How pot businesses are getting smoked by high taxes

The legalized marijuana industry may generate better revenue per square foot than some traditional retailers. Profits, though, are another story.

Operators in the $7.1 billion dollar cannabis industry, such as Colorado-based LivWell Enlightened Health and California's Harborside Health Center, are prohibited under the federal tax code from deducting expenses that other types of businesses can use, such as the cost of labor, marketing and advertising, office supplies and Internet service.

As a result, LivWell and Harborside, two of the largest operators in the industry, are stuck with high tax bills that cut into profits.

LivWell CEO John Lord said his company, which operates in 14 locations in Colorado, pays an effective tax rate of about 80 percent, more than double the 35 percent statutory rate for U.S. businesses. The company can offset some costs by deducting expenses related to the production of marijuana and non-cannabis businesses.

"We are marginally profitable, not exceedingly profitable," Lord said, while declining to provide specific numbers. "Although the top line revenue is there, the bottom line is not."

Harborside, which is structured as a non-profit to comply with California law, is in a similar predicament and is challenging the IRS' efforts to collect a $2.4 million tax bill resulting from an audit of its returns from 2008 and 2009. The company's case is pending before the U.S. Tax Court, with a ruling expected early next year.

The rules "adversely and unfairly" affect their ability to earn income, argued Henry Wykowski, an attorney representing Harborside.

LivWell "is currently being audited and has been for two years," a spokesperson said.

High taxes have prompted operators to try creative ways to lessen their tax burdens by offering non-marijuana services such as massages where these deductions are permissible, according to Chris Walsh, editorial director of Marijuana Business Daily.

The IRS, not surprisingly, is keeping a close watch on the industry, which technically remains illegal under federal law.

A survey released last year by Marijuana Business Daily found that more than 6 percent of cannabis companies reported being audited -- well above the 1.4 percent average rate for all U.S. businesses.

"They do seem to be targeting cannabis businesses," Wykowski said.

The IRS didn't respond to an email query about its policies and procedures related to pot companies.

Adding to the industry's woes is an increasingly less friendly regulatory climate in some states, including Colorado.

Colorado cannabis operators headed off a ballot measure that would have placed limits on the amount of THC, the psychoactive ingredient that makes a user high, in marijuana sold in the state. Other challenges remain, including Denver's new odor ordinance and an initiative in Pueblo that could roll back legalization in their community.

"We're an easy target for over-regulation," Lord said. "I struggle to see how the smaller entities can survive."

  • Jonathan Berr On Twitter»

    Jonathan Berr is an award-winning journalist and podcaster based in New Jersey whose main focus is on business and economic issues.