The Troubling State of State Tax and Cannabis
While the jurisdictional boundaries for marijuana sales are likely to collapse at some point in the future, what we have now in tax treatment is disjointed and challenging.
AUTHORS: Alexander Korzhen and Tram Le
Alexander Korzhen
Tram Le
While cannabis remains a Schedule I controlled substance at the federal level, most states have legalized cannabis sales in some shape or form. By legalizing these sales, state and local taxation is usually implicated, and that can become quite a mess for vendors, especially if multi-jurisdictional sales are concerned.
It can be helpful to view state cannabis taxation from a high-level to get familiar with the issues. Here’s how to think about cannabis taxation at the state level.
Specific use
States that have legalized cannabis sales typically only approved them for specific use, such as medical, recreational or CBD. It is important to understand what is legal in each state—i.e., which combination of marijuana substances have been approved–in order to properly categorize what a business is selling for state tax purposes.
Minnesota authorized medical marijuana several years ago but has not yet legalized the sale of recreational marijuana. In Texas, CBD oil sales were approved a few years ago in a special legislative session and generally subject to sales and use tax. In May 2021, the Texas legislature passed House Bill 1535 permitting limited medical use of low-THC cannabis by patients with certain medical conditions. Effective September 1, 2021, low-THC cannabis prescribed by a physician to a patient under specific conditions would be considered a drug and exempt from sales and use tax in Texas.
State-border constraints
Cannabis products are licensed for sale in specific states where marijuana byproducts are legal. Due to federal laws, cannabis cannot be transported across state lines, so sellers can only make in-state sales.
In some ways, these state-border constraints on sales activities make sales tax processing easier—only one set of state and local tax rates and rules to take into consideration for each category of products sold. While the plants themselves cannot cross borders, the supporting services and vendor products can such as grower services, software companies, and other supply chain products.
Varying tax policies
There is no consistency in tax policy from state to state. Some states will impose an excise tax, others a sales tax and an excise tax together in what is known as tax pyramiding.
It’s not only what’s being sold, but who is selling it in the ecosystem, that impacts sales tax treatment. Who is selling- a cultivator, distributor, wholesaler or retailer—also impact what tax is imposed and at what tax rate.
When there are multiple distributors, the first and the last may not be subject to the same tax. California imposes a 15 percent cannabis excise tax based on the average market price of cannabis and cannabis products sold in a retail sale and a cultivation tax on harvested cannabis based on weight and category (i.e., cannabis flowers, leaves, and fresh cannabis plants). California also imposes a retail sales tax of 7.25 percent, plus up to 1 percent in an automatic local sales tax. Other states such as Illinois base their tax rates on THC content. Identifying the differences correctly is where sales tax automation software may help.
Understanding a seller’s role and types of taxes their products and services might be subject to in each state can be difficult. With 36 plus states allowing some measure of legalized marijuana sales, it is a lot tax rules and regulations to keep straight and understand. From a sales tax perspective, software can help perform calculations and make sure the vendor is charging appropriately but there are so many other factors to sales tax, such as exemption certification tracking, invoicing, licensing and registration, and remediation.
Sales tax rules fluctuate
Sales tax is not a set-it-and-forget-it task. There are exceptions to algorithmic rules in the software that need individual tax decisions that software cannot make independently without a human at the wheel. Unmonitored, sales tax automation will result in overpayments, underpayments, and/or interest and penalties.
We have many clients who supply products and services to this ecosystem and do not have a clear understanding of what they provide vis a vis the tax rules in the jurisdictions where they do business. They are unclear on what is considered exempt from sales tax, such as manufacturing products or items used in agricultural purposes, because every state might characterize cannabis and marijuana differently.
Marijuana is a plant, and in limited situations, may fall under an agricultural exemption when characterized as a crop. But that is a state-by-state statute consideration.
In many states, statute is unclear on these types of issues so an educated tax decision must be made on what to collect and remit. Generally, there is limited guidance available to confirm these decisions, and that’s where businesses can get slapped by an audit.
While the jurisdictional boundaries for marijuana sales are likely to collapse at some point in the future, what we have now in tax treatment is disjointed and challenging.
Alexander Korzhen, JD, MBA, (akorzhen@taxops.com) has almost 20 years of experience managing complex State & Local Tax projects end-to-end. His extensive experience in SALT consulting, compliance and planning delivers positive tax outcomes for clients of all sizes across industries.
Tram Le, J.D., LL.M., CPA, (tle@taxops.com) is a member of the SALTovation team at TaxOps and an adjunct professor at the University of Texas at Arlington. She writes about hot topics in state and local tax affecting business operations and growth strategies.
This content is for educational purposes only and is not intended, nor should it be relied upon, as legal, tax, or accounting advice. Consult with your tax professional to discuss the specifics of your situation and the applicability of any information presented.
