July 1st is the start of DC's final limited application period for medical cannabis retailers - licenses are limited.
All businesses not registered with ABCA will be at risk of enforcement.
K&M is currently helping D.C. conditional licensees open shop in 2024.

Dirty Green Dollars

In the U.S., legal cannabis, medical and recreational, is a multibillion dollar industry which deals almost exclusively in cash. In 2016, the industry generated approximately 7.9 billion dollars in revenue and is on pace to exceed that amount in 2017. That is a whole lot of cash. The disconnect between states and the Fed regarding cannabis has made financial institutions trepidacious about serving cannabis-related businesses (“CRBs”). This trepidation is fueled by fear of federal sanctions, the high of cost of due diligence or the stigma of being a financial institution that works with CRBs. This legal disconnect affects how CRBs are taxed at the federal level, as well. CRBs are forced to pay a higher tax rate than most other small businesses because they are are taxed on gross revenue rather than profit, and are forced to pay these taxes in cash. As long as Congress remains entrenched in its refusal to declassify cannabis, the taxation and banking issues affecting the cannabis industry will only continue to fester.

Banks are Serving the Cannabis Industry Based on a Patchwork of Federal Memoranda.

Roughly 368 U.S. financial institutions, comprised of both credit unions, commercial banks and traditional payment processors are currently serving CRBs. This number represents approximately 35% of the total number financial institutions nationwide – proving that it is possible to cut through the red tape. But how can a financial institution service a federally illegal industry? In 2013, the Department of Justice issued a memorandum (the “Cole Memo”), which provided guidance to federal prosecutors regarding cannabis enforcement priorities. Specifically, the Cole Memo created a policy that permitted CRBs to operate largely without federal interference. In response to the Cole Memo, in 2014 the Financial Crimes Enforcement Network (“FinCEN”), a division of the Department of Treasury, issued a set of its own guidelines to clarify how financial institutions can legally provide services to CRBs. The FinCEN guidelines were intended to encourage banks to make financial services more available to CRBs, and promote financial transparency within the cannabis industry. The guidelines also encouraged banks to conduct thorough due diligence on any customer believed to be operating as a CRB. The main objective of this due diligence is to ensure that the business is in compliance with state cannabis regulations and the enforcement priorities outlined by the Cole Memo.

Death by Taxes?

CRBs are subject to extremely high taxes at the federal level. Yes, the Fed still wants to collect the cannabis industry’s dirty, dirty “drug money”. The Fed will collect these taxes in cash, at coordinated drop off points, mimicking the choreography of a black market drug deal. In cities like Denver and Seattle, the IRS has been so inundated with cash that it was forced to invest in resources that would allow it to process and store all of the excess cash. The federal tax code does not differentiate between income derived from legal or illegal sources, Uncle Sam just wants your money. To determine how much illegal income is taxable, the Fed applies Section 280E of the tax code. Most businesses are taxed using a fairly simple formula: subtract the business expenses from gross income to calculate taxable income. CRBs pay taxes on gross income, and are prohibited from taking standard business deductions such as rent, payroll and advertising. Under 280E, CRBs are permitted to limited deductions for the cost of good sold (“COGS”) and, ironically, the cost of growing cannabis (the very commodity the Fed vilifies) is a permissible COGS deduction. The only reason “illegal” businesses are permitted to take deductions for COGS, is because of the founding fathers and the 16th Amendment, not the goodwill of Congress. Practically speaking these limited deductions translate to a tax rate that can be as high as 90% for CRBs. This significant tax bill is a deterrent for those who seek to enter the legal cannabis industry.

A Change is Gonna Come?

Cannabis policy is primed for a change and the proliferation, wealth and power of the industry has made its voice of reason hard to ignore. This influence has prompted the creation of a bipartisan Cannabis Caucus (the “Caucus”), comprised of House members from California, Oregon, Alaska and Colorado. The legislative agenda of the Caucus includes passing equitable banking and taxation laws for CRBs. This infectious Caucus has also drummed up support in the Senate, which introduced the Secure and Fair Enforcement (“SAFE”) Banking Act in Spring 2017. If enacted, SAFE would prevent federal banking regulators from prohibiting, penalizing or discouraging a financial institution from providing services to CRBs and from terminating or limiting a financial institution’s FDIC protections on the basis of the provision of these services. SAFE would be the first decisive step to wean the industry off of cash. In the House, the Caucus introduced two tax bills: 1) The Marijuana Revenue and Regulation Act which would amend the tax code by imposing a federal excise tax on all CRBs and an occupational tax on cultivation facilities and export warehouses, and also require CRBs to obtain a permit and bond to cover federal tax liability; and 2) The Small Tax Equity Act, which would create an exception to 280E and allow CRBs to take standard business tax deductions. The House also introduced the States’ Medical Marijuana Property Protection Act, which would exempt real property from civil forfeiture due to medical cannabis- related conduct authorized by state law.

Courts Cannot Aid and Abet Criminals.

The federal judiciary has also been forced to confront the banking and taxation issues associated with CRBs. Earlier this year, the Court of Appeals for the 10th Circuit (which includes Colorado) considered whether it could grant a Colorado credit union an injunction to force the Federal Reserve Bank of Kansas City to issue the credit union a “master account”. A master account is essentially a bank account for financial institutions and is necessary for a depository institution to operate. In its lengthy June 27, 2017 decision, the three judge panel opined that because the credit union would admittedly serve state legal CRBs, a request for an injunction is tantamount to asking the court to grant relief that would facilitate illegal activity, i.e. providing banking services to drug traffickers. There is also a legal battle raging over 280E. In 2010 the IRS began auditing the Harborside Health dispensary annually, ultimately slapping it with a bill for back taxes, fees and penalties totaling $15 million. In response, Harborside filed suit against the IRS in 2016, claiming that 280E did not apply to its business because its revenue was not derived solely from medical cannabis and, as such, it should be allowed to take standard business deductions related to these other revenue streams. Not surprisingly, in its court filings the IRS argued that 280E is applicable to Harborside because its business consists of trafficking cannabis, which is illegal under federal law, and revenue from separate streams does nothing to change that fact. A decision in the case is expected in late 2017, and will surely have an impact on the industry.

Outlaw Banks.

Local banks serving CRBs in states with a medical cannabis market are slowly becoming more prolific; but these brave bastions of cannabis cash do so at a significant cost. A bank that serves the cannabis industry can expect to increase operational costs across the board in order to satisfy the due diligence requirements imposed by FinCEN. Banks conduct due diligence through reasonable investigation of a business’ account activity and by reviewing publicly available information about the business. These due diligence obligations often force a bank to hire additional labor and implement new software, in an effort to track the integrity of its CRB customer. Increased costs further deter local banks from participating in the industry. Ohio, however, is trying to implement a new blueprint for CRB banking. Ohio will be the first state to offer safe harbors for financial institutions that work with CRBs, and the first state to implement a state run “closed-loop” payment processing system for patients and CRBs. Ohio is rolling out its medical cannabis program this year, and industry watchers are eager to see whether the State’s novel banking solutions will create an efficient cash-free system.

In the Year 2020.

By 2020, legal cannabis is expected to be a $21 billion industry which employs more people in the United States than the manufacturing industry. It is high time for the Fed to address the banking and taxation inequities at the state and federal level. The federal judiciary’s hands are tied by the illegal status of cannabis, so it is up to Congress to take steps to enact substantive laws that protect the industry. If members of Congress do not want their seats foreclosed on in the 2018 midterm election, they should be mindful that legal cannabis has far more support and goodwill among constituents in blue and red states alike than Congress.

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