In November, 2016, voters in California overwhelmingly approved Proposition 64, legalizing recreational cannabis across the state. California joins eight other states and the District of Columbia in passing recreational marijuana legalization initiatives, and the recreational market has been booming ever since. The law went into effect on January 1, 2018.
Now, four months after the law made recreational cannabis officially legal, how is the state’s market handling it? The answer to that question varies, from questions about policies to surging profits and confusion about the licensing process. In general, though, the state is experiencing substantial growing pains, and many steps will be needed to be undertaken before the market truly stabilizes. In this article, we will discuss some of the problems facing California’s recreational cannabis producers and retailers, not to mention consumers, and provide insights into the work being done to erase an uncertain future for the cannabis market.
Problems for California’s Recreational Market
At a California Cannabis Industry Association conference held in Sacramento earlier in 2018, cannabis business owners aired their many grievances, decrying real and perceived problems by the dozen. Some of the problems facing the nascent recreational market in California include:
- Too few retail sales locations to get product to customers
- Licensing agencies falling behind on approving new recreational licenses
- Distributors that are not following the rules and statutes, undercutting those that comply fully with existing laws
- Not enough laboratory analysis/assay capacity for quality assurance purposes
- Supply chain deficiencies, including insufficient product to keep retail shelves stocked
Part of the overall problem stems from California’s prohibitively high licensing and taxation rates. High license fees are tending to keep legitimate business interests from becoming established, slowing down the process of opening retail locations. High tax rates on the sale of marijuana products has encouraged a resurgence in black-market sales, as products are substantially cheaper for consumers than would be found in the licensed retail outlets. Lawmakers in the state have banded together to co-sponsor a bill temporarily lowering the tax rate to put an end to black market cannabis sales and to spur legitimate retail sales.
Another problem, or series of problems, arises from the regulatory agencies tasked with setting regulations for licensed operators to follow. Despite a year or more of preparation, the California Bureau of Cannabis Control and the state departments of public health and of food and agriculture have not released their final regulations. In fact, those regulations are not expected to be implemented until the end of 2018. In the meantime, lawmakers have proposed a large number of tweaks to the existing statutes, creating an atmosphere of chaos and confusion.
Local Barriers to Entry
Local government initiatives have further clouded the prospects of the legal cannabis industry. Although the recreational legalization initiative is statewide, provisions in that law allow for local jurisdictions to set their own regulatory requirements. Some municipalities have forbidden cannabis operators from doing business in those cities. Others have placed prohibitively high licensing and business registration fees on cannabis entrepreneurs, causing many to simply give up before undertaking the expensive process of getting registered.
Like the high retail sales tax rate and state licensing fees, local governments setting high costs of entry to the market has only served to create a flourishing black market throughout California. This is especially ironic, since the reasoning behind establishing recreational cannabis legislation was to eliminate black market operators by creating a strong and profitable legal market. It is clear that those good intentions have backfired. As of the end of March, 2018, there are just over 4600 temporary licenses granted for cannabis operators in the entire state; this paltry number is in stark contrast to the estimated tens of thousands of gray- or black-market operators without licenses.
One of the largest concerns for the legal marijuana industry in California is that less than a third of all municipalities in the state have adopted some form of legal authorization for cannabis businesses, including both medical and recreational operations. This effectively shuts out 2/3 of the state in finding locations to begin doing business. Without local approval, there is no path forward for a state license to be granted to cannabis businesses, stifling the market even before it has had a chance to establish roots. Local governments have few incentives to streamline the process; as mentioned earlier, the state regulations gave substantial leeway to local municipalities to create their own regulations or to forbid cannabis business operations. There is no specified timeframe, and many entrepreneurs and industry analysts accuse those local governments of creating unnecessary delays for no real reason.
