The legalization of marijuana scored another victory on Nov. 4, as voters in Alaska, Oregon, and Washington, D.C., created new recreational pot industries like those in Colorado and Washington state.
Still, this budding industry faces some genuine headwinds. Despite growing acceptance of legal pot, and the promise of increased revenues for the states and districts that support medicinal and recreational use, marijuana is still considered a controlled substance by the federal government -- a situation that is forcing restrictions upon entrepreneurs who try to cultivate a successful weed-based business.
Stoking state coffers
Colorado has proved how lucrative the recreational pot industry can be, with 2014 state tax receipts showing a steady, month over month rise from January through August. Increasingly, those receipts are being collected from areas of Colorado other than Denver County, where the legal weed industry has its roots.
Colorado's success presages similar profits for other states, as a recent study by NerdWallet demonstrates. Recently, the finance site estimated that nearly $3.1 billion could be collected nationally if recreational use was made legal in all 50 states and Washington, D.C.
Obstacles are slowing the industry's growth
Entrepreneurs looking to open pot shops face unusual difficulties, in large part due to the federal view that marijuana is still an illegal substance. These issues threaten the profitability of such a venture, and discourage investment in the domestic legal marijuana industry.
One huge problem stemming from the federal point of view regarding cannabis has to do with federal tax law. Intended to take the attraction out of ill-gotten gains, Section 280E of the tax code prohibits those who traffic in illegal drugs to deduct any expenses related to such a "business." This means that shops selling legal weed in states with medicinal and/or recreational pot laws have to fork over a high percentage of their profits to the federal government -- as much as 90%, according to some estimates.
Another big hurdle has to do with banking. Many banks are loath to deal with pot vendors, afraid to incur the wrath of federal regulators. This forces business owners to deal in cash only, since they are prohibited from opening bank accounts for their businesses -- despite guidance from the U.S. Department of Justice and the U.S. Treasury this past February that was meant to ease banks' fears in that regard.
Currently, many institutions still worry that engaging in the legal weed industry could cause them big problems with regulators at some point in time, absent an actual change in the language of the law, and thus avoid any whiff of involvement.
This puts pot shops in a difficult predicament: Besides the inherent danger of keeping large quantities of cash on hand, pot entrepreneurs find paying bills particularly challenging, especially tax bills.
When the two issues of tax law and prohibitive banking rules collide, legal marijuana vendors could find themselves in an unresolvable dilemma: unable to pay federal taxes electronically, as the Internal Revenue Service requires, shop owners are getting slapped with a fine for paying their quarterly withholding taxes in cash.
One shop in Denver, Allgreens, filed a petition in U.S. Tax Court recently, challenging the IRS's rule on tax payments. The agency has declined to make an exception for pot shops, but has apparently made suggestions to marijuana business owners on ways to avoid the levy -- proposed methods that sound uncomfortably close to money laundering techniques.
Investors lose out, too
Not only might states and Washington, D.C., lose revenue from the artificial restraints placed on the industry by these federal statutes, but investors are also hobbled by the federal government's perception of marijuana. Since Canada decriminalized medical marijuana earlier this year, U.S. investors have shoveled money into that country's pot industry, hoping to cash in on Canada's burgeoning cannabis market while escaping tax scrutiny at home. It remains to be seen whether or not these American investors will face charges of money laundering, however.
Will a majority of states in the U.S. have to legalize the use of marijuana before federal prohibitions are lifted? Certainly, the federal government seemingly has no incentive to decriminalize pot, considering the tax windfall it stands to make as legalization marches steadily across the nation.
By the same token, restrictive laws will likely hold back an industry that promises to be worth $21 billion within the next few years. Considering the fact that Colorado reported combined medical and recreational marijuana sales for the month of August to be $67.5 million, this estimate might actually be too low -- and that's with no change in federal statutes regarding marijuana.
As more states legalize cannabis and see how profitable this industry can be, pressure will likely mount on the federal government to change its viewpoint. In my opinion, the idea of an unfettered expansion of the industry bringing in more tax revenue at the local level is just the type of argument that could bring about a change of heart on Capitol Hill, resulting in bigger profits for sellers and investors -- as well as higher tax receipts for all levels of government.
