Legalization has been a bumpy road for California cannabis operators, and since January 1, owners are learning that it also comes at a price. The state’s steep taxes on cannabis businesses – with effective tax rates as high as 57% for some cannabis activities – have many operators bracing, and calling for a reduction in these so-called sin taxes. Consumers are also encountering price increases -- prices are up about 15% compared to last year.
As of this year, cannabis business is legal in Los Angeles, but the process of drafting and refining the laws and regulations that will actually govern the legal cannabis industry is still in its early stages.
To that end, over the past month, the LA city council met to adopt the following items:
- Item #21: Cannabis Advertisement
- Item #22: Prop D Dispensaries, MMD's, AUMA
- Item #23: MAUCRSA, Prop D, Land Use, Preparation of Ordinance, AUMA
- Item #24: New hires at the DCR, Cannabis Business Fees, Interim Position Authority
- Item #25: Medicinal and Adult-Use Cannabis Regulation and Safety Act / State-Chartered Bank / Cannabis Banking Activities
While none of these items are extremely surprising in their own right, they may have significant consequences for the nature of Los Angeles’ cannabis industry.
For instance, Item #23 lays out a path to adjust the LA municipal code, adding “provisions to allow for the Cannabis Regulation Commission to make exceptions to the 600-foot school restriction for non-retail cannabis activities subject to a California Environmental Quality Act of 1970 analysis of environmental impacts and conditions to address public health, safety and welfare considerations, as well as a public hearing.” This means that buildings that were not in the correct zoning could be, if the City finds after the environmental analysis that there are not negative effects from having a cannabis cultivation or manufacturing operation near a school. A change to this rule would potentially mean that, as long as they were in keeping with public health and safety, cannabis businesses could be located in far more locations across LA. Note that under state law, local jurisdictions can allow for closer than 600 feet.
Other ideas in these items may also have major impacts on the LA cannabis industry. For instance, Item #23 also provides for mixed-light cultivation and social consumption lounges, two activities that the city’s cannabis ordinances haven’t allowed in the past, while Item #25 expresses the city’s support for a State-chartered bank that would allow cannabis businesses to bank their money in California. Each of these changes would be a major step toward full legal legitimacy for marijuana in the Los Angeles area.
While these items are significant in their own right, they also reflect a trend of increasing acceptance of the cannabis industry in LA. Establishing regulations however, is an ongoing process. For more information, check our guide to California cannabis business law or contact us at firstname.lastname@example.org to speak with one of our Los Angeles cannabis lawyers.
Many are excited about California’s new era of legalized marijuana. For the first time, state and local governments are allowing marijuana sales to all adults. There is also a new licensing system for all sectors of the industry. The new system creates many new opportunities for businesses and consumers. But is also comes with new taxes that have caused sticker shock for many California cannabis operators and customers visiting dispensaries this month. Governments are eager for the new tax revenues, although some predict that if taxes are too high, a black market will persist as people opt out of the licensed system. One of the questions our Los Angeles cannabis attorneys are most frequently asked is about the new cannabis taxes and how they will affect California cannabis businesses.
To sum it up, effective tax rates for marijuana operators are high. Not only do cannabis businesses have to pay corporate taxes like any other business (except that they can't take deductions on their federal taxes due to 280E), but there are also additional city and state taxes specifically for cannabis operators that need to be factored in as well. Just as Federal, State and Local law apply to cannabis operators, those governments all also apply their own taxes to cannabis.
Here is a chart that gives you an overview of the effective tax rates for different cannabis businesses, using Los Angeles as an example for factoring in local taxes as well:
NOTE that the Excise Tax (15%) and Sales Tax (8.5%) imposed on retailers is passed directly on to the consumer. So the effective tax rate is similar to the other activities when you factor that in, but overall the tax rates are very high for operators.
