Cannabis Companies Get Some State Tax Relief: This Week in Cannabis Investing

Illinois joined Connecticut in signing legislation that will reduce tax burdens for cannabis companies.

Gavel next to pile of marijuana and stack of dollar bills
(Image credit: Getty Images)

Connecticut's legal adult-use cannabis market may be young, but it is already experiencing great success. In May, adult-use recreational marijuana sales eclipsed medical sales for the first time in state history. This is a great milestone for the people of Connecticut and it is a great sign of what could happen in the foreseeable future.

We were recently in Connecticut and see substantial growth potential there given the limited amount of legal dispensaries open. Those that are open are seeing healthy growth as noted in recent quarterly earnings calls from public companies with exposure to the state.

Connecticut is committed to supporting the growth of its legal cannabis industry. The state recognizes the unjust federal tax rate for cannabis, known as tax code 280e. Governor Ned Lamont recently signed legislation allowing operators to take deductions at the state level that are prohibited at the federal level. 

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"I am fully aware that this makes Connecticut an outlier among the states in this current political climate and I don't take that for granted," Governor Lamont said earlier this month when signing the state's new budget legislation into law. "By working together collaboratively, we are making Connecticut stronger and adopting policies that benefit the people who live here."

Illinois signs cannabis tax deductions legislation

Ned Lamont is not the only governor to enact beneficial tax policy changes for cannabis businesses. This week, Governor J.B. Pritzker of Illinois approved legislation that allows licensed cannabis businesses to utilize state tax deductions. Newly enacted provisions allow cannabis company business deductions for "an amount equal to the deductions that were disallowed under Section 280e of the Internal Revenue Code for the taxable year."

"Signed, sealed [and] delivered," the governor tweeted shortly after the bill was signed into law.

Connecticut and Illinois join several other states by taking this meaningful step in the right direction. States are recognizing that high taxes do not mean more revenue. In fact, high taxes are actually worse as it creates an unfair advantage for the illicit and alternative cannabinoid markets. 

The cannabis industry is not asking for special treatment in comparison to other American industries. We are simply asking to be treated the same as our peers and we are thankful for the states that share that mindset.

States punish bad-actor cannabis companies

The legalization cannabis industry has been volatile since Colorado launched adult-use sales in 2014. Since then, the industry has witnessed cycles of extreme investor euphoria and despair. 

Equity markets have also largely dried up and many companies have pivoted to leveraging their balance sheets. This recent shift within the cannabis industry has materialized in debt, real estate leasebacks, vendor financing, tax accruals and much more. Many of these shifts can be tied back to the federal tax rate born on the industry and states and municipalities with overly burdensome tax rates. Operators have also struggled with a whipsaw of wholesale pricing of cannabis because initially high prices collapsed faster than most pro forma plans expected. 

With all these challenges, some companies have slowly realized that their best option would be to shutter growth and survive by improving cash flow. Unfortunately, many cannabis companies have been unable or unwilling to explore this option. As a result, these bad actors are unable to pay their counterparts or taxes. 

California has dealt with this ongoing issue, but the lack of federal tax reform and continued tight capital markets have allowed this issue to spread into new territory. States have responded by recognizing the industry's immaturity and are seeking to implement similar laws used in other industries, like alcohol, that went through similar cycles. 

"Businesses that are working to comply with regulatory systems face a tremendous squeeze," said Chris Lindsey, director of state advocacy and public policy of the American Trade Association of Cannabis and Hemp, according to MJBizDaily. "Our public policy needs work because there is too much of a burden on struggling businesses who want to be compliant."

It is not a positive reflection of our industry that companies are behaving in this manner and it may deter investors' willingness to underwrite this business. We believe that denying licenses to those that are behaving in this manner will improve the industry. We also believe that bad actors should not be licensed to operate and should get out of the way of those that want to shepherd forward a legal and credible cannabis industry.

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Morgan Paxhia
Contributing Writer

Morgan Paxhia is Managing Director and Co-Founder of Poseidon Investment Management. With over 10 years experience in investing and finance, Morgan has developed a deep understanding of individual company analysis, portfolio construction, and risk mitigation. This content is not intended to provide any investment, financial, legal, regulatory, accounting, tax or similar advice, and nothing should be construed as a recommendation by Poseidon Investment Management, LLC, its affiliates, or any third party, to acquire or dispose of any investment or security, or to engage in any investment strategy or transaction. An investment in any strategy involves a high degree of risk and there is always the possibility of loss, including the loss of principal. This content should not be considered as an offer or solicitation to purchase or sell securities or other services. Any of the securities identified and described herein are for illustrative purposes only.  Their selection was based upon nonperformance-based objective criteria. The content presented is believed to be factual and up-to-date, but we do not guarantee its accuracy and it should not be regarded as a complete analysis of the subjects discussed. Past performance is not indicative of future results.