A Law Designed to Target Coke Lords Is Screwing Over Legal Pot Companies

Voters in Oregon, Alaska, and Washington, D.C. headed to the polls Tuesday to decide whether to legalize sales of recreational marijuana.

But would-be weed entrepreneurs in the states might be disappointed to learn that a federal tax law designed to target coke lords in the '80s is eating into the profits of legal pot merchants across the country.

"This is one of the most critical issues facing the industry today because it directly affects the bottom line of anyone who cultivates or sells medical or recreational marijuana," said Taylor West, deputy director of the National Cannabis Industry Association, an association of more than 750 cannabis-related businesses across the United States. "It results in businesses paying effective tax rates of 70 to 85 percent when they should be only paying 30 or 40 percent."

The tax code allows the federal government to take a larger share of the profits from the sale of legal marijuana than the businesses themselves.

Mitch Woolhiser, owner of a cannabis store called Northern Lights Cannabis Co. in Edgewater, Colorado, told USA Today that the tax code makes it feel like the federal government wants legal cannabis businesses to struggle.

"It's almost like they want us to fail," Woolhiser said. "Everything I do is aimed at keeping us in business because if I don't, then (the feds) win. And I'm not going to let them win."

Woolhiser first opened his shop in 2010, selling medical marijuana, which he expanded to sales of recreational pot when it became legal in Colorado in early 2014. Last year he ended up paying almost $20,000 to the IRS despite not earning a profit. Had he been selling anything other than weed, he would not have owed any federal income tax because he was operating at a loss.

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Everyone in the US — even those making their money illegally — has to pay taxes, according to a Supreme Court ruling more than 50 years ago.

In 1982, Congress amended the US tax code to include section 280E, which stated that businesses selling a Schedule I or II drug — like marijuana, heroin, methamphetamine, or cocaine — cannot deduct all of their regular business expenses.

Under 280E, only the "costs of the product," like the soil and fertilizer, are deductible; the "costs of selling," like advertising, rent, employee salaries, and utilities, are not.

"This provision of the tax code was never intended to apply to cannabis," West said. "It was put into [effect] in the 1980s and the target was coke traffickers who were writing off the speedboats they were using to bring drugs into the country. It was never meant to apply to companies operating legally under state law."

In 2010, lawmakers in Arizona, California, Colorado, and Massachusetts asked the IRS to stop enforcing 280E in states that legalized the sale of marijuana. The IRS responded with a letter detailing that only Congress could make that change.

"The result you seek would require the Congress to amend either the Internal Revenue Code or the Controlled Substance Act," the IRS said. Congress has yet to make the change.

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"The problem is that we have passed laws that allowed these medical marijuana and recreational marijuana companies to do business," Mac Clouse, a University of Denver finance professor who studies the industry, told USA Today. "But we have all these other laws, tax laws, federal laws that make it incredibly difficult if not utterly impossible to survive."

More states may legalize marijuana this year, but state laws don't trump federal laws. West believes that expanded state legalization could help put pressure on Congress to reform the tax code.

"Those [in Congress] who don't have constituents who are not affected don't have a reason to get involved," she said. "But as the numbers increase, the number of concerned congressmen will also increase."

In the meantime, businesses have to spend additional money to hire attorneys and accountants to make sure they are on the right side of the law.

KC Stark is co-founder and chief executive officer of MMJ Business Academy based in Colorado, which coaches aspiring pot entrepreneurs. Stark likes to call himself the "Steve Jobs of weed."

The Academy has helped launch thousands of businesses across the country, and it has also advised them on their taxes. Stark laments the 280E tax code, which he told VICE News "is designed to spur economic growth, not to impair it."

"They [the Feds] are by default just as guilty of money laundering as anyone else," Stark said. "The industry is in its infancy, but that does not make it fair for the code to unjustly penalize it. We are all fellow Americans and we must be treated the same as other business owners."

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Follow Olivia Crellin on Twitter: @OliviaCrellin