The Cannabis Administration and Opportunity Act (CAOA) introduced in draft form by Senators Booker, Wyden, and Schumer in July, 2021, has marijuana investors leaping for joy at the thought of a federal legalization bill that will level the playing field between cannabis businesses and their counterparts in alcohol and tobacco industries.
Cannabis business owners have been beaten down repeatedly over the onerous constraints of 26 U.S.C. 280e, which disallows deductions for anything other than cost ofgoods sold for businesses that consist of trafficking in controlled substances.(See https://www.irs.gov/pub/irs-wd/201504011.pdf) From the early days of the legal marijuana industry, business owners have speculated on how they will save time and money when they no longer have to comply with 280e, or when they don’t have to pay an accountant to sort outtheir complex tax returns.
Looks like you will need more accounting work – not less!
But hold on – not so fast! The CAOA has features that call for even MORE sophisticated accounting procedures – not less.
Congress has to pay for the Reinvestment Grant Program
A key feature of the CAOA is the establishment of a three grant programs: 1) the Community Reinvestment Grant Program, which will be administered by theDepartment of Justice, and is designed to provide services such as jobtraining, legal aid, and reentry services to individuals damaged by the War on Drugs; 2) the Cannabis Opportunity Program, which will provide funding toeligible states and municipalities to make loans to small businesses owned by socially and economically disadvantaged individuals; 3) and the Equitable Licensing Grant Program, which will provide a means for states to minimize barriers to entry into the industry for those who have been adversely affected as well as to create expungement programs.
How will the costs of the Opportunity Trust programs be covered? Through tax dollars, of course!
While cannabis businesses have been paying state and municipal taxes, the CAOA will introduce a federal excise tax, similar to what already exists in the alcohol and tobacco industries.
What does the draft of CAOA say about federal excise taxes for cannabis?
Let’s look at how that might play out. The following information is from the summary ofthe discussion draft of CAOA. For a copy, please click here: https://www.democrats.senate.gov/imo/media/doc/CAOA%20Detailed%20Summary%20-.pdf.
The General Federal Alcohol Tax Rates provide for taxation of beer at a rate of $18 perbarrel (IRC 5051). Distilled Spirits are taxed at a rate of $13.50 per proof per gallon. Wines are taxed in a range from $1.07 per gallon to $3.40 per gallon, depending on the alcohol content or the mix with other substances, such as carbonation.
Cigarettes and other tobacco products are taxed pursuant toIRC 5701. Generally, producers are taxed $50.33 per 1,000 small cigarettes(defined as weighing 3lbs or less per 1000 cigarettes). The IRC also provides for taxation of cigars, roll-your-own tobacco, pipe tobacco, snuff, cigarette papers, and tubes. Producers are granted some discounts, depending on production volume, bottling, and wholesale rates. In a few cases in the tobacco industry, the excise tax is 100% of the cost of the product. Tax is generally payable semi-monthly, and is calculated at the point at which the product istransferred from the producer to the wholesale distributor. And, as anyone who has visited a duty-free shop knows, some alcohol and tobacco is not taxed at all.
There are other fees, such as the permit required of alcoholproducers under the Federal Alcohol Administration Act, or the permits requiredof tobacco producers under the Family Smoking Prevention and Tobacco Control Act.
So what about the federal excise tax for cannabis?
The Discussion Draft proposes language in the InternalRevenue Code that will create a general tax rate of 10% for the year ofenactment and the first full calendar year after enactment. The following yearswould provide for an increase in federal taxation of 5%, such that the ratewould be 25% beginning in year five and for all years after. Taxation would belevied on a per-ounce rate on flower, or a per-milligram of THC rate in thecase of any cannabis extract.
