unsubstantiated claims.

Finally, if you are a medical marijuana business planning to use the Duncan case as a defense to having to collect and pay sales tax to DOR in the future, it is critical that you realize there are going to be severe limitations on such a defense. Duncan paid sales tax to DOR and is seeking a refund of tax paid. Medical marijuana businesses that have failed to collect and pay sales tax will still have to answer to DOR unless and until the Duncan case is resolved through the appeal.

Because marijuana remains illegal on the federal level, transporting it across state lines is a federal crime. It is therefore understandable then that most marijuana companies consider their state tax obligations to be limited to just one state. However, as the cannabis industry expands, out-of-state investors need to consider the state income tax impact of their investment activity.

One example is licensing. After talking with a number of marijuana companies that are licensing their product across state lines, it is clear that marijuana companies engaged in such licensing arrangements rarely realize that they also have state tax issues outside their own resident state.

Marijuana and TaxesA number of dispensaries and producers have entered into licensing agreements with out-of-state retailers and producers to leverage their marijuana branding outside their own state. In addition, a number of marijuana businesses will soon be up and running in states like Illinois and Oregon, both of which currently allow non-residents to invest in their emerging cannabis marketplaces.

Licensors and other investors need to be aware that the income they receive from a cannabis enterprise is probably subject to income tax in the state from which they receive that income. This is because the law has evolved to permit a state to impose income tax on businesses that have continuous and systematic economic contact with that state (or its residents). This contact is called “economic nexus” and does not require a company to have a physical presence in the state such as an office or employees. Oregon and Illinois both apply an economic nexus standard.

Oregon regulations provide that a licensor of intellectual property (such as a logo) would be subject to income tax because the logo is used by an Oregon licensee/retailer. For example, a Colorado processor of a cannabis-infused brownie that licenses to an Oregon bakery the right to use their logo and recipe would be subject to Oregon income tax. The Colorado processor is subject to Oregon income tax even if the processor has no other connection to Oregon. Oregon casts a very wide net to subject a business to income tax; its regulations suggest that even licensing and regulation by an Oregon administrative agency, such as the Oregon Liquor Control Commission, could subject a business to income tax.

Illinois regulations explicitly state that the following licensing arrangements subject companies to Illinois income tax:

Entering into franchising or licensing agreements; selling or otherwise disposing of franchises and licenses; or selling or otherwise transferring tangible personal property pursuant to such franchise or license by the franchiser or licensor to its franchisee or licensee with the State.

As in Oregon, the Colorado processor would be subject to Illinois income tax solely by virtue of its licensing agreement with an Illinois medical cannabis cultivation center.

Because each state’s tax laws are unique, you must look at the laws of each state in which you planning to do business or are doing business. Other factors regarding income tax need to be considered as well before investing in a cannabis enterprise. For example, though Oregon allows a deduction for expenses, those same expenses are disallowed for federal tax purposes. In addition, states such as Illinois and Oregon will often tax related legal entities as one business enterprise. As the cannabis industry grows, participants in this marketplace will also need to consider the state income tax consequences of their activities outside their resident state.

Almost everyone in the cannabis industry loathes Section 280E of the Federal Income Tax Code. For more on why this is the case, check out In the Wake of Marijuana Legalization, It’s Time to Repeal Section 280E.  

Section 280E prevents cannabis producers, processors and retailers from deducting expenses from their income, except for those considered a Cost of Goods Sold (COGS).  As a consequence, marijuana businesses are required to determine what expenses are included in COGS and, therefore, what expenses are deductible.  To date, very little guidance was available to help taxpayers make this determination.

On January 23, 2015, the IRS released an internal legal memorandum outlining how Section 280E should be applied in the cannabis industry. Though this memorandum may not be used or cited by taxpayers as precedent it does outline how some IRS officials analyze Section 280E and how to determine COGS.

In the memorandum, marijuana retailers and producers are required to compute COGS under inventory rules that predate the enactment of Section 280E. According to the memorandum, a retailer can include in COGS the invoice price of cannabis, less trade or other discounts, plus transportation and other “necessary charges” incurred in acquisition.

A producer may include in COGS direct material costs (such as seeds) and direct labor costs (such as planting, harvesting, sorting, cultivating).  Indirect costs are included so long as they are “incidental and necessary for production,” such as the following:

  • Repair
  • Maintenance
  • Utilities
  • Indirect labor
  • Indirect material and supplies
  • Cost of Quality control

In addition, certain other indirect costs may be included (such as depreciation, excise taxes, factory administration expenses, and insurance), depending on accounting treatment.

