SALT Blawg – State and Local Tax Blog
State and Local Tax ("SALT") blog issues require state and local tax knowledge. Chamberlain Hrdlicka's SALT Blawg provides exactly that knowledge with news updates and commentary about state and local tax issues.
You can expect to find relevant information about topics such as income (corporate and personal) tax, franchise tax, sales and use tax, property (real and personal) tax, fuel tax, capital stock tax, bank tax, gross receipts tax and withholding tax. SALT Blawg, offers tax talk for tax pros … in your neighborhood.
Chamberlain Hrdlicka Blawgs
Pennsylvania recently joined 29 other states and D.C. in legalizing medical marijuana. With the growing acceptance of the use of marijuana for medicinal — and in some states, recreational — purposes, a new industry booms. With that boom comes revenue to the states in the form of new taxes.
As with any tax and policy, it is important to understand the history of how we got to where we are today. But it is particularly important to see what has framed our cultural views of marijuana. Medicinal marijuana has a long history, dating back to ancient cultures that used it as an herbal medicine, starting in Asia around 500 B.C. During the 17th century, the government encouraged production of hemp for rope, sails, and clothing. Virginia went so far as to pass legislation requiring every farmer to grow hemp. Further, hemp was accepted as legal tender in Maryland, Pennsylvania, and Virginia. Hemp production flourished through the late 19th century, until other materials started to replace it.
During the 1830s, Sir William Brooke O’Shaughnessy found that marijuana helped to lessen stomach pain and vomiting in people with cholera. By the late 19th century it became a popular ingredient in many medicinal products and was sold in pharmacies. Under the Food and Drug Act of 1906, over-the-counter marijuana products were required to be labeled.
Although legal, recreational use of marijuana did not begin in the United States until around 1900. During the Mexican Revolution, Mexicans began immigrating to the United States and introduced into American culture the recreational use of marijuana. Fear and prejudice followed the Spanish-speaking immigrants, and marijuana became associated with the newcomers. Crimes began to be attributed to marijuana and the Mexicans who used it.
The Great Depression further spurred resentment of the Mexican immigrants and public fear of their “evil weed,” which — combined with the Prohibition era’s view of all intoxicants — led 29 states to outlaw marijuana by 1931. The federal Marijuana Tax Act, enacted during 1937, essentially criminalized marijuana use by restricting possession to individuals who paid an excise tax. This was the first time federal law criminalized marijuana. The Act, which tried to change behavior through taxation and regulation, was seen as less susceptible to legal challenge than outright prohibition. The arguments supporting the act were not grounded in any scientific research or evidence. Instead, they were grounded in racism, hearsay, and stereotypes, namely that it caused black men to become violent and seduce white women and that it led Mexicans to murder their white neighbors. This is also the time when the nomenclature changed from “cannabis” to “marijuana” in an attempt to link Mexicans to the drug and garner prohibition support from anti-immigrant sentiment.
In response to the Marijuana Tax Act, New York’s Mayor Fiorello Henry LaGuardia commissioned a report to study the effects of marijuana. After five years of extensive research, in 1944 the New York Academy of Medicine issued the La Guardia Report, which declared that the use of marijuana did not induce violence, insanity, or sex crimes, or lead to addiction or other drug use.
Despite the research, a culture of fear followed marijuana, spurred in large part by Harry Anslinger, then-commissioner of the Federal Bureau of Narcotics. Anslinger campaigned against marijuana for years and condemned the La Guardia Report as unscientific, while using fear and racism coupled with the mass media to propel his anti-marijuana views.
From 1937 through the 1960s, states began outlawing marijuana, culminating in the federal Controlled Substances Act of 1970. The Act was part of the “War on Drugs” and it repealed the Marijuana Tax Act and listed marijuana as a Schedule I drug — in the company of heroin, LSD, and ecstasy. Schedule I drugs are those with no medical use and a high potential for abuse.
The Shafer Committee, an investigative body appointed by President Nixon, issued a report in 1972 that admitted that Anslinger’s attacks on marijuana had been baseless, recommended the removal of marijuana from the list of Schedule I drugs, and even questioned its designation as an illicit substance. However, Nixon and other government officials vehemently rejected the report’s findings. Marijuana’s designation as a Schedule I drug was, “more due to Nixon’s animus towards the counterculture with which he associated marijuana than scientific, medical, or legal opinion.”
