Federal Tax Burns Up Recreational Pot Profit

Mitch Woolhiser owner of Northern Lights Cannabis Company, rubs his forehead as he talks about federal taxes he pays from operating his medical and recreational marijuana store in Edgewater, Colo., on Friday, Oct., 31, 2014. Under a federal tax law, Code 280E, marijuana shops in Colorado report that they regularly paying taxes of more than 70 percent compared to 30 to 40 percent business exempt from Code 280E.

Joe Mahoney / Rocky Mountain PBS I-News

Mitch Woolhiser owner of Northern Lights Cannabis Company, rubs his forehead as he talks about federal taxes he pays from operating his medical and recreational marijuana store in Edgewater, Colo., on Friday, Oct., 31, 2014. Under a federal tax law, Code 280E, marijuana shops in Colorado report that they regularly paying taxes of more than 70 percent compared to 30 to 40 percent business exempt from Code 280E.

Voters in Oregon, Alaska, and Washington, D.C., legalized recreational marijuana on Tuesday.

But without the support of the U.S. Congress, any of the new, voter-approved pot shops may not be able to survive a drug war-era tax code that already threatens many businesses in Colorado and Washington state.

Voters in Oregon, Alaska, and Washington, D.C., legalized recreational marijuana on Tuesday.

Jordan Wirfs-Brock / Rocky Mountain PBS I-News

Voters in Oregon, Alaska, and Washington, D.C., legalized recreational marijuana on Tuesday.

Under this tax code the federal government stands to make more money from the sale of marijuana than those legally selling it. And that could be enough to shut down many shops.

“It’s almost like they want us to fail,” said Mitch Woolhiser, while walking through his store called Northern Lights Natural Rx in Edgewater, Colo. “Everything I do is aimed at keeping us in business because if I don’t, then (the feds) win. And I’m not going to let them win.”

Woolhiser believes the federal government is actively seeking to undermine his business.

Woolhiser first opened shop in 2010, selling medical marijuana. He started selling recreational pot when it became legal in Colorado at the start of this year. Last year, his business didn’t earn a profit. Had he been selling anything but cannabis, he would not have owed federal income tax, as he ended up with a loss.

Instead, he ended up paying close to $20,000 to the IRS because of a 1980’s tax code called 280E.

“I believe that the feds extend the drug war through 280E,” said Jordan Cornelius, a Denver accountant who has worked with Woolhiser and many other marijuana companies in Colorado. “If (the federal government) can’t put them out of business legally when voters are mandating these businesses to move forward, it’s very easy to put them out of business financially.”

Understanding the Federal Marijuana Tax from Rocky Mountain PBS on Vimeo.

It’s unclear that the federal government is actively enforcing this tax code in an effort to undermine the legal business, but that is the effect.

No one from the U.S. Department of Justice, Drug Enforcement Administration or Internal Revenue Service would comment for this story. However, an IRS spokesperson provided a 2010 letter written in response to several lawmakers in Colorado, Massachusetts, Arizona and California who had asked the IRS to stop enforcing the tax code in states that legalized the sale of marijuana. The IRS letter pointed out that only Congress could make that change.

“The result you seek would require the Congress to amend either the Internal Revenue Code or the Controlled Substance Act,” the IRS letter said.

Though multiple members of Congress received the letter, there has been little effort to amend the code.

Instead, the federal government collects taxes on what it considers an illegal drug because the Supreme Court ruled more than 50 years ago that everyone has to pay taxes – even those who make their money illegally.

Then, in 1982, Congress amended the U.S. tax code to include code 280E, which says businesses selling a Schedule I or II drug – like marijuana, heroin, methamphetamine or cocaine – cannot deduct all of their regular business expenses.

The rule means that the “costs of the product,” like the soil and fertilizer used to grow plants, are deductible. But the “costs of selling,” like advertising, rent and utilities – even salaries for employees – are not deductible.

“If it made sense, I would feel better about following it,” said Rob Corry, Denver attorney and marijuana advocate. “I don’t see why production is deductible – they are still producing marijuana!”

But that quirk in the tax code has helped many cannabis companies stay in business over the last several years in Colorado. Medical marijuana stores were required to grow their own product, and therefore had some associated deductions.

Since Oct. 1, nearly 100 new cannabis companies got licenses to operate in Colorado and will no longer have to grow the products they sell. But without growing, many may soon find that they will have very few, if any, business deductions when filing federal taxes next April.

Vicki Murgach, a shift manager at Northern Lights Cannabis Company holds a container of marijuana for a customer to smell at the legal marijuana shop in Edgewater, Colo., on Friday, Oct., 31, 2014. Under a federal tax law, Code 280E, marijuana shops in Colorado report that they regularly pay taxes of more than 70 percent compared to 30 to 40 percent business exempt from Code 280E.

Joe Mahoney / Rocky Mountain PBS I-News

Vicki Murgach, a shift manager at Northern Lights Cannabis Company holds a container of marijuana for a customer to smell at the legal marijuana shop in Edgewater, Colo., on Friday, Oct., 31, 2014. Under a federal tax law, Code 280E, marijuana shops in Colorado report that they regularly pay taxes of more than 70 percent compared to 30 to 40 percent business exempt from Code 280E.

For Woolhiser, whose sales have increased dramatically since he began selling recreational marijuana Jan. 1, the confusing nature of the code means he has no idea how much he will owe in taxes – just that it will be far more than what it might be if he was selling anything else.

“A lot of people think that the marijuana industry is just a license to print money,” said Taylor West, deputy director of the National Cannabis Industry Association. “And it’s just not the case.”

West works for an association of more than 750 cannabis-related businesses across the United States, and says that 280E results in her clients paying more than 70 percent of their profits in taxes to the federal government.

Sometimes, the rates are far higher than that.

“A lot of times, instead of paying a tax rate that should be 30 to 40 percent, they are paying rates between 80 or 90 percent,” Cornelius, the accountant, said. “I even have a client right now that is paying more than 100 percent effective tax rate.”

Mitch Woolhiser is hoping that increased sales this year will make up for the loss he took last year – but he is still paying off his debt to the IRS.

“The problem is that we have passed laws that allowed these medical marijuana and recreational marijuana companies to do business,” said Mac Clouse, University of Denver finance professor who studies the industry. “But we have all these other laws, tax laws, federal laws that make it incredibly difficult if not utterly impossible to survive.”

Barring any changes from Congress, new cannabis businesses in the states that approved recreational marijuana on Election Day, along with the established shops in Colorado and Washington state, face a large, and possibly ruinous, tax bill come April 15.

Vicki Murgach, a shift manager at Northern Lights Cannabis Company rings up a customer's order at the legal marijuana shop in Edgewater, Colo., on Friday, Oct., 31, 2014. Under a federal tax law, Code 280E, marijuana shops in Colorado report that they regularly pay taxes of more than 70 percent compared to 30 to 40 percent business exempt from Code 280E.

Joe Mahoney / Rocky Mountain PBS I-News

Vicki Murgach, a shift manager at Northern Lights Cannabis Company rings up a customer's order at the legal marijuana shop in Edgewater, Colo., on Friday, Oct., 31, 2014. Under a federal tax law, Code 280E, marijuana shops in Colorado report that they regularly pay taxes of more than 70 percent compared to 30 to 40 percent business exempt from Code 280E.

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