The memorandum outlines a very narrow reading of the cost included in COGS by suggesting that the IRS will not allow cannabis businesses to allocate purchasing, handling, storage and administrative costs to COGS.

The memorandum suggests that a cannabis producer or retailer should be on an accrual basis of accounting unless explicitly allowed to use the cash basis in the tax code (e.g., farmers and certain small businesses). Under the cash basis, a producer generally may deduct costs in the year of payment and includes income in the year cash is received. Under the accrual method, a producer would report income in the year it is earned and deduct costs in the year incurred.  Taxpayers need to look at their specific facts to determine the impact of cash accounting vs accrual accounting, but it is important to note that the tax liability difference between these two accounting methods could end up being substantial.

The Colorado Department of Revenue (“Department”) recently addressed common tax questions for participants in the state’s new green economy. Specifically, the Department’s website offers guidance to four key stakeholders: Local GovernmentConsumers, Cultivators and Retailers.

Consumers. When speaking of taxes, a great deal of press has been focused on cultivators, growers, processors, retail sellers and health care professionals. Not much has been written about taxes from a consumer perspective.

In Colorado, retail consumers pay the state sales tax of 2.9% plus any local sales taxes plus an additional 10% state marijuana sales tax.  However, retail consumers are still absorbing a 15% Retail Marijuana Excise Tax. Colorado imposes a 15% excise tax on the first sale from the cultivator to the retail manufacturing facility, retail store or another cultivator facility. The cultivator is liable for the tax.  However, the retail marijuana store will include this excise tax in its consumer sale price similar to liquor or tobacco.

Medical marijuana is not subject to the 15% excise tax. What this means is that no Colorado tax is embedded in the sale price of medical marijuana purchased from a medical marijuana center. Nonetheless, consumers of medical marijuana will pay the 2.9% state sales tax plus any local sales taxes on the consumers purchase.

Local Government. The Department clarified the distribution of tax revenue to local governments. With respect to retail marijuana sales tax, local governments receive 15% of the retail marijuana sales tax revenues. For example, local governments would share $1.5 of tax revenue for every $100 sale ($100*10%*15%). The city or town share is apportioned based on the percentage of sales tax revenue collected within the boundaries of the city or the town. Counties will not get a percentage of sales tax revenue unless there is a retail marijuana store in an unincorporated area. The 15% excise tax goes to construction of Colorado public schools.

Most interesting is the Department’s acknowledgement of the newsworthiness of the amount of marijuana retail sales generated in Colorado. However, the Department cautions disclosing sales information can jeopardize the confidentiality of taxpayer information.  Specifically, the Department reiterates Regulation Section 39-21-113 that “every tax return and all information therein contained together with correspondence, papers, affidavits, assessments, protests and hearings are secret and confidential and no information relating thereto can be disclosed…” Disclosure is allowed in some circumstances, but is the exception not the rule.

The Department sets out its own policy guideline for releasing sales tax information. Specifically, the Department only release sales tax information if there are three or more vendors and any one vendor does not constitute more than 80% of the total sales tax number.  The Department encourages that local governments adopt a similar policy. For those jurisdictions that have a single marijuana establishment the Department states that no information may be released. Finally, the Department reminds local jurisdictions of the requirement to execute a MOU (Memorandum of Understanding) with the state regarding the control of confidential data.

Cultivators. The Department clarifies three key areas.  The first area is the computation of the Retail Marijuana Excise Tax. The excise tax is equal to 15% of the average market rate of retail marijuana. The average market rate for 2014 is summarized below.

Retail Flower Rate


Retail Trim


Retail Immature Plant


The second area is the requirement for a Surety Bond to be filed with the Department. This is in addition to any bond that is already filed with the Marijuana Enforcement Division.

The third area is in regard to filing and paying tax. Taxes are filed electronically; paper forms are not available on the website and will not be mailed to Cultivators. A return must be filed even if no sales were made or if no tax is due for the period. In such case, a Cultivator must file a “Zero” tax return. In general, it is a best practice to file a Zero tax return as such filing in most state jurisdictions begins to run the statute of limitation on tax assessments. Even if no tax is due, the failure to file a return grants a state unlimited time to assess tax, penalties and interest.

