The marijuana industry has been on an incredible ride over the past 20 years, and it appears as if that ride could pick up steam once again come November.
As it stands now, half of all U.S. states have legalized the use of medical marijuana, including Pennsylvania and Ohio, which both recently legalized medicinal marijuana entirely through the legislative process (i.e., without putting the issue on a ballot for citizens to vote on). An additional four states -- Washington, Oregon, Colorado, and Alaska -- have legalized the sale of marijuana for recreational purposes to adults ages 21 and up. The result, according to cannabis research firm ArcView Market Research, was an estimated $5.4 billion in legal marijuana sales in the U.S. in 2015. Between now and 2020, ArcView believes the legal-marijuana market can grow by an average of 30% per year.
This is why November is such an important time for the cannabis industry. Residents in at least eight states are set to vote on a marijuana initiative or amendment that could legalize medical or recreational marijuana. Approval is, of course, no guarantee, with Florida's attempt to pass a medical-marijuana amendment narrowly failing in 2014, and Oregon's first attempt to pass a recreational-marijuana law falling short in 2012. However, with Gallup suggesting in its October 2015 poll that 58% of respondents now favor the full legalization of cannabis, a rapid expansion of the industry seems quite possible.
Marijuana's expansion definitely has investors seeing its potential -- but that's not the only group of individuals whose attention has been caught. The Internal Revenue Service and its highly trained team of auditors is seeing green as well.
Marijuana has the IRS seeing green
For those of you who may need the reminder, cannabis-based businesses face two inherent disadvantages as long as the federal government keeps marijuana as a schedule 1 (and therefore illicit) drug.
First, businesses that sell substances which are defined as illicit by the federal government are disallowed from taking normal businesses deductions when they prepare their taxes. This U.S. tax code, 280E, means that marijuana companies can't deduct even simple things, like rent, when filing their annual income taxes. It also means they're likely paying a much higher tax rate than normal businesses with similar revenue and income.
Secondly, since marijuana is still considered illegal at the federal level, banks generally want nothing to do with the industry. Of the roughly 6,700 banks around the country, just 3% have been willing to work with cannabis-based businesses, the reason being that banks fear the potential for prosecution down the road for circumventing a federal law. This has left cannabis-based business to mostly deal in cash, which is both a security risk, and a logistical nightmare come tax time.
According to Marijuana Business Daily, the IRS has set its keen eyes on Colorado's marijuana businesses and is specifically focusing on Form 8300, which is a form that needs to be filed by businesses with the IRS in any instance where $10,000 or more in cash was received as payment. With the industry so reliant on cash, there's the notion that it could be easier for payments to fly under the radar of the IRS, or for money laundering to occur. MBD notes, via Colorado attorney Jim Thornburn, that at least 30 of the more than 500 marijuana dispensaries in Colorado have been hit with a Form 8300 tax audit within the past couple of weeks.
It's worth noting that all businesses are required to file Form 8300 when receiving $10,000 or more in cash, not just the marijuana industry. But given that so few banks have been willing to offer basic financial services, such as a checking account, to cannabis-based businesses, the IRS could be taking an especially careful look to ensure it gets its fair share of taxes from the industry.
Chalk up yet another reason to not invest in marijuana (for now)
Although there are clear avenues for the marijuana industry to rapidly grow, there are an increasing number of obstacles standing in the way of John and Jane Q. Investor who'd like to profit from marijuana's expansion.
We've discussed two of the biggest disadvantages: taxes and a lack of access to basic financial services. But we can also see there are more issues to contend with. If the IRS is going to pay extra close attention to cash transactions in the cannabis industry, legal expenses for these businesses could be a lot higher than investors had factored in. Again, I want to reiterate that IRS audits of Form 8300 are normal across all businesses, but the cash-specific nature of the marijuana industry makes it a prime target for the IRS.
Additionally, most marijuana-based businesses that you can buy as an investor are trading on over-the-counter exchanges and/or are losing money. In theory, there's nothing wrong with buying a stock on the OTC exchanges. However, listing requirements can be more lax on OTC boards, which can make it tougher for you, the investor, to get any sort of up-to-date information on a company's balance sheet, or in some cases business model. What you'll find as you peruse through the minefield of marijuana stocks is that they're nearly all penny stocks with a mountain of losses.
As I've said previously, the marijuana industry isn't worth your hard-earned investment dollars unless we see genuine change from Capitol Hill. When the industry becomes more business-friendly is when investors can consider entering this space. But until that time comes, green means "stop" when we're talking about investing in marijuana.
Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.
The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.