One of the reasons cannabis operators must pay so much in taxes is that cannabis is still a Schedule I controlled substance under Federal Law. Section 162 of the U.S. Tax Code allows for businesses to deduct Ordinary and Necessary expenses from their taxes. An exception to this section is 280E, which prevents deductions from Federal Taxes for businesses involved in selling Schedule I controlled substances. You can read the text of 280E here and check out a seminal 2007 Tax Court decision -- CHAMPS v. Commissioner (2007) which allowed an operating dispensary to separate out product-touching deductions and deductions for a separate ancillary business. A related 2015 ruling in U.S. Tax Court held that unlike CHAMPS, an operator running an activism business and selling cannabis could not separate the two businesses and take deductions under 280. These two cases apply to retailers. Other cases have found that cultivators and manufacturers can take certain deductions for costs of production. We will cover this in a future post.
Here are the individual maximum tax rates that apply:
|Federal Corporate Tax Rate***||California Cannabis Taxes||California Business Taxes 8.84%||Los Angeles Cannabis Taxes||Los Angeles Business Taxes (.425%)||Payroll Taxes (Estimated effective rate)||Estimated Effective Tax Rate|
|Retail||21%||23.5% -- 15% excise tax + 8.5% sales tax||8.84%||10% in LA for adult use; 5% in LA for medical||0.43%||3%****||57%|
|Cultivation*||21%||12% estimated ($9.25/ounce tax on flower = $148 per pound) + $0 sales tax||8.84%||2%||0.43%||3%||45%|
|Manufacturing||21%||Collect Cultivator Tax + $0 sales for resale||8.84%||2%||0.43%||3%||35%|
|Distribution||21%||Pay CDTFA Cultivator Tax + $0 sales for resale||8.84%||1%||0.43%||3%||35%|
|Testing||21% + Deductions = Estimated 15%||-||8.84%||1%||0.43%||3%||34%|
|Microbusiness||21%||per activity||8.84%||per activity||0.43%||3%||Varies per microbusiness activity|
|*(flower - different tax rates for stems and fresh plants; clones are not taxed by state)|
|**280E likely does not apply to testing labs|
|***280E prevents deductions for businesses trafficking cannabis|
|****Social Security, Medicare, Calif & Fed. Unemployment - this is a percentage of employees' salaries, for purposes of the chart it is converted to be tied to revenue consistent with the other percentages|
These are the required California state cannabis taxes by activity:
Cultivators must pay a $9.25/ounce tax on all dried cannabis flowers (and a lower rate per ounce for cannabis leaves or fresh cannabis plant).
Retailers must pay both a 15% excise tax on all their purchases of cannabis, as well as a sales tax on all their taxable retail sales, which varies by locality but can be close to 10%.
Manufacturers must collect cannabis cultivation taxes from cultivators from which they receive unprocessed cannabis, and pay these cultivation taxes to the distributors.
Distributors must collect cultivation taxes from cultivators and manufacturers from which they receive cannabis, and collect cannabis excise taxes from retailers they supply with cannabis.
In addition to these taxes, localities are free to impose their own cannabis business taxes, and many impose substantial taxes on both cultivation and all business proceeds.
It is important to note that the cannabis specific taxes are in addition to standard taxes like Federal and State corporate tax, and local business taxes for businesses operating in cities like Los Angeles.
While distributors, testing facilities and manufacturers appear to pay less taxes than cultivators or retailers, they will no doubt share the costs of taxation as cultivators increase their prices to account for the cultivation tax.
If these taxes are passed directly on to consumers, that could mean a retail outlet previously charging $60 per 1/8 of an ounce of marijuana would increase their price to $90. On the other hand, many have predicted that the pre-tax prices of cannabis will drop over time, as more large-scale cultivation, distribution, and retail operations reduce their overhead costs and margins, would could counteract some of the higher taxes.
For operators, these effective tax rates are extremely high and it is important to consult with a tax attorney and a qualified accountant who can help you with tax planning and preparation to set up your business for success. For more information and worksheets to calculate your California cannabis taxes, refer to the CDTFA’s website.