Supply-Chain Issues Affecting California’s Cannabis Market
Two other problems are facing California’s recreational cannabis market, and both have to do with supply-chain concerns. First, California’s regulations specify that retail sales locations will be required to sell only those products that have met testing standards set by the state. That stipulation goes into effect in July, 2018. The problem here is that laboratories are not yet set up in sufficient numbers to handle the required testing. In fact, only about 20 labs have obtained the necessary licenses from California authorities. This is wholly insufficient to handle the testing needs for thousands of cannabis operations, and is expected to create a product shortfall across the entire market unless lab licensing rapidly expands.
Distribution is another huge concern, with less than a hundred large-scale distribution operations servicing cannabis businesses in California. This weak supply-chain system will only struggle in the coming months; industry analysts point out that many distributors are not charging the required excise tax to buyers (at a 15% tax rate), misguidedly believing it is the retailer’s responsibility to collect the tax. When distributors are served with exorbitantly high tax bills due to their error, it will cause many distributors to pull out of California operations. California is racing to establish a comprehensive supply-chain tracking and tracing system, which, once operational, will shine a spotlight onto distributor practices falling outside of accepted norms. If distribution is curtailed, this could potentially compound product stock problems faced by retailers.
It is clear that much needs to be done to ensure California’s cannabis industry can do business. With the necessary tax and regulation reform, the largest cannabis market in the United States can once again move to profitability as retail sales expand statewide. Time will tell whether lawmakers and regulatory officials are up to the task of protecting this lucrative retail market in time for it to flourish rather than fail.
Beating the Cannabis Black Market
For decades, black market cultivators and sellers serviced the huge cannabis-using population in the United States. Recent passage of legalization initiatives in a number of states, on both recreational and medical fronts, was designed to finally curtail illicit sales and distribution of cannabis products. Still, black-market sellers are an ever-present threat to the legal cannabis market, and many entrepreneurs are taking steps to fight back. In this article, we will discuss best practices for outsmarting the cannabis black market, helping legal companies to encourage their consumers to support the growth of a legitimate and thriving cannabis market.
A Regulatory and Taxation Quagmire
As of April 2018, 29 U.S. states and the District of Columbia have passed some level of medical marijuana legislation, legalizing the cultivation, distribution, possession, and sale of cannabis or cannabis-infused products. Nine states and D.C. have also passed recreational marijuana legalization initiatives. Together, the legal cannabis industry represents billions of dollars in retail revenues and taxes – in fact, industry analysts suggest the retail side alone may be worth as much as $40 billion by the year 2020.
Despite these glowing figures, all is not well with the legal marijuana industry. To a large extent, legitimate cultivators and distributors are still battling against black market operators. Why hasn’t legalization legislation stamped out the illicit production and sale of cannabis products? The problem is two-fold, and centers on taxes and regulation of the industry.
Taxes on retail marijuana sales can be extremely steep, exceeding 15% or more in some states. For example of the restrictive taxes imposed on retail cannabis sales, California charges sales tax and an excise tax on retail sales of marijuana products. Taxes on producers and distributors further drive prices up. These taxes have tended to make legal products prohibitively expensive, forcing many consumers to source their products on the illicit market. To counteract this trend, lawmakers in California and in other states are considering bills that may temporarily lower taxes in an effort to spur the legal part of the industry while curtailing the cost advantages the black market represents to customers.
Licensing is another area where the black market gains an advantage. The licensing process for legitimate cannabis businesses is complex and expensive; high fees and a potentially long waiting period before license issuance means that many would-be marijuana entrepreneurs give up before completing the process. In the meantime, unlicensed cultivators and operators are flooding the market with cheap cannabis. Avoiding licensure and operating under the radar gives them significant advantages, allowing them to offer their products more cheaply to budget-minded consumers who don’t mind the risk.
