Implications of Federal Prohibition of Cannabis for State Sanctioned Cannabis Industry

Cannabis Industry

Operating a cannabis business while it remains federally illegal can be a challenge, to say the least. A host of issues exist with operating a business which the federal government deems illegal. Even with state-sanctioned regulations in place, often the federal government has supremacy over state regulations which break federal law.

Luckily, there have been some safeguards put in place from the federal government to ensure the proper function of state-approved marijuana operations. The most famous example of this within the cannabis industry may be the Cole memo issued by the attorney general in 2013. While this has been repealed since implementation, it still serves as a fantastic pro-cannabis memo. More recently, we’ve seen Congress set up with a key addition to a bill which restricted the justice department from using any funds to attack medical marijuana operations in compliance with a state program. Even with these minor federal supports for cannabis, there are still many challenges which a business will face because of the state and federal discrepancy for cannabis regulations. This includes having to operate an all-cash business, tax implications, and threats from federal investigators. After reviewing these many challenges, we will also take an educated guess at when the United States federal government will implement the legalization of cannabis.

Cannabis Industry
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Importance of the Cole Memo for the Cannabis Industry

Developed as a response to the legalization of adult-use cannabis in Washington and Colorado, the federal government issued a memo outlining their policy on these changes. The memo, produced by acting deputy attorney general at the time, James M. Cole became the cornerstone of the safety net for business owners in the cannabis sector. The memo, released in August 2013, approximately a year after the two states legalized cannabis, directed all federal prosecutors to only enforce federal cannabis laws if a variety of conditions were not met by states looking to implement cannabis programs.

First, the states had to ensure that cannabis would not be readily accessible to minors. This feature became fairly easy to implement since regulations required state identification before a licensed store would sell to a consumer. Second, the states had to ensure that marijuana profits would not end up in the hands of gangs, cartels, or other criminal enterprises. This became a bit harder to implement but with a strict background check process adopted by both states for operators in the industry, this too proved to be easy to follow. Third, the state had to stop the diversion of cannabis products to other states. This became a bit more a challenge than the first two guidelines and ended up with a lawsuit being filed from neighboring states to Colorado because so many cannabis goods were being seized by everyday folks and drug dealers smuggling cannabis out of Colorado. Luckily, this lawsuit ended up being thrown out by the courts.

Read Also: State by State Overview of Medical Marijuana Programs in Recreational Markets

The remaining regulations revolved around public safety and included guidelines that prevented marijuana companies to be a front for other illegal drug operations. Also, added on a similar note, the state had a responsibility to prevent violence from being involved in the cultivation or distribution of marijuana. Again, the act of regulating the substance naturally made both of these points covered more than they were during prohibition. Furthermore, the memo required the states to prevent drugged driving or other “adverse public health consequences associated with marijuana.” Finally, the memo required cannabis operating states to prevent any cannabis from being grown, possessed, or consumed on federal public lands. All and all presenting a fairly reasonable set of guidelines for states to follow if they wanted to be exempt from federal authorities while implementing their state-sanctioned cannabis programs. That is until the Cole memo was repealed by former Attorney General Jeff Sessions.

Senate Restricts Justice Dept. through Funding Allocation

In 2018, after the then acting A.G. Jeff Sessions repealed the Cole Memo, Congress found itself in need of stepping up to protect the emerging cannabis industry. Luckily the financial costs with implementing the prohibition of cannabis at the federal level greatly outweighed the benefits. This concept of removing the funding apparatus for the justice department to prosecute state-sanctioned cannabis programs became more of a reality a few years prior in a congressional spending bill. At least in regards to medical marijuana programs, Congress added protections through the restriction of federal funds. The 2014 spending bill passed by both houses included a provision that stated, “None of the funds made available in this Act to the Department of Justice may be used, with respect to states… to prevent such states from implementing their own state laws that authorize the use, distribution, possession, or cultivation of medical marijuana.” This provision has long been held as another cornerstone to the safety net of protection for cannabis businesses from the federal government intervening in their state-sanctioned businesses.

Federal Government Leaves Many Challenging Loop Holes Open

Even with these two positive moves for the industry from the federal government, much can still be desired by cannabis business operators. The discrepancies between state and federal law create a host of problems for businesses in this emerging industry to deal with. A few of these include operating an all-cash business, tax implications, and recent threats from federal investigators against licensed cannabis businesses. These challenges have led to a host of businesses offering services to counteract the troubles created. One great example of this is the advent of cannabis specific security operations which helped these businesses deal with their vulnerable all cash operations.

Operating with Cash Only

The cannabis sector has continually struggled to get access to banks and professional financial services. This made it difficult to secure traditional loans for the industry. Luckily, alternative forms of investment were ready nonetheless for the nascent cannabis sector. The problem with no access to traditional banking services became more of a burden with daily operations. The businesses, which could generate millions of dollars in revenue in a year, couldn’t deposit the cash into a bank account, use a debit card, or access a checkbook. Instead, it led many within the industry to simply bring tens of thousands of dollars in cash directly to the state to pay for taxes or licensing fees.

The industry also saw a rise in the number of niche security firms which existed to serve the sector. These were needed for a variety of reasons though since the plant’s value was artificially inflated still from prohibition, it made a single harvest of cannabis worth tens of thousands of dollars, if not much more. Furthermore, the all-cash nature of these businesses led many to fear organized crime would try to maliciously rob an operator flush with cash. This was just one caveat of an industry operating in a legal grey area between state and federal law.

Tax Implications

Many cannabis businesses have not been able to survive despite favorable cannabis commodity prices and a huge demand for the goods. This may be due to the tax challenges these businesses faced, again as a consequence of operating in the gray area of federalism. Most businesses qualify for many types of tax write-offs as they operate. This includes writing off the payroll, supplies, and other operating expenses. It’s a very normal process, especially for a CPA to manage. However, because the cannabis plant is federally illegal, it became much harder for cannabis companies to take advantages of these tax write-offs. What became known as regulation 280E, named after the section of the tax code which stops illegal operations from using write-offs.

When will the United States Federal Government Legalize Cannabis?

The cannabis industry excitedly saw this change come to the country of Canada during this year. Furthermore, there has been very positive cannabis news coming from Mexico, to name just a couple examples of how the movement to end cannabis prohibition has been steadily moving forward. Some have speculated that recent moves in the American political system may be signaling better times for cannabis federally. Although this is purely speculative, we believe cannabis legalization will happen sooner than later at the federal level. First, with 30-plus states already operating medical marijuana programs across the country, there is a good amount of revenue the feds could seek through regulating the substance nationally. Furthermore, the president has signaled he would support a bill to end the prohibition of cannabis if a bill were passed by Congress. Finally, a couple senators from Colorado and Massachusetts have co-sponsored a bill to federally allow cannabis legalization at the state level, through a bipartisan bill.

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