Cannabis SALT Shaker: State and local tax developments (Q2 2023)
Like any business expanding into new territories, a cannabis business must keep careful track of the many state and local taxes, regulations, and market conditions it will be subject to. But, as is often the case, cannabis’ varying legality can add an extra layer of complexity. In this quarterly feature, we explore recent state-specific developments and what they could mean for your business.
Spotlight on 280E: Readers will notice that three of our four items this quarter include decoupling from IRC Section 280E’s restrictions on cannabis businesses’ deducting business expenses. Those are the latest illustrations of a trend that started amid the COVID-19 pandemic. We believe that moving forward, as additional states legalize use, we will see 280E decoupling included in their initial tax structures. Cannabis taxpayers should continue to carefully monitor their states’ 280E regulations to be sure they are in compliance – especially in light of how devastating 280E, and the resultant effective tax rate, is on operator cash flow. Tenuous market conditions have further exacerbated the cash flow challenges, and decoupling provides some needed relief.
Requests for California’s High-Road Cannabis Tax Credit (HRCTC), available for tax years beginning on or after Jan. 1, 2023, start July 1. Requests for credits must be made by July 31 for tax years starting in the first half of the year. The credit is granted on a first-come, first-served basis, and the reservation system will be disabled once $20 million of credits have been granted for the tax year.
Qualified taxpayers may receive nonrefundable credits up to 25% of their qualified expenditures, with the credit capped at $250,000 per year. Unused credit may be carried forward for eight tax years after the credit was generated.
The HRCTC is claimed on qualified taxpayers’ California income tax returns. Qualified taxpayers are commercial cannabis businesses in possession of either a:
- Type-10, retailer license, or
- Type-12, micro-business license.
Qualified expenditures include:
- Wages for full-time employees
- Safety-related equipment, training, and services
- Workforce development and safety training for employees
To claim the credit, a qualified taxpayer must have an HRCTC Tentative Credit Reservation (TCR) from the Franchise Tax Board (FTB) for a tax year. Taxpayers must request the TCR online between July 1 and July 31 for taxable years beginning January through July; for taxable years beginning August through December, the TCR must be requested within 30 days of the start of the year.
A link to the TCR system will be available here when the reservation period arrives.
- Because the HRCTC may not be claimed without the TCR, it is imperative that eligible taxpayers be mindful of the brief window in which to submit a TCR request. Additionally, it is in the best interest of eligible taxpayers to submit TCR requests at the earliest date possible to increase the likelihood of the credit being available to them, given the $20 million credit ceiling.
On April 23 and 27, bills legalizing and taxing recreational adult-use cannabis in Delaware became law without the signature of Gov. John Carney, after he issued a statement indicating he would not veto House Bill 1 or House Bill 2, but allow them to become law without his signature. While it will still be some time before legal sales begin – likely in late 2024 or early 2025 – these laws pave the way for a new market.
House Bill 1 legalizes the possession and use of cannabis for adults 21 years of age or older. Legal possession is limited to no more than 1 ounce of leaf cannabis, 12 grams of concentrated cannabis, or 750 milligrams of THC in cannabis products.
House Bill 2 imposes a 15% tax on the purchase at retail of cannabis and cannabis products, excluding medical cannabis products under Chapter 49A of Title 16. The tax is imposed on the retail sales price of the product. The tax is to be collected at the point of retail sale and remitted to the Division of Revenue by the retail cannabis store licensee.
In addition, House Bill 2 allows corporate and pass-through entity taxpayers a state deduction for ordinary and necessary business expenses by cannabis businesses that are disallowed by IRC Section 280E.
- As with other states that have enacted recreational adult-use cannabis laws, taxpayers should be aware of the disparities between federal and state cannabis-related tax laws. Cannabis remains an illegal controlled substance for federal purposes, and as such the restrictions on business expense deduction under federal law still apply.
Thanks to recently passed legislation, starting tax years beginning on and after Jan. 1, 2023, New Jersey has provided a partial workaround to the federal limitation on certain business expense deductions for cannabis businesses. Cannabis businesses filing income tax returns as C Corporations, S Corporations, or partnerships or as an unincorporated business are now allowed to decouple from the federal limitations imposed under IRC Section 280E.
Additionally, the new legislation allows cannabis licensees to deduct expenditures that qualify as specified research or experimental expenditures under IRC Section 174, and also allows these expenditures to be claimed as a qualified research expense for purposes of the New Jersey research and development credit.
This new legislation seeks to provide a state-level deduction for New Jersey cannabis businesses, thereby alleviating somewhat the inability of such a business to take such expense deductions at the federal level.
The District’s Medical Cannabis Amendment Act became law at the end of March, following the Act’s period of Congressional review. The Act provides several changes to the District’s medical marijuana program.
The Act increases the number of licensed dispensaries allowed to operate in the District by eliminating business licensing caps within the District. While the number of licenses available for businesses is no longer limited in nature, a single license holder in the District is only permitted to hold up to:
- Three retailer or internet retailer licenses
- Two cultivation licenses and either a retailer license or an internet retailer license
There is no limitation on the number of manufacturing licenses that a business may hold.
Note that a testing laboratory license holder is not permitted to hold a cultivator, manufacturer, retailer, internet retailer, or courier license.
The Act also increases penalties for illegal operators who previously took advantage of “gifting” cannabis. D.C. has had a number of retailers who “gift” cannabis to non-medical customers after they make legal purchases of tangible goods. The Act attempts to eliminate this practice by allowing these previously unlicensed dispensaries to obtain a medical cannabis license.
Going forward, at least 50% of all new licenses (excluding those for cultivation centers that have a manufacturing license) are slated to go to social equity applicants.
The Act also enacted two business-friendly tax changes. The first is that starting in 2023, licensed operators will decouple from federal IRC Section 280E and be allowed business tax deductions and credits. The second is a permanent sales tax holiday for medical cannabis called “4/20 Medical Cannabis Sales Tax Holiday Week,” for the period of April 15 through April 24 every year.
- While the District is still pushing forward on adult-use cannabis legalization, the changes under the Act provide relief to individuals and business operators within the District, and a step forward in curbing illegal sales.
Any advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues. Nor is it sufficient to avoid tax-related penalties. This has been prepared for information purposes and general guidance only and does not constitute legal or professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice specific to, among other things, your individual facts, circumstances and jurisdiction. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and CohnReznick LLP, its partners, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.
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