After Year Five, it doesn’t get easier
“The applicable rate for year five and thereafter would be a per-ounce or per-milligram of THC amount determined by the Secretary of theTreasury equal to 25 percent of the prevailing price of cannabis sold in the United States in the prior year. In order to remove barriers to entry, smallcannabis producers with less than $20 million in sales annually would be eligible for a 50 percent reduction in their tax rate, via a tax credit. Producers with more than $20 million in sales would be eligible for a tax credit on their first $20 million of cannabis sold annually, with sales abovethat amount subject to tax at the full rate.” (Discussion Draft, Cannabis Administration and Opportunity Act)
Wait – how are they calculating the taxafter Year Five?
The language that has been proposed thus far is that the tax rate will be a per-ounce or per-milligram of THC amount equal to “25 percent ofthe prevailing price of cannabis sold in the United States in the prior year.” This is problematic on so many levels, not the least of which is the fact thatcannabis pricing varies widely from one region to another.
Any chance of catching a break on it? Cozy up to your cannabis-trained accountant and tax attorney. Your GAAP accounting workpapers will have to show whether you have less than $20 million in annual cannabis sales or more than $20 million in annual cannabissales. that you are either a small producer with less than $20 million in annual sales. The tax credit is substantial, and every penny you spend on accounting will be well worth the difference. Your accountant will be the key person to document that you qualify for either the 50% reduction in tax rate for small businesses or 25% reduction in tax rate on the first $20 million each year for large producers.
Whew! This is a lot to take in. Anything else I should know?
More permits for cannabis owners will be required when thefederal excise tax structure is implemented. Fortunately, the authors of theact seem to be sensitive to the need to reduce paperwork. The proposal is for a single application to cover a permit with the Treasury Department for any person selling cannabis products, a registration for tax purposes, and a permit with the FDA for producers of cannabis products
“[A] cannabis permit may be denied or revoked if the premises is inadequate to prevent tax evasion or diversion, operation of the premises do not comply with federal or state law, or an applicant fails todisclose material information or makes a false statement.” There is also talk of providing a permit fee waiver for a first-time applicant whose income falls below 250 percent of the Federal Poverty Level. But think through all of that: a person won’t be able to get funding for their venture if they cannot display good financial health. And won’t they need a permit before, or shortly after,getting their funding? Also – what are we talking about in terms of federalcannabis permit fees? Hundreds? Thousands? Tens of thousands? Who knows? Who makes this determination?
Can I voice my opinion somewhere?
From now until September 1, 2021, you can send your comments to the committee that is developing the bill. (Remember – we are still in thediscussion phase right now.) They want to know about the following:
·The appropriate sales or production threshold for the small producer credit;
·Appropriate anti-double-benefit rules regarding the small producer credit, including rules related to substantial processing;
·The proper manner to measure potency of a cannabis product and which products should be subject to a per-THC content tax rather than a purely weight-based tax;
·The appropriate entity and methodology for measuring the prevailing price of cannabis for purposes of setting annual rates of tax;
·Whether certain small producers should be eligible for quarterly or annual tax payments, similar to the rules applicable to small alcohol producers;
·Considerations related to the non-application IRC 280E, including transition rules and interactions with tax incentives for activities that may have occurred while a business was subject to the limitation on credits and deduction; and
·Additional conforming amendments to other parts of tax law, including the definition of tobacco rolling papers tubes and interactions with the alcohol and tobacco tax regimes.
So don’t be shy. Now is the time to send in your comments. Until then, network with accountants, bookkeepers, and staff. Sounds like a significant portion of your operating budget will go to just keeping up with taxation and compliance.
Paula Collins is an Attorney and Accountant, licensed in New York, New Jersey, and Missouri. For help with licensing, business formation, tax, or accounting in cannabis, contact her at email@example.com or by phone at 646-467-4646. You can learn more about Collins at www.paulacollinslaw.com. Collins is on the Board for ELEVATE Northeast, a cannabis education and advocacy organization based in Massachusetts, a member of DopeCFO, the premier cannabis accountingand tax organization, and INCBA, the International Cannabis Bar Association.