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I am aware of no business in the United States that can operate profitably if it is prohibited from deducting “ordinary and necessary” business expenses. While the maximum U.S. corporate tax rate is 35%, I have heard estimates of actual tax rates for Colorado’s medical marijuana dispensaries and retail marijuana stores ranging from 70% to 90%.
Because 280E allows marijuana retailers and dispensaries to deduct their cost of goods sold, many operators of “integrated marijuana businesses,” those that include grow facilities and retail stores and dispensaries in the same ownership group, have been aggressive in what they include in their cost of goods sold.
In January 2015, the IRS issued its Memo 201504011 which clarified which type of costs and expenses that could be included in the cost of goods sold.
The actual reported number of I.R.S. audits in the State of Colorado varies from a few dozen to over 150 making it difficult to gauge the true level of federal involvement.
Based on what I’ve learned regarding the IRS audits in Colorado, It appears that the IRS is taking the position that the cost of goods sold can only include direct costs of production. These include the direct labor for growing or trimming and the portion of the rent and utilities attributable to the square footage used for growing. The IRS is also apparently taking the position that no managerial or corporate overhead may be included in the cost of goods sold.
This apparent IRS position is devastating to Colorado’s marijuana businesses. The bottom line, under 280E, corporate and managerial expenses, may not be deducted on the retail or dispensary side of the business, and with the IRS position regarding the cost of goods sold, these expenses can not be deducted on the grow side either. This results in managerial and administrative costs having to be paid from after-tax dollars, another challenge to operating profitably.
Supply, Demand, and Pricing
Industry colleagues in Colorado have shared with me their thoughts that probably every marijuana store and dispensary in Colorado is for sale! Obviously, this is an exaggeration, but there is some truth in it.
Perhaps the biggest issue in Colorado’s marijuana industry are three words that are familiar to anyone who has taken Economy 101 in college. They are: supply, demand, and pricing. Right now there is a tremendous oversupply of legal marijuana in Colorado.
The retail demand for both medical and recreational marijuana are growing at a fast rate, while the supply of marijuana has been growing at a faster rate. This oversupply has been great for consumers and patients, but it’s been devastating for the bottom-line of marijuana businesses in Colorado.