Update on marijuana regulation – #12

Not much in the news lately on the crushing effect of overregulation on the newly legal industry of recreational marijuana. (You now know my opinion and can filter my comments accordingly.)

This post will catch up on a few older articles.

11/8 – The Economist – The Marlboro of marijuana – The legal cannabis industry is run by minnows. As liberalisation spreads, that may not last – Here are a few more regulatory restraints that will strangle the industry: Article says that in Colorado, dispensaries have to grow at least 70% of what they sold and growers had to sell at least 70% of what they grew. That recently changed.

Obviously, none of the cannabusinesses (there’s that word again) can sell across state lines. Hadn’t thought about that, but it makes perfect sense.

The largest distributor in Colorado has 10 stores. That actually is more than I thought was allowed.

All those factors mean that the operators will be small. They cannot gain economies of scale. Thus, there won’t be any big, recognizable, national brand. There won’t be any “Marlboro” of pot for a long time.

Regulation will prevent growth in the industry. Will also prevent consolidation and rationalization of distribution channels.

11/3 – USA Today – Marijuana profits up in smoke under IRS rules – Article again points out that Rule 280E is creating havoc for marijuana stores. That rule disallows a tax deduction for the operating expenses of a business involved in selling schedule 1 or 2 drugs. Cost of goods sold (i.e. purchase price paid for the stuff sold) is allowed.

I had this backward – I though the cost of goods sold was non-deductible. Verification I misunderstood….

Cornell University Law School – 26 U.S. Code § 280E – Expenditures in connection with the illegal sale of drugs:

No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances (within the meaning of schedule I and II of the Controlled Substances Act) which is prohibited by Federal law or the law of any State in which such trade or business is conducted.

Losing the deduction for all the rent and salaries it takes to run a business could put the marijuana growers, manufacturers, and retailers in a position where their federal tax bill is far larger than their profits on either a GAAP basis or on cash flow basis.

Creative accounting to the rescue….

3/4 – Law 360 – Tax Creativity Keeps Pot Industry Out Of IRS Hot Water – Shorthand for accountants: cost allocation to non-marijuana sales; capitalization of overhead to inventory.

Longhand for other people:  Sell non-marijuana items and then the costs of operating the business could be allocated between pot and non-pot sales. Thus an allocated portion of costs are deductible.

IRS rules require applying some of the overhead costs of a business to the inventory that is produced. It is capitalized until the product is sold and then taken as a cost of sales. Thus, capitalize insurance, accounting, rent, and such into inventory. That makes the costs a part of inventory and thus deductible under 280E.

Muddled confusion of federal and state laws creates extra cost for accounting work and tax fees.

Like a previous article said, this is complicated. And will severely restrain the industry from what it would be otherwise.

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