Tips for Cannabis Entrepreneurs
Faced with challenges in combatting black-market production and sales of cannabis products, what can legitimate marijuana entrepreneurs do to turn the tide? Business advisors and cannabis industry analysts have put much thought into strategies that reward consumers while taking away some of the advantages that black market operators have in the current industry atmosphere. In simple terms, these strategies:
- Build brand and business loyalty
- Help entrepreneurs gain customers and retain those customers
- Encourage lawmakers to reform existing taxation and licensing issues
Here are some of the techniques savvy cannabis entrepreneurs are using to advance the legal market:
Loyalty Programs – in any business, rewards or loyalty programs encourage repeat customers, providing incentives on prices or special deals. In the legal cannabis industry, enterprising retailers have instituted similar loyalty programs. There are several types of programs, including those that offer points for each purchase, discounts for signing up for newsletters and updates, or point-of-sale perks. Signups for news and updates seems to be one of the most popular programs; these programs offer instant discounts or discounts to be used in future purchases. And, this allows the dispensary or retail outlet to share information with their customers, which ultimately impacts sales in a positive way. Communication with customers is key in building brand loyalty.
Humanitarian Support – in a crowded marketplace, retailers often look for ways to differentiate themselves from one another. In the legal weed industry, a large number of operations work to support humanitarian causes such as food banks, medicine for underserved populations, and clean water initiatives. This type of support appeals to conscientious consumers – those who make purchasing decisions with their hearts as well as with their wallets. Delivering social good creates an atmosphere of goodwill, and customers across market sectors tend to support companies that give back to the communities around them.
Education and Customer Outreach – as mentioned earlier, communication with customers helps to build brand loyalty. One way that cannabis entrepreneurs further the communication is by providing information and education to customers at the point of sale and on packaging/labeling. Certain states, such as California, require cannabis products to be laboratory tested. Even in states where this is not a requirement, having products assayed by a certified lab can mean the difference between increased sales and lackluster retail performance. Educating patients and recreational customers on the safety standards, lab testing processes, and concentrations of active ingredients in the cannabis products goes a long way toward building brand awareness, differentiating those that educate from others that simply sell products. This kind of education is simply unavailable on the black market, creating a significant advantage for legal operators. Of particular note is the market segment containing infused products and extracts; black-market operators have no incentive to adhere to safe practices, and their products may contain harmful chemical residues. Legitimate extracts producers, however, can demonstrate to their customers that their products are free from contaminants and are made under industry best practices.
Originality – in any market, brands that are perceived as original stand out from their competitors. This is just as true in the regulated cannabis market. Cultivators, distributors, and retailers can showcase their originality by developing products and strains that meet certain criteria, such as potency or concentration of CBD, an active compound shown to provide significant health effects without the debilitating “high” of recreational marijuana products. Strains that are produced regionally can be “curated” much like fine wines, lending a sophisticated air to the retail environment. And, innovative products, such as extracts, vaping cartridges, and flavorful edibles provide plenty of opportunities for smart cannabis retailers to be original. Black-market operators can’t or won’t match the dizzying array of products and strains, putting the ball directly into the court of legitimate cannabis businesses.
The black market sales and cultivation of cannabis will continue well into the foreseeable future. However, with some regulatory reform and creative thinking on the part of legal cannabis businesses, the black market influence will lessen over time, opening new doors of opportunity for the regulated players in the legitimate and booming commercial cannabis industry.
In an effort to keep buyers away from the black market, one California city has lowered its sales tax on recreational cannabis.
Berkeley, California, has lowered its sales tax on recreational cannabis. Economics 101 students know that supply and demand dictate any market. However, with California’s heavy tax program on marijuana dispensaries, these businesses are not able to compete with the low prices offered on the black market.
More evidence is proving that legalization of marijuana disrupts and breaks down the black market. It decreases the number of illegal drugs smuggled across the border and nearly eliminates the likelihood of violence when purchasing cannabis. When excessive taxes are placed on legal items, such as marijuana, historically, the need for lower priced items are filled by the black market.
