At Tax Time, Pot Merchants Don't Get a Break

Kayvan Khalatbari Photograph by Kathryn Scott Osler/The Denver Post via Getty Images

Turning marijuana into a legitimate industry has been a long, long road for Kayvan Khalatbari. He’s worked for more than a decade on the cause, even donning a chicken suit to heckle John Hickenlooper, former Denver mayor and current governor. Now that his quest is succeeding, with Colorado leading the push into legal recreational sales, Khalatbari and other pot entrepreneurs are grappling with in the minutiae of taxation.

The problem Khalatbari faces stems from the awkward reality that marijuana is a controlled substance under federal law but legal in various forms in 20 states. The most visible problem created by that conflict is the lack of banking for pot businesses, but Section 280E of the federal tax code presents an additional challenge.

That portion of the law, passed in 1982, prevents companies from deducting business expenses related to trafficking in controlled substances, including marijuana. What exactly can and can’t be deducted is complicated. The direct costs of goods can be deducted (PDF), but expenses such as rent and labor related to sales can’t. While pot businesses can bring in a lot of revenue, their costs are also high. Without being able to deduct the same expenses as a typical business, pot companies have effective tax rates  far higher than the standard 35 percent corporate tax rate. Politico interviewed one dispensary executive who said the effective tax rate is 55 percent to 60 percent.

The effect of the law can be seen in the design of many dispensaries. Typically, the stores have some form of anteroom, where customers sign in and wait to be accompanied into a separate sales room. The waiting rooms can be spacious, with chairs, coffee, and t-shirts on display. But the sales rooms, where the actual pot and infused products are traded, are often tiny. That’s because the rent for the waiting is deductible, while rent on the sales space is not. “People try to keep the retail sales area as small as possible,” says Khalatbari, who owns the Denver dispensary Denver Relief and consults for other entrepreneurs looking into the industry. Businesses also write very explicit job descriptions for employees that specify all their non-sales responsibilities, because their sales-related salaries are not deductible.

Khalatbari says 280E and access to banking were the two most pressing topics he and other industry representatives raised when they were lobbying on Capitol Hill last year. Khalatbari said they were able to get a few members of Congress to support a bill, introduced by Representative Earl Blumenauer (D-Ore.), that would allow the deductions. The legislation died in committee but still represents the hopes of Khalatbari and the National Cannabis Industry Association. In mid-March, he plans to join the industry as it heads back to Washington, with banking and 280E remaining the top priorities.

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