Few industries offer the hype or growth prospects that are currently surrounding legal marijuana. A March 2017 report from GreenWave Advisors predicted that the legal cannabis industry in the U.S. could grow at a compound annual rate of 36% between 2016 and 2021, leading to a $30 billion market. Investment firm Cowen & Co. has gone one step further, predicting $50 billion in U.S. sales by 2026.

This rapid growth has meant one thing for marijuana stock investors and the businesses that operate in the industry: big returns. The average return of the 14 largest marijuana stocks by market cap is well in excess of 100%, and investors see little signs of slowing in the years to come, with favorability toward pot improving with each passing year.

A person holding cannabis leaves in their hands.

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Nevertheless, cannabis remains a wholly illegal Schedule I substance at the federal level. With that scheduling comes a host of disadvantages that pot-based businesses face. These include an inability to take normal corporate income-tax deductions, as well as difficulty in securing basic banking functions. Since financial institutions report to the Federal Deposit Insurance Corporation (FDIC), and the FDIC is a federally created entity, they simply don't want to run the risk of being fined or face criminal charges for money laundering.

This bifurcation whereby marijuana has flourished at the state level and been stymied at the federal level has gone on for some time now. As long as the federal government maintains its hands-off approach, marijuana stock investors and the industry remain cautiously optimistic regarding their growth prospects.

But what if the federal government's approach to overseeing the cannabis industry wasn't as hands-off as perceived?

Are the DOJ and IRS cracking down on pot businesses?

As reported by the Denver Post, a lawsuit filed by a legally operating marijuana business in Colorado, one of the eight states to have legalized recreational weed, alleges that the Internal Revenue Service (IRS) has been using the guise of tax audits to conspire with the Department of Justice (DOJ). The case, filed by the owner of Rifle Remedies, a marijuana business in Silt, Colo., is challenging IRS subpoenas to the Colorado Marijuana Enforcement Division (MED) seeking information about how they've grown cannabis, and to whom they're selling their cannabis.

An IRS employee conducting an audit at his desk.

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Lawyers representing Rifle Remedies had this to say:

The IRS is working jointly with the Department of Justice to investigate purported criminal activity of the taxpayers. To this end, the IRS has converged on Colorado and is conducting mass audits of those it has determined to be unlawfully trafficking in controlled substances... dishing out summonses like candy.

The lawyers have also suggested that the DOJ trained IRS agents in March 2016 in criminal drug law investigator techniques.

Why would Colorado businesses feel threatened by IRS audit inquiries? To begin with, as noted, businesses that sell a federally illegal substance aren't allowed to take corporate income-tax deductions under U.S. tax code 280E. More importantly, though, they're fully aware that they're selling an illegal substance at the federal level and fear the potential for federal prosecution. The lawyers representing Rifle Remedies have suggested that their clients would be willing to hand over whatever information is requested in exchange for immunity from prosecution.

For its part, the IRS and DOJ have denied the claims in the lawsuit. The IRS supports its audits and subpoenas with MED as necessary, given its need to verify financial information and ensure that Colorado weed businesses do not owe more in taxes.

A book on federal and state marijuana laws sitting next to a judge's gavel.

Image source: Getty Images.

Good news, bad news for legal marijuana businesses

Regardless of the outcome of this specific lawsuit, legally operating marijuana businesses in Colorado, and other legal states for that matter, have one silver lining to fall back on: the Rohrabacher-Farr Amendment. This piece of federal legislation protects marijuana businesses that are operating legally from federal prosecution. It won't protect them from tax fraud if they're purposely deceiving the IRS and not paying their fair share of taxes, but it'll keep the federal government from using federal funds to prosecute medical and recreational pot businesses that are selling a substance deemed to be illegal.

That's the good news. Now here's the bad news: Attorney General Jeff Sessions doesn't really care about states' rights. In May, Sessions sent a letter to Congressional leaders asking them to repeal the Rohrabacher-Farr Amendment so that he could go after medical marijuana businesses operating in the 29 currently legal states. Sessions has long opposed any expansion of cannabis in America and has not minced words about the drug. In effect, marijuana businesses and stocks are never fully safe from prosecution as long as Sessions maintains the office of attorney general.

For the time being, it looks as if Congress will continue to deny Sessions federal funding to go after legally operating weed businesses. But considering Republicans are among two groups of people still opposed to marijuana's expansion (the other being senior citizens), it's not out of the question that the Trump administration and Congress change their tune at some point in the future. In short, the marijuana industry should continue to remain a volatile and risky bet for both businesses and investors.

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