Highlighting the absurdity of the federal government refusing to legalize cannabis, the Internal Revenue Service (IRS) made a show of support for state-legal (but federally banned) cannabis businesses. Named the Cannabis/Marijuana Initiative, this “groundbreaking effort” by the agency will entail large-sale training of IRS agents, revision of IRS policy, as well as outreach and education programs to fully integrate the cannabis industry into the federal infrastructure.
“While there are 14 states that still ban cannabis use, we expect both unlicensed and licensed marijuana businesses to grow,” writes De Lon Harris, Commissioner for the Small Business/Self Employed Examination division of the IRS. “It’s tricky from a business perspective, because even though states are legalizing marijuana and treating its sale as a legal business enterprise, it’s still considered a Schedule 1 controlled substance under federal law. That means a marijuana business has additional considerations under the law, creating unique challenges for members of the industry.”
The IRS does see the illegal status of the cannabis industry as a challenge to overcome, but they are willing and trying to impart advice on how to sidestep the consequences of running an illegal business. “That’s why I’m making sure the IRS is doing what it can to help businesses with our new Cannabis/Marijuana Initiative,” says De Lon Harris.
The Challenges to Overcome
The IRS’s newly launched irs.gov/marijuana page immediately addresses the central issue that cannabis businesses have to deal with: they are illegal operations which “traffic” illicit substances in contravention of federal law. In the eyes of the U.S. government, state-legal cannabis businesses are indistinguishable from street-corner drug dealers.
As a result, paragraph 280E of the Internal Revenue Code applies; it bars cannabis businesses from receiving tax credits or deductions, although the government is not turning down the tax revenue from these unwanted, illegal businesses. “The Internal Revenue Code doesn’t differentiate between income derived from legal sources and income derived from illegal sources. It’s all income and is taxable,” the IRS explains.
Commissioner De Lon Harris points out the holes in his own organization’s rules: “While IRS Code Section 280E is clear that all the deductions and credits aren’t allowed for an illegal business, there’s a caveat: Marijuana business owners can deduct their cost of goods sold, which is basically the cost of their inventory. What isn’t deductible are the normal overhead expenses, such as advertising expenses, wages and salaries, and travel expenses, to name a few.”
The biggest, baddest enemy of the legal cannabis industry in states that have legalized it is the risk for financial institutions working with the industry. Unlike the IRS, banks, credit unions and insurance providers are legally liable for handling income from illegal activities. Only 706 financial institutions are currently willing to work with state-legal cannabis businesses in the entire nation, which is just a small fraction of them. While lawmakers have been attempting to pass the SAFE Banking Act, which would protect financial institutions from liability for servicing state-legal cannabis businesses, this Act has been introduced to Congress every year since 2013, without success.
As such, most cannabis businesses are forced to operate purely in cash. They cannot accept debit or credit cards because no bank is willing to process the transaction; they can’t pay their taxes electronically, and the subsequent hurdle for the IRS to collect that revenue has been driving a call for legal reform from financial authorities.
“As a consequence of these arcane restrictions, businesses are forced to hire armored vehicles to transport their tax payments in cash to the local IRS,” IRS Commissioner Charles Rettig revealed to Congress in a call for change. This situation strongly encourages fraud and criminal activity, as cannabis businesses become a juicy, cash-filled target for would-be thieves.
Even under the Trump Administration, financial experts were ringing the alarm bell regarding the immediate need for reform. In 2019, then-Treasury Secretary Steven Mnuchin revealed that the cash situation was a nightmare for the IRS itself, as the organization had to build “cash rooms” in IRS locations just to hold the literal mounds of physical currency paid in taxes by the multibillion-dollar cannabis industry. This is an inconvenience as well as a significant security risk for IRS offices and workers, Mnuchin explained to Congress in another call to change regulations. “I hope this is something that [lawmakers] can work with on a bipartisan basis, there are people on both sides of the aisle that share these concerns,” he expressed.
It is interesting to note that both IRS Commissioner Charles Rettig and former Treasury Secretary Steven Mnuchin are both affiliated with the Republican Party, which has been consistently blocking reform for years now. While the SAFE Banking Act, which would solve the issues which dismay these Republicans, has been unanimously supported by Democratic lawmakers, Republican congresspeople have been repeatedly voting against it. When the House of Representatives successfully passed the SAFE Act, then-Senate Majority leader, Republican Sen. Mitch McConnell chose to let the bill die without a floor vote.
Unlike much of the Republican party, reality-minded organizations such as the IRS cannot ignore facts in favor of doctrine. Therefore, despite the best efforts of obstructionist Republicans, the IRS is explicitly on the side of business owners and fair trade, and thus, on the side of legal cannabis.