Tax Cuts in Berkeley
The city of Berkeley cut their city-level tax on recreational marijuana from 10 percent to 5 percent in an effort to bring down the total cost of marijuana in their city. When state taxes are factored in, the total amount of tax paid, before the cut was 35 percent. With the new tax cut, it will drop the tax amount to 30 percent.
Although this still seems exorbitant, Berkeley’s new tax level on marijuana is actually one of the lowest in the country. In some places in California, the tax on marijuana is a staggering 45 percent. California law mandates that taxes on cannabis include city tax, sales tax, cultivation tax, and state excise tax. This makes it difficult for reputable dispensaries to compete with the black market.
As with any new commodity, legal cannabis sales boomed in California after recreational marijuana was legalized. However, dwindling legal cannabis sales are dwindling in California after only a few months of legalization. Now that the initial excitement has worn off, consumers are looking for lower prices and finding them on the black market.
A marijuana shopper told CBS he believes that taxes are driving people away from legal marijuana. “The taxes, I think, are what’s driving people not to come to the club anymore,” he stated, “I know a lot of my friends who used to come to the clubs are going back to the black market.”
Illegal marijuana can be found online for $20 less than what is found at local dispensaries. Until California drops the taxes on legal marijuana, the black market will continue to boom. In fact, higher taxes may mean less revenue for the state.
For example, Colorado’s marijuana sales yield a billion dollars in tax revenue for the state. Most tax rates average around 15 percent in Colorado, with some even higher. In turn, Colorado is able to collect funds for education and other social endeavors. California had hoped that raising its tax rate to 35 percent, the state would be able to collect the revenue it so desperately needs. However, this plan backfired as consumers are going back to the black market leaving California with even less revenue that Colorado.
Berkeley Patients Group worker, Sabrina Fendrick explains, “Everybody wants to generate revenue, we all want to serve our communities, but if everyone is going to the illicit market, then nobody is generating revenue, and nobody is being helped.”
Too Much of a Good Thing
Can there really be too much marijuana grown in California? Another basic economic principal is that too much of a product in a market will drive prices down. California’s cannabis production is estimated to be eight times more than what is currently consumed in the state. This leaves literally “tons” of extra marijuana.
California produces between 14 to 16 million tons of marijuana. In turn, Californian’s only consume around 2 million tons. This leaves well over 12 million tons of marijuana on the market. In addition, this excess cannabis cannot be exported to other states under federal law and the new California state regulations which went into effect in January.
Hezekiah Allen, executive director of the California Growers’ Association said, “In the past, when a product left the farm, there’s a really good chance the grower had no idea where it was going. But in the future, every single license holder is going to need to know exactly where every gram of product is ending up and so conditions are going to change very quickly.”
It seems he was correct. In addition to the surplus marijuana flooding the market, the higher price, due to extreme taxation, leaves Californian’s turning to the black market in waves.
In addition to buying on the black market, many growers are growing their products without state approval. California enforces strict pesticide regulations on growers. Since many farmers can’t afford or don’t qualify for a permit stating that they follow the state’s strict environmental regulations, they sell their products on the black market instead of at dispensaries. This floods the market with lower priced marijuana.
Legislators Finally Listen
Berkeley’s cut on city taxes for marijuana is just one measure officials in California are taking to combat high pricing. Currently, state officials are working on developing legislation that would help to lower the excise tax by 4 percent statewide. However, it is clear that additional cuts need to be made.
As long as there is demand for lower priced cannabis, and growers are willing to fill that demand, the state of California will be left with two choices. One, be willing to accept lower revenue in lieu of higher taxes and tight regulations on growers; or two, lower taxes, lighten up on growing regulations and allow growers and dispensaries the ability to compete with the black market.
Experts believe that over time, if patrons are used to purchasing their products from dispensaries and come to expect a certain level of quality, then, the black market will dry up and raised taxation on marijuana can be slowly increased without consumers leaving the market. For example, how many black-market cigarettes are being sold today even though there are higher taxes placed on tobacco? There are not many farmers growing tobacco nationally to sell to the black market. This is because taxes on tobacco have been slowly raised over time.
