Meadow Memo: California Cannabis Taxes
Taxes are too damn high. They are also complicated and if miscalculated could lead to a lot of trouble down the line.
California’s legal cannabis market has been up and running for almost 2 months, but retailers across the state are still scrambling to figure out exactly how their taxes need to be calculated and paid. An over-complicated tax system means even the most diligent retailers may be miscalculating their taxes — the result of which could be anything from fines to audits to lawsuits.
“Any successful cannabis operator will need to understand the regulations, maintain detailed records, calculate their taxes correctly, and pay on time. While it may not be sexy, that will ultimately be the key to success in California’s legal cannabis market. “
Under the new regulations, cannabis retailers in California must calculate, record, and remit the state excise tax, sales & use tax, and local taxes for their particular jurisdiction. While that may seem straightforward enough, a number of complications and questions arise, including when and how to calculate the state excise tax, which taxes apply to non-cannabis products, how to pay taxes for loyalty, promotional, and compassion products, and which taxes are taxed.
We’ve invested a lot of time and energy in taxes and have helped our partners to navigate the pain, confusion, and frustration. Here is our attempt at sharing our learnings and bringing some clarity.
Disclaimer: We are not your accountants. We are not your lawyer. Please discuss any decisions around taxes with your accountant or tax attorney.
While some of the taxes may appear ridiculously complex, they are rule-based and therefore manageable when you know the rules and can apply them with a consistent process. So let’s begin!
First, some background…
The California cannabis tax structure first appeared in Prop 64 (AUMA) requiring retail cannabis sales be subject to: (1) any local tax that jurisdiction imposes on adult use and/or medical cannabis sales, (2) the California sales & use tax, and (3) a 15% state excise tax. As California’s emergency regulations were developed and implemented, changes were made regarding how and when these taxes should be calculated. As a result, local and state taxes — and the excise tax in particular — have become more complicated for retailers.
In October 2015, Governor Jerry Brown signed into law California’s first Medical Cannabis regulations (MAUCRSA). In November 2016, the state of California voted YES on Prop 64 (AUMA) to legalize Adult-Use Cannabis.
The regulations for both Adult Use and Medical cannabis went into effect on January 1, 2018. With these new regulations came a complicated tax system and new taxes across the supply chain.
Calculating the State Excise Tax
The California excise tax is calculated at a rate of 15% of the average market price of cannabis and cannabis products. When retailers purchase products from a distributor — an “arms-length transaction” — the average market price is determined by the wholesale cost of goods sold (COGS) and a markup determined every 6 months by the CDTFA. That markup is currently 60%, so the average market price is calculated as:
(COGS x 1.6)
The excise tax is therefore 15% of the average market price, or:
.15(COGS x 1.6) = 24%
The majority of cannabis products sold in California will come through third-party distributors. Taxes in these arms-length transactions should be calculated at the time the Purchase Order is made and are due within 90 days of receipt of the product.
There are cases, however, when a third-party distributor is not involved — “non arms-length transactions”. For vertically integrated retailers who produce and distribute cannabis and cannabis products themselves, the average market price of those products is equal to the retail purchase price, so the excise tax is 15% of gross retail receipts.
Why is the Excise Tax so important?
After decades of grey market operations, California’s legal cannabis industry is going to be regulated and taxed — and the state is going to make sure it’s getting the tax revenue.
Regulatory compliance and clean accounting will be a major factor in determining which businesses survive the first few years of legalization. The excise tax has proven to be especially difficult in its application, but miscalculating this tax could result in a business overtaxing customers (which is illegal), misreporting taxes (which is illegal), or under/overpaying taxes (which is also illegal). The consequences range from fines and back-taxes to audits to lawsuits. Understanding the excise tax and utilizing the right technology to employ a consistent, compliant approach will be essential for maintaining regulatory compliance and surviving California’s legalized market.
What to look out for
High taxes and regulatory costs across the supply chain have sent cannabis price soaring and customers are experiencing sticker shock. Retailers are trying to advertise competitive pricing, and one way to do that is to apply taxes at the point of sale, rather than baking those taxes it into the base product price. While this is a tempting practice in California’s uber-competitive and price-sensitive landscape, calculating the excise tax this way for any arms-length transaction is illegal, will throw off your books, and could result in a business collecting more tax from customers than it remits to the state, landing it in a lot of trouble with its customers and the CDTFA.
Local Taxes
Under current law, any jurisdiction (municipality or county) can create additional taxes on cannabis businesses and sales. That means taxes are calculated differently in each of the 540 jurisdictions allowing cannabis, with local taxes rates ranging from approximately 0% to 10%. These can be set at a single rate or variable rates depending on a few factors. To determine the correct local taxes on a transaction, you will need to know which jurisdiction the sale is taking place in and what the local adult use and/or medical taxes are in that jurisdiction. These taxes may differ by license type, business size, and how the local tax is calculated.
Sales and use taxes
Sales tax is familiar to consumers and businesses — it’s tacked on every retail sale in the state and cannabis is no exception. However, there are some cases when the sales tax is not so straightforward.
Medical cannabis patients with an MMIC issued by their county Department of Public Health are exempt from sales tax on cannabis and cannabis products only; accessories and non-cannabis products are never exempt from sales tax. When retailers give a sales tax exemption, they should record the MMIC number in the patient’s secure profile for sales records.
Another consideration is use tax for free products. Dispensaries will often give out free samples, promotional products, loyalty rewards, and compassion products to their patients. While retailers may not want to charge the purchaser tax in such cases, the use tax will still be due for those items. In this case, the use tax rate would be applied to the wholesale cost of goods sold.
Taxing Taxes
California has explicitly stated that when sales tax is calculated, the amount taxed must include the state excise tax — which means we have a tax taxing another tax. Same goes for local taxes added as a line item on top of the retail subtotal. So when a retailer rings up a customer or patient, they must first add up the subtotal as (base price with excise tax included + local taxes). The sales tax will then be applied to that subtotal. Valid MMIC holders will be exempt from this sales & use tax for purchases of cannabis and cannabis products.
Accuracy and Compliance
It’s important to find a technology partner who can help you navigate these taxes. Meadow has an all-in-one dispensary software platform for retail and delivery and we’re ready to help. Please reach out to partners@getmeadow.com for more information.
For more information please check out CDTFA’s Tax Guide https://www.cdtfa.ca.gov/industry/cannabis.htm#Retailers
