So you want to start a California pot biz: a primer

 
California is experiencing a “Green Rush” following the recent passage of Proposition 64 legalizing recreational use and growth of marijuana. More and more individuals and businesses are considering getting into the cannabis industry to cash in on this billion-dollar ($6.7 billion to be exact) industry. So what do you need to be aware of before diving into the pot biz?
 
1.Marijuana is Illegal Under Federal Law
 
Let’s briefly go over some basic federalism principles for those of us who snoozed through that section of American government. Federal laws are enacted by Congress, apply to all 50 states, and are enforced by, you guessed it, the Federal Government. State laws are laws adopted by individual states and are enforced by the State government.  Here’s the kicker, the Federal government cannot compel States to enforce federal laws or enact specific regulations. However, if Federal law conflicts with State law (as is the case with state legalization of marijuana) the Supremacy Clause of the Constitution says Federal law trumps (no pun intended).
 
In 1970 President Richard Nixon and the 91st United States Congress enacted the Controlled Substances Act (CSA) which outlined the familiar Schedule I-IV system of classifying drugs. The CSA is a Federal law. Under the CSA, marijuana is Schedule I controlled substances meaning it has a “high potential for abuse which may lead to severe psychological or physical dependence” and no currently accepted medical use in treatment. Other Schedule I controlled substances include heroin, ecstasy, and LSD.
 
Fast forward to 2017, twenty-six states including California have enacted broad state legislation legalizing marijuana in some form. So what does this discrepancy between State and Federal law mean for a budding (pun intended this time) pot business owner? The Federal Government can descend upon your fully state compliant pot business and decide to enforce the CSA at any time (although they’ve said they won’t for now...more on that later). 
 
The risks of Federal enforcement is one that all cannabis entrepreneurs must be aware of and the consequences are not limited to asset seizure.
 
2. It’s Hard to Make a Profit Under Current Tax Schemes
 
Let’s face it, taxes suck but they especially suck for cannapreneurs thanks to a super archaic section of the tax code that has recently been dusted off in a blaze of glory. Section 280E of the Internal Revenue Code says:
 
“No deduction or credit shall be allowed for any amount paid or incurred . . . if such trade or business . . . consists of trafficking in controlled substances.”
 
If your business is involved with distribution of cannabis (dispensaries I’m looking at you) you may not deduct ordinary expenses such as rent, utilities, and payroll when calculating your taxes. If your business can’t deduct expenses from your profits when calculating taxes, this means your business will pay handsomely to the IRS. Yes, it’s illegal, but you still have to pay taxes on it.
 
This section of the tax code was so arcane and irrelevant for so long that many skilled CPAs are not aware that it exists. It's impact on cannabis profits is tremendous and It is very important that a marijuana entrepreneur operating in this space hire a CPA who is deeply familiar with 280E (and all other applicable state/county cannabis taxation schemes) to ensure tax compliance and that corporate taxes do not swallow up all of an entity’s income. 
 
3. California Cannabis Entrepreneurs Should Look Carefully at County Regulations
 
The United States Department of Justice (DOJ) is the federal executive department responsible for the enforcement of Federal laws so it’s no surprise that folks in the cannabis industry are watching it carefully. Between 2009 and 2013, the DOJ issued three memos providing guidance to federal prosecutors in States, such as California, with marijuana legalization schemes. These memos did not change Federal Law or the CSA in any way but they did provide some insight into how the Federal Government plans to deal with the conflict between State and Federal Law. All aspiring cannabis small business owners should read these memos in their entirety.
 
One important nugget of information from these memos is the DOJ instructed its prosecutors to lay off individuals whose actions are in clear and unambiguous compliance with robust state cannabis regulatory schemes.
 
In California, those robust regulatory schemes are held at the county and incorporated city level. California has 58 counties and 482 incorporated cities each with its own regulatory schemes and agendas.  Accordingly, a California marijuana entrepreneur should carefully weigh the location of his or her business within California especially with regard to the County’s particular regulations, taxes, and permitting schemes when deciding where to set up shop.
 
4. The Current Administration Might be Hostile Towards Legalization of Marijuana
 
The elephant in the room is what will come of this burgeoning industry under the recent regime change. Trump stated repeatedly during his campaign that he would respect states’ rights with respect to cannabis regulation. More recently however, Press Secretary Sean Spicer stated recreational use may see “greater enforcement.”  This suggestion is in line with Trump’s pick for Attorney General (head of DOJ) Jeff Sessions who was quoted saying, “good people don’t smoke marijuana.” The question remains whether the cannabis industry’s potential for tax revenue will be enticing enough to keep federal enforcement at bay.
 
In summary, getting into the pot biz has the potential for a tremendous upside if executed carefully. However, it’s certainly not for the faint of heart or risk adverse. Knowledge is key and staying abreast of new developments as the landscape of cannabis law evolves in California is of utmost importance. Smith Shapourian Mignano PC is available to answer your cannabis business questions, please feel free to contact us for a consultation.
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This blog does not constitute solicitation or provision of legal advice, and does not establish an attorney-client relationship. This blog should not be used as a substitute for obtaining legal advice from an attorney licensed or authorized to practice in your jurisdiction. You should always consult a suitably qualified attorney regarding any specific legal problem or matter in a timely manner, as statutes of limitations may bar your claim.