Maybe California lawmakers need to take a page from other states who have a positive revenue surplus and still have a sizeable tax on marijuana.
Let’s face it. America’s cannabis industry is tenuous, at best. Thanks to Attorney Jeff Sessions, the revocation of the Cole Memo leaves states at the will of their State District Attorney’s, instead of being protected by federal guidance. The Cole Memo protected the recreational cannabis industry from federal interference. Now that it has been revoked, uncertainty has spread across the United States.
In addition to the Cole Memo, the fate of the Rohrabacher-Blumenauer amendment was in the balance, or rather unbalance, of Congress. When members of the Senate and House of Representatives were unable to come to an agreement on a budget, the federal government shut down, leaving entrepreneurs on the edge of their seats.
However, even with all of the uncertainty swirling around the federal government, investors are still diving deep and funneling hundreds of millions of dollars into the cannabis industry, expecting exponential growth.
There seems to be one senator that is in agreement for the legalization of marijuana. Senator Rand Paul proposed two budget amendments to the House spending bill that allows for expanding the protection of state-legal cannabis. Marijuana Moment reported that Paul has proposed two different measures which include:
- Defund any attempts by the Justice Department to interfere with either state-legal medical or recreational cannabis
- Prevention of the DOJ from prosecuting banks that serve state-legal cannabis companies
Even with Sessions’ self-proclaimed war on marijuana, companies like Seattle-based private equity firm Privateer Holdings are still investing in the country’s legal marijuana industry. Privateer Holdings recently set a new record by investing $100 million into a round of cannabis-focused funding. Companies such as Tilray, Privateer, and Leafly are forging ahead, even with threats from Sessions. According to Privateer CEO Brendan Kennedy, “We closed a number of investors in the last two weeks. The memo didn’t change anything for us.”
This is good news for the U.S. cannabis industry. However, those who lack confidence in the capacity to survive the multitude of threats, federal prohibition continues to throw up heavy amounts of roadblocks, cutting off legal cannabis’ access to both the American stock markets and proper banking industries. Instead of choosing another industry to back, investors are now looking to Canada, where cannabis will become fully legal by the end of 2018. Canadas stock market will welcome the new industry, just like any other commodity.
Although Kennedy is not scared by Sessions’ actions, he is concerned about the “ability of companies inside the United States to lead this industry globally.”
Privateer is always on the lookout for global opportunities. Outside the U.S., there is less risk and more certainty in opportunities. Kennedy stated, “They’re easier to scale, and we have the ability to partner with real companies – such as pharmaceutical distributors – that we wouldn’t be able to partner with in the U.S.”
The Canadian Security Exchange
With most of the investment opportunities happening outside the United States, company CEOs such as Kennedy see the Canadian Security Exchange (CSE) rising above the NASDAQ or the New York Stock Exchange (NYSE) in the cannabis industry.
“We raised this capital from investors around the United States and around the world, and frankly, we’ll deploy the vast majority of this capital outside the United States,” Kennedy said. “Most of the investment opportunities we’re looking at today are outside the U.S., where the pace of change in many ways seems to be happening at an even faster rate than inside the U.S.”
CNBC reported that U.S. based cannabis company, MedMen, plans to go public on the CSE rather than the NASDAQ or NYSE. With a plethora of dispensaries in California and New York, it is a disappointment to those who want to invest in the U.S. stock market.
CEO Adam Bierman recently told CNBC that there is a brewing excitement around the national legalization coming to Canada this year. He also stated that with the hungry appetite among global investors, the Canadian public markets are luring these investors with the speed of their legalization and ability to invest in the CSE.
He also eluded to an explosive U.S. market, if and when the cannabis industry is allowed to trade on the NASDAQ or NYSE.
“…there is this appetite among global investors to invest in a U.S. play. Specifically, global investors want to invest in a U.S. play that has California exposure. Now is the time where it makes the most sense.”
