By Beau Whitney, Chief Economist at Whitney Economics.
- We start with the assumption that An increase in US corporate tax rates from 21% to 28% is imminent.
- Due to a relatively opaque IRS regulation called 280E, this increase in federal tax rates would lead to it Increase in effective tax rates for cannabis operators to over 70%.
- Without reform of 280E, Forced consolidation will be an unintended consequence that hurts smaller minority and women-owned cannabis retailers.
- This is a turning point for the U.S. cannabis industry.
An increase in corporate tax is coming
Obviously, raising taxes in the middle of a pandemic-triggered recession is no easy task. If tax hikes are too tightly focused, they won’t hit their revenue targets. However, if tax increases are not focused enough, they can have significant negative effects that lead to unintended outcomes. The proposed Washington, DC corporate tax hike will have a negative impact on the cannabis industry, which has earned a reputation for generating tax revenues and creating jobs.
Due to an obscure IRS tax code, this corporation tax hike will hurt smaller cannabis operators
Although cannabis is medically legal in 37 states, with 15 of those states allowing sales for adult use, it is still a List 1 drug. It is declared illegal by the federal government. Despite the strong state-level acceptance of cannabis, cannabis retailers are subject to a criminal federal business tax called IRC 280E. Our analysis shows that the proposed corporate tax increases (from 21% to 28%) would increase corporate taxes for cannabis operators by $ 6.8 billion over a 5-year period. This amount is estimated to add additional tax payments of $ 140,000 per cannabis retailer per year for the same period. With the addition of $ 140,000 in additional federal taxes, cannabis operators are faced with the daunting task of spending nearly two full months’ worth of revenue just to cover federal taxes. Lower margins lead to slower growth, lower employment, lower wages, fewer benefits and lower tax revenues.
Why is 280E so harmful to cannabis retailers?
280E does not allow the deduction of cannabis costs (other than the cost of goods sold) from federal taxes, increasing the effective tax rates for most cannabis companies. The current average effective tax rate for cannabis retailers is between 50% and 60%. Combined with the 28% increase in corporate tax, the effective tax rate for cannabis retailers rises to over 70%, potentially affecting the ability to run small cannabis, women’s, or bipoc cannabis businesses.
Is the intent to tax cannabis companies at 70%?
In a scenario where the corporate tax rate is raised and 280E is not reformed, U.S. cannabis operators would pay an effective tax rate of 70%, which would be the highest tax rate in the world. According to the Tax Association *, an effective tax rate of 70% is more than 20% higher than the highest national corporate tax rates in the world, including Norway, Finland and New Zealand. Interestingly, France, the Netherlands and Sweden are cutting corporate taxes in 2021 to fuel economic stimulus.
Standard deductions that the IRS does not allow for federal filings under 280E
- Wages and salaries
- Commissions and payments to independent contractors
- Health and other insurance premiums
- Security services
- Marketing and advertising costs
- State and local taxes and fees
- Legal, accounting and other professional costs
- Rental and home office costs
- Interest Paid on Business Loans
A taxpayer affected by 280E pays tax on “phantom income,” where a taxpayer’s taxable income is greater than their actual income due to the 280E denied deductions.
Why a 280E reform is necessary
Record sales and tax revenues were achieved in 2020, which was positive, but cannabis retailers struggled to survive. In 2020, 7,500 retail cannabis stores had average sales of $ 2.4 million. Even without the proposed tax hike, cannabis operators will pay an average of $ 2.2 billion in additional taxes over the next five years compared to similar legal companies. Due to high taxes and low margins, most cannabis operators are already struggling to pay the costs of labor, taxes, and product sourcing. Benefits, rent, and debt servicing are often a monthly battle. At a time of high unemployment due to the displacement of Covid-19, our analysis shows that current federal taxes are suppressing the hiring of more than 30,000 people in the cannabis industry. Hiring this new group would generate approximately $ 1.1 billion in annual wages.
- The cannabis industry is already experiencing what you would expect any industry to be if taxed way too heavily.
- While other industries receive tax breaks or deferrals, taxes on cannabis companies continue to rise.
- In 2020, many states declared cannabis operators major companies. Even so, they are still not taxed immediately.
- Cannabis operators struggle to justify their essential business names while paying heavy penalty taxes.
Cannabis has proven its viability despite criminal taxes
Cannabis retailers have paid $ 7.3 billion in taxes to state coffers since 2014. In 2020, they created 79,000 jobs for the economy and generated $ 44 billion – $ 51 billion in economic activity. Cannabis has more than proven itself to be a viable industry and will thrive if it receives the political and regulatory support it needs to sustain it in its early days.
Why Legis?lators have a unique opportunity for reform
Senators Schumer (D-NY), Booker (D-NJ) and Wyden (D-OR) have announced that cannabis reform is a legislative priority in the US Senate. With such a high level of visibility, a tax increase in connection with an already criminal tax policy seems contradictory. This would get the legs of cannabis retailers out of the way, one of the fastest growing industries in the United States. There is strong public support for cannabis reform from two parties.
The next few months will tell. This is a turning point for the cannabis industry and cannabis tax policy.
About the author.
Beau Whitney is the founder and chief economist of Whitney Economics in Portland, Oregon, a global leader in business data, consulting, and economic research for cannabis and hemp.
The previous article was written by one of our external contributors. It does not reflect Benzinga’s opinion and has not been edited.
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