Finally, the Department clarifies that payment of tax may be made online via Electronic Funds Transfer or in cash, check or voucher.  Payments made by credit card or e-check will display as Co. Dept. of Revenue Colorado.govNo information regarding the type of tax is sent to the bank or to the credit card company.

Retailers. Similar to the guidance provided to Cultivators, the Department clarifies the registration, reporting and collection responsibilities of the retailer. First, the Department clarifies that a sales tax license is required for each type of marijuana sold (medical and retail). A separate license is required even if medical and retail marijuana is sold at the same location. Second, the Department clarifies that sales tax must be separately stated on the receipt.

Retailers have two separate reporting requirements. The 2.9% sales tax is reported on the Retail Sales Tax Return using the same account number as listed on the sales tax license. The 10% additional Marijuana Sales Tax is reported on the Retail Marijuana Sales Tax Return. Medical Marijuana sales are reported on the Retail Sales Tax Return and filed under the account number that matches the sales tax license for medical marijuana. Department guidance regarding payment of tax as well as filing Zero returns is the same as for Cultivators.

The State of Colorado continues to be at the cutting edge of regulating an integrated medical and recreational marijuana marketplace.  The Department understands that tax compliance and administration is a crucial component to legitimizing this new marketplace. The Department should be commended for reaching out to stakeholders to provide such guidance.

Now that the deadline for submitting Illinois cannabis license applications has passed, it is time to look forward to another aspect of the Compassionate Use of Medical Cannabis Pilot Program Act — taxes.

The Act has generated two new state taxes, the Medical Cannabis Cultivation Privilege Tax (“Cultivation Tax”) and the related Compassionate Use of Medical Cannabis Pilot Program Act Surcharge (“Surcharge”). The Illinois Department of Revenue recently issued regulations on both the Cultivation Tax and the Surcharge.

The Cultivation Tax is imposed on the privilege of cultivating cannabis for medical use. The tax is 7% of the sales price per ounce. The tax is paid by the cultivation center and is not the responsibility of a dispensing organization, qualifying patient, or designated caregiver. However, the new regulations clarify that the cultivation center may seek reimbursement of the tax; the charge may not be identified on the invoice as a tax.

Persons subject to the Cultivation Tax must apply for a certificate of registration from the Department of Revenue. Those already registered with the Department of Revenue under the Retailers Occupation Tax are not required to register separately for purposes of the Cultivation Tax.

The Cultivation Tax is not imposed on free samples of medical cannabis given to a dispensing organization by a cultivation center. Nonetheless, the cultivation center will incur use tax liability on the cost price of the samples given. Furthermore, under the regulations, a cultivation center may not directly or indirectly discriminate in price between different dispensing organizations that are purchasing a like grade, strain, brand, and quality of cannabis or cannabis-infused products. Pricing based on differences in the cost of manufacturing, quantities sold, such as volume discounts or delivery method, are not prevented under the Department of Revenue regulations. Finally, the new regulations impose detailed record keeping requirements on all marijuana businesses.

The Surcharge statutes and regulations are somewhat complex. In general, the Surcharge is imposed on: 1) all taxpayers; 2) deriving income from sales and exchanges; 3) of certain tangible, real and intangible property of an “Organization Registrant.”  In general, an Organization Registrant is a legal entity registered in Illinois either as a cultivation center or as a medical cannabis dispensary. An important point is that liability for the Surcharge is not limited to cultivation centers and dispensaries. The income of certain investors may be subject to the tax.  Specifically, partners and S Corporation shareholders may be subject to the tax even if such partners and shareholders are not themselves a cultivation center or dispensary.

Finally, the taxes with which we are most familiar (e.g. income tax) are often rate based. The Surcharge is a bit different in that the Surcharge is equal to the amount of the taxpayer’s federal income tax liability for the taxable year attributable to transactions subject to the surcharge. Accordingly, a taxpayer must have a clear understanding of his or her federal income tax liability and treatment of asset sales and exchanges before The Surcharge can be analyzed. Finally, the regulations outline several exceptions to The Surcharge, including bankruptcy and certain transfers of registration, acquisitions, and restructurings.

In addition to these two new taxes, cultivators, and dispensaries must still consider other Illinois state taxes such as: Income Tax, Retailer Occupation Tax, Use Tax, Employee Withholding and other local taxes. And, of course, all Illinois marijuana businesses must grapple with 280E under the federal tax code.