The Toronto Stock Exchange (TSX) is Canada’s largest stock exchange with over $20 billion in Canadian-based cannabis capital. However, American-based cannabis companies are also represented, compiling over $230 million in capital.
Entrepreneurs and investors are flooding Canada’s cannabis markets due to the current up-and-running international cannabis distribution network. There is also the flourishing local market set to grow even more after legal recreational sales begin later this year.
Canadian Marijuana Prices Drop
Statistics Canada released a report that claims nearly 5 million Canadian cannabis users spent almost $4 billion on marijuana in 2017. This number includes legal and illegal sales. However, experts predict that the illegal marijuana sales market will shrink considerably in the years to come. A cultivation boom has meant that the retail price of marijuana has decreased significantly. The average price of a gram of marijuana in Canada has dropped $1.00 (CAD) in the last year.
Even with the price drop, industry experts predict that there will still be a hefty profit to be made in Canada. As production grows and consumer spending increases by 6% per user per year, the future of Canada’s cannabis industry looks profitable for investors.
Investors in the U.S. are looking for changes in federal cannabis laws that will ultimately allow for the fledgling cannabis market in the U.S. to grow to its full potential. There is a great opportunity for investors to make enormous profits, but only if the federal government gets out of the way and finally removes all barriers to funding the cannabis industry. However, with Sessions’ recent actions, it does not appear that it will be soon.
Hemp production has soared in the past year. The number of licensed producers and acres of cultivation space in the top 10 hemp-growing states grew by 140 percent. The number of licensed hemp producers rose from 609 in 2016 to over 1,200 in 2017. Additionally, the number of acres licensed for hemp cultivation also rose from 16,377 acres in 2016 to almost 40,000 acres in 2017.
States such as Kentucky, Colorado, Minnesota, Nevada, New York, North Carolina, North Dakota, Oregon, Tennessee, and Vermont are the top 10 hemp producing states in the U.S.
The Reason for the Spike in Production
Increasing acceptance for hemp and cannabidiol (CBD) oil, in addition to relaxed state level regulations allowed U.S. hemp production to surge in 2017. This increase is only the beginning for the fledgling hemp industry in the United States.
Since full-fledged hemp cultivation is still illegal at the federal level, the plant that produces hemp and CBD oil can only be grown in states that have an established hemp program. There are still lingering questions about the legality of hemp-based extracts, such as CBD oils. Farmers are also still learning the optimal growing processes. It is unclear the demand for products made from hemp grown in the U.S. However, CBD which is derived from hemp is soaring in popularity.
Brightfield Group, a cannabis research firm, estimates that the demand for hemp-based products will increase from $291 million in 2017 to over $1.65 billion by 2021. This increase in demand has prompted U.S. farmers who have grown more traditional crops to look into growing hemp as a replacement for lower-valued crops such as cotton or alfalfa.
Certain states have shown support to the fledgling industry by allowing more growers into their hemp programs and relaxing regulations to acreage limits. States that have shown increases in hemp production are set to cash in on the bull market of the next few years.
More than half of the United States hemp production occurred in Colorado. Even though Kentucky has more licensed acres, Colorado has more acres in production, farmers who grow the crop, more CBD processors, and more opportunities for selling hemp plants. Colorado was the first state to legalize recreational marijuana and in 2012, farmers began to grow the crop for cultivation.
Due to Kentucky’s well-suited growing climate, former tobacco farmers are taking a strong interest in hemp. The state’s willingness to experiment and invest in hemp processing and growing makes Kentucky a leader in the hemp growing industry. Kentucky has the most acres authorized for growing hemp in the nation at 12,800 acres. However, only 3,200 acres were planted in the bluegrass state.
With a well-established network of hemp processors and growers, along with a new testing regime, Oregon has grown in its position in the hemp industry. With new laws on testing requirements that have been passed in 2017, Oregon hemp products have the same testing regulations as marijuana. This means that all hemp products that come from Oregon will be food-grade quality and pesticide and contaminant tested.
