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Challenges of Operating a Cannabis Business

Is it Legal or Illegal?

I have previously blogged about regulatory and ethical issues surrounding the use of cannabis based on whether states have adopted “compassionate use” laws that permit the sale of marijuana for medical purposes. I have also written on the sale for recreational purposes. In this blog I look at the operating issues of running a marijuana business.

Nine states and Washington, D.C. have legalized marijuana for recreational use – no doctor’s letter required – for adults over the age of 21. Medical marijuana is legal in another 29 states. There is no doubt that marijuana use will be legalized by more and more states in the future.

The challenges for businesses that cultivate, distribute, and/or sell marijuana are many including:

  • Does state law permit the sale of marijuana for medical purposes?
  • Does state law permit the sale of marijuana for recreational purposes?
  • What are the implications of the federal Controlled Substances Act?
  • What are the implications of banking laws that preclude opening a bank account?
  • How should the proper amount of taxable income be determined and the “fair share” of taxes to be paid? Marijuana

A major consideration in running a cannabis business is that it is illegal to sell marijuana under the federal Controlled Substances Act and that conflicts with state laws that permit the sale for medical/recreational use. Under federal law, any entity that supports illegal activity or knowingly accepts fees derived from illegal sources may run afoul of federal racketeering laws, including banks, financial institutions, insurance companies and accounting and tax firms.

Most banks refuse to provide services to marijuana businesses due to concerns about application of both the Controlled Substance Act and anti-money laundering laws. As a result, these businesses handle large amounts of cash, highlighting the need to address internal quality controls and the risk of theft or fraud.

The ethical and legal issues for accounting firms are significant. Under U.S. Treasury Section 280E, marijuana businesses are prohibited from deducting from taxable income expenses incurred in a business of trafficking in a controlled substance; therefore, the businesses selling marijuana generally cannot deduct their expenses (i.e., marketing and other operating expenses). However, such businesses can deduct cost of goods sold. This creates a higher taxable income and increased taxes that should be paid to the federal government. Some states where marijuana sale is legal are trying to overturn this ruling because they are operating a legal business under state law.

Another problem for accountants is how to properly value the ending inventory of marijuana products. Ending inventory should be valued at the lower of cost or market. There’s little doubt the market value is higher than cost so that there is no need for a write-down. Still, disclosure in the financial statements seems desirable to alert owners and other investors to the fact that revenue is likely to greatly exceed cost of goods sold going forward thereby increasing future tax obligations.

The operating issues for a cannabis business are daunting. To some extent the rules will be determined based on trial and error. I am concerned about the fact that marijuana sellers cannot open bank accounts in most states because the sale still violates federal law. I also believe it’s not fair that they cannot deduct all ordinary and necessary expenses of operating such businesses. Again, this is because of federal laws. It’s time for those laws to be modified, at least in states which have legalized marijuana.

Like it or not, we cannot undue what has been done. We cannot put the genie back in the bottle. The key issue now is what must a cannabis business must do to comply with the law and how to operate the business.

Blog posted by Steven Mintz, aka Ethics Sage, on May 15, 2018. Visit Steve’s website and sign up for his Newsletter that deals with cannabis issues this month.