At the same time, state interest in medical marijuana was emerging. During the 1970s, Oregon, Alaska, and Maine decriminalized marijuana, and New Mexico commissioned a short-lived medical marijuana research program. In 1996 California voters approved Proposition 215 (Compassionate Use Act), the first state legalization of marijuana for medicinal purposes. The use of medicinal marijuana was limited to those with severe or chronic illnesses. Other states followed suit and, to date, 29 states allow the use of marijuana for specified medical purposes, while eight states and Washington, D.C., have legalized marijuana for recreational use.
Research from states that have legalized medical marijuana shows that the average doctor in medical marijuana states prescribes 1,826 fewer doses of painkillers and 265 fewer doses of antidepressants annually. Additionally, states with medical marijuana have a 25 percent lower rate of opioid-related deaths than states that do not.
The Medical Marijuana Act (MMA) of 2016 legalized the use of some forms of medical marijuana in Pennsylvania by patients with specified serious medical conditions. The MMA was championed, through a bipartisan effort, specifically for children with extreme seizure disorders and other medical conditions.
The MMA did not legalize recreational marijuana, only medical marijuana. And it is not even a broad grant of legalization for all forms of medical marijuana for all persons. Instead, Pennsylvania limits the forms of medical marijuana that can be used and limits the types of eligible patients. The leaf and plant forms of marijuana are prohibited, with approved forms limited to pill, oil, and topical forms, vaporization or nebulization, tincture, and liquid. Further, only 17 medical conditions qualify for medical marijuana. Patients with any of these maladies must be certified by a practitioner registered to recommend medical marijuana. Patients must submit that certification to the Department of Health to receive a medical marijuana identification card. Practitioners who wish to certify patients must apply with the Department of Health and complete a four-hour training session.
There is a 5 percent tax on gross receipts from the sale of medical marijuana by a grower/processor to a dispensary. Receipts from the tax will be deposited into a fund that is used to pay for operating costs, financial assistance for those with demonstrated financial hardship, drug and alcohol treatment services, enforcement funding for police departments, and research into how medical marijuana can treat other conditions. The sale of medical marijuana is not subject to Pennsylvania sales tax. The Department of Health, along with the Department of Revenue, may regulate the price of medical marijuana; if they deem the per-dose price excessive, they may impose a price cap.
Apart from the medical marijuana tax, businesses involved in the sale or disbursement of marijuana, like any other business, may be subject to various Pennsylvania taxes, including gross receipts, personal income, and corporate net income. Further, the new jobs the medicinal marijuana industry create will be a source of revenue from wage and employment taxes.
Applicants must also pay $5,000 per dispensary application and $10,000 per grower/processor application. Business licensees pay registration fees of $30,000 for each dispensary location and $200,000 for growers/processors.
While medical marijuana may be legal in Pennsylvania, from a federal perspective it is still an illegal, Schedule I, drug. The Rohrabacher- Blumenauer Amendment prohibits the U.S. Department of Justice from using federal funds to interfere with state medical marijuana programs or from prosecuting medical marijuana businesses that comply with state laws. However, because marijuana is still illegal under federal law, there are tax consequences. Internal Revenue Code ("IRC") § 280E prohibits any business that is “trafficking in controlled substances” from taking any business expense deductions that would otherwise be available.
Because Pennsylvania follows federal taxable income, a business is likewise unable to use those deductions for purposes of its state tax liability. Despite the inability to take business expense deductions, a marijuana business must meet its federal, state, and local tax obligations.
There are important caveats to the lack of business expense deductibility. First, pursuant to IRC § 164, taxes paid relating to the disposition of property are a reduction in the amount realized on the disposition. Therefore, medical marijuana tax imposed on producers should allow for a reduction in gross receipts. This is not prohibited by IRC § 280E because the tax is not a deduction or credit. Second, those taxpayers who choose or are required to use the accrual method of accounting may skirt some of the effect of section 280E. Under the accrual method, cost of goods (COG) is an offset to gross revenue, not a deduction. Therefore, it is not prohibited by the language of section 280E. However, the IRS has taken the position that the COG deduction applies only to inventory costs allowable under section 471, which was in effect when section 280E became effective. Again, since Pennsylvania follows federal taxable income, corporate taxpayers in the marijuana industry should be able to benefit from the COG deduction allowed under the accrual method of accounting for Pennsylvania purposes as well.