As a future leader in hemp, North Dakota has more than 3,000 acres in active production. However, North Dakotas cold climate and recent drought have limited hemp’s potential to thrive. In addition to the natural determents to growing hemp in the state, high production costs and expensive seed costs that are higher than typical row crops, do not help entice farmers to grow hemp.
Since 2016, Minnesota has allowed farmers to grow hemp. In fact, there is an abundance of wild hemp from World War II-era crops. With a climate similar to Canada, varieties already grown in the neighbor to the north are a natural fit for the state. Unfortunately, no hemp farmer has reported a profit as of yet. Processing delays, legal confusion, and natural pests make growing hemp difficult for many farmers.
Governor Andrew Cuomo helped establish the hemp industry in New York in 2017 when he invited entrepreneurs to compete for development grants in excess of $5 million. These grants were a first in the nation. Most state programs are funded mostly by feeds paid by farmers, but New York’s decision to invest in promoting hemp cultivation and processing has allowed New York to be a frontrunner in the hemp industry.
For a state once dominated by textile manufacturing and tobacco farming, officials in North Carolina see hemp as a natural fit for farmers. In 2017, North Carolina finished the growing season with more growers, acres, and processors than any other state in the first year of hemp production.
The climate in Tennessee has created a challenge for hemp farmers. High humidity and a 50-plus inch per year rainfall makes it difficult to grow a plant that thrives in an arid climate. However, Tennessee hemp entrepreneurs are trying to develop strains for a damper climate. The state also has no legal restrictions in selling hemp products. The state also permits CBD extraction which is highly valuable.
With the nation’s most lenient hemp regulations, Vermont’s latitude makes it easy for hemp cultivars that were developed in northern Europe and Canada. However, hemp producers may be under an entirely new set of guidelines as the state implements regulations for recreational marijuana.
Nevada hemp farmers are selling their products as quickly as they can produce them. There is a booming demand for flower in CBD production. Prices of up to $350 per pound are being seen for quality, high-CBD varieties. This is almost 10 times what Colorado growers receive for midgrade hemp flower. In addition, Nevada growers are increasing the amount of acreage and processing equipment. Farmers in the state are hoping that they can cash in on the boom before states that have a better water supply and a milder climate overtake the market. Growers in Nevada are also expecting a challenge from California growers, so they are looking for new hemp uses in the industrial markets and animal feed.
Although the market players are still unclear about the future of the hemp industry, industry entrepreneurs and policymakers are forging ahead and hopeful about the industry’s future.
Once again, the federal government stands in the way of businesses in the marijuana industry that operate in states where marijuana is legalized. In January, the Internal Revenue Service (IRS) issued new policy updates totaling over 280 pages. In this extensive policy update, buried deep inside, there is a ban on future nonprofit organizations who lobby for the marijuana industry. For advocacy groups trying to change federal cannabis laws, life could get a lot harder.
The IRS hid inside the 280-page policy update a provision that declares that the agency will no longer acknowledge any tax-exempt applications for an organization “whose purpose is directed to the improvement of business condition…relating to an activity involving controlled substances…which is prohibited by federal law regardless of its legality in the state in which such activity is conducted.”
The Obama-era Department of Justice policies that protected the marijuana business have essentially destroyed. The IRS policy change can just two short days before U.S. Attorney General Jeff Sessions revoked the Cole Memorandum that protected marijuana industries from federal prosecution.
Rachel Gillette, a Colorado-based cannabis attorney, stated that the IRS’s new policy is not shocking. “It’s another example of the IRS’ punitive policies towards the cannabis industry.”
Another professional involved in the cannabis industry, California accountant Jerry Chin stated that the policy change is, “an interpretation of what the IRS sees in its own rules and regulations.”
Chin added, “What the IRS is saying is, if your trade association’s main purpose is the advocacy of a Schedule I substance, then we’re going to deny your application for that fact alone.”
