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Paying taxes in cash, marijuana companies have a lot to hash out with IRS

  • Thousands of companies involved in the $6.7 billion US cannabis industry are forced by disparities in state and federal law to conduct nearly all transactions in cash.
  • The volume of payments coming into the IRS from the legal cannabis industry has prompted the IRS to increase cash-counting capability in Denver and Seattle.
  • 29 states and the District of Columbia have legalized marijuana in some form, and 8 have approved laws enabling the sale for recreational use.
  • The cannabis industry is expected to balloon to $21 billion by 2021.
Marijuana Cannabis
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It's Tax Day. No company likes handing money over to the tax collector, but for Oakland-based Harborside Health, settling up with the Internal Revenue Service represents a unique kind of headache. Like many successful retail operations, Harborside — which brought in $44 million in revenue in 2016 — owes millions of dollars in taxes to federal, state and local governments. Unlike most other companies, Harborside has to count and hand-deliver those millions of dollars to the IRS and other authorities in cash.

That's because legal marijuana businesses have to pay taxes under IRS code 280E, the same category reserved for illegal drug traffickers. Cannabis is categorized as a Schedule I substance under the Controlled Substances Act. While more than half of the states in the U.S. have legalized some form of medicinal marijuana, and several others have passed laws permitting recreational cannabis use, under federal drug laws the sale of cannabis remains illegal.

Harborside is one of thousands of companies involved in the $6.7 billion legal cannabis industry forced by disparities in state and federal law to conduct nearly all transactions in cash. As a result, thousands of companies have in the past week counted and delivered millions of dollars in cash to their respective IRS offices and state tax authorities. Those offices then have to count all that cash again — a process that's taxing IRS resources as well.

The volume of cash payments coming into the IRS from the legal cannabis industry this year has prompted the IRS to increase its cash-counting capacity at offices in Denver and Seattle. (Colorado and Washington have both legalized the sale of cannabis for recreational purposes, boosting industry revenues.) It's a sign of a larger problem facing a nascent but booming industry that continues to have trouble utilizing the traditional banking industry despite explosive growth.

Harborside Health pays every bill in cash that it feasibly can, says CEO and founder Steve DeAngelo. That means the company has some volume of cash moving around almost every single day, creating logistical and security problems. With that much cash moving around, there's a real threat to the security of the people doing the moving, essentially painting targets on the backs of cannabis industry employees at a growing number of legal cannabis industries across the United States.

"There are thousands [of cannabis businesses] in the United States now, and all of them are carrying around tens or hundreds of thousands of dollars in cash," DeAngelo said. "If something isn't done to change the situation, it's, in my opinion, just a matter of time before we see a tragedy."

Even in states that have legalized cannabis, banks are wary of doing business with companies that derive their revenue from the the industry, for fear of running afoul of federal drug law.

The unbanked

For most legal cannabis companies, banking in the traditional sense is an aspiration rather than the norm — a big problem for an industry expected to balloon to $21 billion by 2021, according to Arcview Group, a cannabis industry investment and research organization. Twenty-nine states and the District of Columbia have now legalized marijuana in some form, and eight have approved laws enabling the sale of cannabis for recreational use (though not all of those laws have gone into effect).

DeAngelo describes Harborside as "banked, but tenuously." While the company does have a bank account that allows it to accept debit card payments, the company has to manage that account very carefully. In other words, the company uses the account for card transactions but does not deposit cash into that account for fear that privilege might be revoked.

"We've been banked many times, and many times those accounts have been shut down," said Lance Perryman, founder and CEO of Next Harvest, a vertically integrated cannabis company in Colorado that produces and sells its own products and does between $5 million and $10 million in revenue annually. Its dispensary sees more than 500 customers per day, virtually all of which pay in cash.

"We're on a purely cash basis," said Marques Moore, COO of Denver-based MMJ America, a 70-person operation with five retail locations that has never had a bank account. While there are banks in Colorado that will deal with the cannabis industry, the process of being vetted and approved to deal with a bank — for an account that might be closed by the bank without warning at any time — is strenuous enough to be prohibitive for many companies, he says. "We were close to getting approved by one of these banks, and then we were told that they weren't taking any new clients, because the IRS was auditing them."

"There are thousands [of cannabis businesses] in the United States now, and all of them are carrying around tens or hundreds of thousands of dollars in cash. ... It's, in my opinion, just a matter of time before we see a tragedy." -Steve DeAngelo, CEO and founder, Harborside Health 

The lack of financial infrastructure makes it difficult for cannabis companies to establish exactly the kind of fiscal paper trail that federal and state regulators could use to help enforce regulatory compliance, said Perryman of Next Harvest. His company is currently undergoing an audit, a common occurrence for legal cannabis companies and a process that is particularly fraught when a company has been operating on a cash basis for years.

The lack of banking services creates myriad logistical headaches within the day-to-day operations of what are otherwise conventional production and retail operations.

"People work with us; we calculate their taxes for them; we fill out their forms for them; we tell them where they can remit their taxes," said Keegan Petersen of Wurk, a Denver-based start-up that provides various technology solutions to help legal cannabis companies account for all their cash and remain in compliance with layers of complicated state and federal tax law. "But they have to figure out how to get their money to the IRS building or the state building."

Armed guards

Traditional armored truck services are sometimes used to transport cash, Harborside's DeAngelo says, but like banks, they too fear backlash from the federal government for doing business with the industry. Some avoid taking clients in the cannabis industry, fueling the rise of an entire sub-industry of security companies, largely staffed by former military and police, that specialize in hauling huge bags of cash around for the cannabis industry.

During tax season, those services are particularly busy delivering a sum total of hundreds of millions of dollars to tax authorities. The security situation surrounding the transfer of all that cash has cast a tinge of militarization over what is often viewed as a somewhat "granola" industry.

"At the department of revenue, they have armed guards there waiting for you," Perryman said. "So they have armed guards, we have armed guards, and they meet — it's secure all the way through."

It's also expensive, both for the cannabis companies themselves and for the tax authorities that have to devote resources to counting and processing all that hard currency. "This isn't just an IRS problem," Petersen of Wurk said. "State taxes have to be collected as well. You have to remit your payroll taxes quarterly. Your excise taxes are collected monthly. It goes on all year." He added, "I think the IRS wants to get behind the industry not being in this situation. For them its extra work and extra security risk for their employees."

IRS officials did not respond to requests for comment.

Given the ambiguity around the approach the new administration in Washington will take in enforcing federal drug law as it pertains to cannabis — newly minted Attorney General Jeff Sessions has in the past taken a hard line against legal marijuana — there's uncertainty within the industry whether any meaningful change will happen.

Meanwhile, the expanded cash-counting capability at two IRS offices this tax season is "cold comfort," DeAngelo said. Though it constitutes some degree of recognition that the industry and the federal government have a shared problem, it does nothing to solve the very real security issues facing the industry.

"We are building more and more support in Congress with each day, each week, each year," he said. "But my fear is that somebody is going to have to die before we really see effective action."

— By Clay Dillow, special to CNBC.com

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