Individuals and pass-through entities not subject to the corporate net income tax (that is, those taxpayers that do not start with federal taxable income) are permitted to deduct ordinary, reasonable, and necessary business expenses associated with the business activity. However, because no case law exists on the issue, it is unclear what will be viewed as “ordinary, reasonable, and necessary” for the medical marijuana industry for purposes of the deduction.
Third, to the extent a business is doing more than selling or producing medical marijuana, it should be able to deduct that portion of business expenses that are not attributable to the “trafficking of marijuana.” In Californians Helping to Alleviate Medical Problems, a medical marijuana facility bifurcated its business: one in which the facility bought and sold marijuana, and the other in which it provided counseling to customers as to which type of marijuana worked best for their ailments. The tax court allowed the facility deductions attributable to the counseling segment of the business.
Of the states that have legalized and are taxing medical marijuana, as the chart indicates, Pennsylvania’s 5 percent excise tax is not out of line with other states.
StateMedicalMarijuanaTaxRecreationalMarijuana TaxAlaskaNo tax*Wholesale: $50 per ounce on flower; $15 per ounce for stems/ leavesArizona6.6% state tax + 2-3% optional local taxN/AArkansas4% state taxN/ACaliforniaSome medical marijuana sales are tax-exemptRetail: 15% excise tax; Wholesale: $9.25 per ounce of flowers; $2.75 for leavesColorado2.9% sales taxRetail: 15% excise tax; Wholesale: 15% excise taxConnecticut$3.50 per gramN/ADelawareNo tax*N/ADistrict of ColumbiaNo taxNo retail sales allowedFloridaNo taxN/AHawaii4% excise tax; 4.5% tax on OahuN/AIllinois1% pharmaceutical taxWholesale: 7% tax on cultivators/ dispensariesMaineNo taxRetail: 10% sales taxMarylandTBDN/AMassachusettsNo taxRetail tax:10.75 %; State tax: 6.25%; Local municipality tax: 2-3%Michigan3% sales taxN/AMinnesota$3.50 per gramN/AMontanaTax on gross sales* — 4% from July 1, 2017, to June 30, 2018; 2% after thatN/ANevada2% excise taxRetail: 10% excise tax; Wholesale: 15% excise taxNew HampshireNo tax*N/ANew Jersey7% sales taxN/ANew MexicoNo taxN/ANew York7% excise taxN/ANorth DakotaNo taxN/AOhioTBDN/AOregonNo tax*Retail: 17% state tax + 3%optional local municipality taxPennsylvania5% excise tax on gross receipts from grower to dispensaryN/ARhode Island$25 per plant tag for patients and caregiversN/AVermontExempt from sales and use taxN/AWashington37% excise taxRetail: 8% sales tax + 37% excise taxWest VirginiaNo taxWholesale: 10% excise tax*State does not have a state sales tax.
It is estimated that annual sales in Pennsylvania will start at $125 million and increase at a rate of 180 percent per year for the first few years, resulting in about $6 million in revenue for the first year. If Pennsylvania were to legalize and tax recreational marijuana, it is estimated that would generate between $200 million and $350 million per year. During 2016 marijuana generated tax revenue of $220 million in Washington, $129 million in Colorado, and $65.4 million in Oregon.
Marijuana is a billion-dollar industry, and with that could come needed revenue for Pennsylvania, which has a projected budget shortfall of nearly $3 billion over 2017-2018. Medical marijuana typically has much lower tax rates than recreational marijuana, generally to avoid affecting the medical marijuana marketplace. Recreational marijuana has been approached in different ways by the states that have legalized its use. For instance, Massachusetts and Washington both levy sales taxes, while Alaska and California use a flat per-unit tax.
Typical sources of “sin” tax revenue are on the decline. Cigarette smoking is waning, resulting in declining state revenue. Gas prices are also relatively low, meaning that states are unable to tap into traditional areas of easy revenue. Taxpayers don’t want higher income taxes or higher sales taxes, yet they also do not want to give up services provided by the state. The legalized marijuana industry represents what many view as a solution to revenue shortfalls. And since many view marijuana as a vice, the industry accepts high tax rates as a cost of doing business.
Before state legislatures denounce legalization or impose rigid criteria on the medical marijuana industry, they should make sure that they are not acting out of an antiquated and unsubstantiated fear of marijuana, and instead are basing their actions on scientific research and an understanding of what responsible cultivation and use of marijuana could do for those suffering various maladies. They should also consider the boost it could give the economy. As acceptance and increased use of marijuana grows, so too will the SALT world surrounding it as the states try to find the best ways to capitalize on their newest “sin” tax.