By Susan Kowalske, CPA | Manager, Tax
In December 2018, Ohio’s registry for medicinal marijuana became activated as the state is now one of many that legalized the use of cannabis for 21 qualifying conditions. The evolution of cannabis’ legality, including Canada becoming the first country to legalize adult usage, continues to dominate headlines and has the potential to become a massive industry for serious investors.
However, although Ohio has legalized medicinal marijuana, restrictions placed by the current federal administration should be considered by investors. Before you dive deep into the Ohio medical pot movement, explore these considerations and recognize you may not realize the profits you anticipate.
Nondeductible Business Expenses
Ohio and several other states have legalized the use of marijuana for medical treatment, but the Federal government still considers cannabis a Schedule 1 drug and while Cost of Goods Sold (COGS) is allowed, the other business expenses associated with the medical marijuana industry, while legal, are not deductible. This results in investors and owners being taxed on all the income, receiving no deductions for standard business expenses.
The IRS disallows any deduction for expenses paid in carrying on any trade or business trafficking in controlled substances (Code Section 280E).
Making an Example in California
A recent tax court case in California (12/20/18) denied deductions of a dispensary and assessed underpayment penalties and accuracy-related penalties onto the investors. Ordinary business expenses and indirect inventoriable costs– or what we CPAs like to refer to as 263A – for the medical marijuana industry are excluded from a deduction. Only the direct cost to produce (CPAs refer to this as 471) would be allowed as COGS. Those considering investing in opportunities becoming present in Ohio should be aware income will be taxed while many deductions are disallowed. Basically, the epitome of a high-risk investment.
Not Changing Anytime Soon
In early 2018, the Department of Justice rescinded the Cole memo which directed the DOJ not to enforce federal marijuana prohibition in states that legalized marijuana. A 2018 bill introduced in both the US House and Senate to amend the controlled substances act and clear the way for businesses to operate within state laws was a non-starter. With the current administration’s hard line on drug policy, the recent court case in California confirmed the IRS is maintaining the same position dictated by other departments in the Federal Government. Even though state law approves medical marijuana, the IRS can – and apparently will – penalize investors. There will be an abundance of opportunities for investors in Ohio – from cultivation, testing, prescribing, and dispensing – but venture capitalists should be prepared to be taxed on all the income and almost none of the deductions. Even more so, investors should calculate their potential return on investment without allowing a tax deduction for expenses.
Some may believe a true investment is one of significant risk and in that case, medicinal marijuana in Ohio could be the golden opportunity. However, investors should be fully aware of the abundance of current hazards. If you have any questions for the current tax implications, please feel free to contact me.