Groups Affected by the IRS Change
There has already been one nascent marijuana trade group affected. The New Jersey Cannabis Industry Association (NJCIA), which celebrated its one-year creation in January, was denied an IRS determination letter for its application for tax-exempt status. The organizations president, Hugh O’Beirne, had fought back-and-forth with the IRS for months before the final decision came down.
It first appeared as if O’Beirne’s hard work was paying off as the conversation between the IRS and NJCIA was moving along with the IRS asking the organization for “further details on our application,” according to O’Beirne.
Then, at the “eleventh hour,” he was informed by the IRS of the procedural rule change and told that the IRS would not be issuing those types of letters to “your type of company.” All of this happened within 7 days of the procedural rule change announcement.
Whether other newly formed trade associations have been denied determination letters or tax-exempt status is unclear at this point. The IRS has not responded to requests from various publications. Additionally, since the policy change is so new, there is a great deal of confusion of how this change will affect the cannabis industry or organizations that are associated with the industry.
The Effect to Established Groups
There are no answers for current, long-standing marijuana advocacy groups wondering if their tax-exempt status will be revoked or whether the policy change applies only to organizations initially applying for tax-exempt status. Experts are not in agreement on that point.
The National Cannabis Industry Association (NCIA) has been registered as a 501(c)6 nonprofit organization since 2010. They feel as if they are a target for the IRS. For the NCIA, taxes owed to the IRS would total $210,000 for 2017 revenue received if not for the tax-exempt status.
Chin, who has been working with the cannabis industry since 2012, estimates that this type of cost could affect all marijuana nonprofit organizations under the new federal policy. His estimates for NCIA are based on their $3 million in revenue less $2 million in deductible business expenses for 2017.
He believes that there is the “distinct possibility” that the IRS may use the new policy to revoke the tax-exempt status previously granted to organizations like the NCIA. Unfortunately, the IRS has the ability to review the status of any organization and revoke it based on policy changes.
However, Henry Wykowski, a San Francisco based attorney, who serves as NCIA’s general counsel disagrees with Chin. He believes that the IRS does not have the power to remove an organization’s tax-exempt status except under limited circumstances and that the new policy is just another kick to the shins to the marijuana industry.
He believes that in order for the IRS to remove any tax-exempt status, an organization must “run afoul” of their tax-exempt obligations. He also believes that the new policy does not apply to any entity that may have already received a determination. He added that if the IRS revokes NCIA’s tax-exempt status that the organization could sue the IRS in U.S. Tax Court.
There is currently no clarity on whether the IRS will implement the new policy retroactively. Ed Bartlett, a Boston-based tax attorney stated, “The IRS would have to rule specifically that an organization no longer qualified for tax-exempt status. Until that happens, existing organizations should continue to function as tax-exempt entities.”
The IRS could potentially use the new policy to target groups already granted tax-exempt status. This could affect groups that work indirectly with the cannabis business and are not directly involved in the production aspect, such as Marijuana Policy Project (MPP) or Americans for Safe Access.
Hundreds of marijuana organizations that currently have tax-exempt status are potential targets if policy is interpreted to include state chapters of national nonprofits dedicated to reforming cannabis laws.
Companies such as NCIA are “prepared to fight” if the IRS tries to remove their tax-exempt status. Aaron Smith, executive director of NCIA, stated that he has not heard from the IRS about the policy change.
If nonprofit organizations lose their tax-exempt status, their profits will be tax, leaving fewer dollars to advocate for law changes. However, this is the worst potential outcome, according to industry insiders. Chin noted that a trade group that loses or is never issued tax-exempt status is subject to a 21% federal tax on any profits.
Even if the IRS decides to deny groups that have yet to receive tax-exempt status, it will still harm those particular groups’ effectiveness and credibility. With 21% less dollars to spend on advocacy, the groups will not be able to truly operate as nonprofits and complete the work expected of their members.