Your taxes pale beside what marijuana businesses pay

You think your taxes are high?

For medical marijuana dispensaries in the United States, they can be stratospheric. Cannabis retailers face an effective tax rate of up to 85 percent, and that won't be reduced by the new tax law.

Most mainstream businesses pay effective tax rates of about 15 percent to 30 percent.

"It's a burden," said Chris Visco, co-owner of TerraVida Holistic Centers, which opened one of Pennsylvania's first medicinal cannabis shops on Feb. 17 in Sellersville. "People think that we're getting rich. It's really not the case. The profit margins are going to be really narrow after taxes. And you have to still pay local and state taxes."

Rent, salaries, utilities, and insurance are among the expenses any other business can write off on their federal taxes. None of those deductions is available to cannabis dispensaries.

"There is no other business where you're not allowed to take your other business expenses," said Jennifer Benda, a tax lawyer with Fox Rothschild LLP who works out of the firm's Denver office.

Even other illegal enterprises can write off expenses related to overhead.

"Prostitutes and brothels, for instance, can write off their costs of doing business," Benda said.

But not marijuana dispensaries, thanks to Section 280E in the IRS tax code. Congress created it at the height of the War on Drugs to target illegal drug traffickers. It prohibits any business that sells Schedule 1 substances from taking deductions or credits.

In 1974, police busted a petty coke, dope and amphetamine dealer in Minneapolis. After Jeffrey Edmondson's arrest, the IRS came calling, looking to collect taxes on his undeclared income. Boxed in a corner was Edmondson's late return, which attached a laundry list of deductions that included the price he paid for the drugs. He also wrote off the rent on his apartment, which he listed as his place of business, car mileage, a business trip to San Diego, a $180 phone bill, and the cost of a $50 scale.

Surprisingly, a U.S. Tax Court judge approved most of the deductions, finding them "ordinary and necessary." An incensed U.S. Sen. William Armstrong of Colorado introduced a bill that closed the loophole in 1982.

Federal law considers all forms of marijuana as illegal. The U.S. Drug Enforcement Administration regards cannabis as being on par with heroin and LSD, dismissing it as having no legitimate medical use. But since Section 280E was enacted more than three decades ago, 29 states and the District of Columbia have legalized some forms of marijuana for medical or adult use.

Congress did not envision a state legal industry in conflict with federal law when it passed 280E, said Neal Levine, chairman of a cannabis industry lobbying arm, the New Federalism Fund.

The tax code also gives criminal markets a leg up on state-regulated businesses. "I know of some compliant dispensaries that had tax bills for more than they made," Levine said. "But on average, they're paying more than 80 percent. The criminal competition pays no tax."

He estimated that the IRS collected more than $200 million from legal marijuana businesses in 2016.

Bills are pending in both the U.S. House and Senate to strike down 280E, Levine said. "We had hoped it could be part of comprehensive tax reform, but it didn't happen. Most members of Congress didn't understand the issue."

Until the law can be changed, dispensaries are scrambling to find ways to reduce their tax bills.

"Dispensaries can turn a profit if they're run correctly, but in every state, we've seen businesses regularly go under," said Justin Moriconi, an Elkins Park lawyer who specializes in marijuana law. "Taxes are usually the nail in the coffin."

Because marijuana is federally illegal, dispensaries can't file for federal bankruptcy protection.

"If you go under, you have to be bought out, or take an amazing loss," Moriconi said.

In most states, marijuana retailers can sell T-shirts, candles, soaps, and lotions. Others open wellness centers complete with yoga studios and massage tables. In Colorado, some open tea bars, said William Roark, a lawyer who is co-chairman of the Pennsylvania Bar Association's Medical Marijuana and Hemp Law Committee.

The ancillary sales and services allow the dispensaries to deduct some of their real estate expenses, utilities, insurance, and other costs. But in Pennsylvania, those options are prohibited by law.

"If we could sell other things, we'd be able to write off a portion of our square footage," Visco, co-owner of TerraVida, said. "We're hoping the state will allow us to do that by summer."

Another strategy is to separate the company that owns the dispensary from the business that leases out the property, so that costs are attributed to the real estate entity, Roark said.

"It's one of the many reasons that when people are looking at entering the business, they need a long-term plan," Roark said. "Because they're not going to have revenue if they haven't planned for the brutal tax consequences."

If the taxes are so onerous, why does anyone bother with running a marijuana dispensary?

"Half of it is waiting for legalization," Moriconi said.

When a state limits the numbers of dispensaries, there can be lots of money to be made, he said.

In Connecticut, there are only nine dispensary licensees. Some of them gross $15 million a year, Moriconi said.

"They all do very, very well," Moriconi said. "At the end of the day, even if you're paying high taxes, as long as you're making enough sales it can be very worthwhile."