Why do medical cannabis companies pay the highest corporate taxes in Minnesota?

While recreational marijuana isn’t legal in Minnesota, medical marijuana is. But there are only two companies licensed to produce it in the state, and high taxes are harshing their buzz.

That would change if provisions in the House and Senate omnibus tax bills become law. The tax committees of each body approved language that would allow medical cannabis manufacturers to subtract such business expenses as rent, utilities, insurance and maintenance from their taxable income.

The language appears in both HF2125, sponsored by Rep. Paul Marquart (DFL-Dilworth), and SF5, sponsored by Sen. Roger Chamberlain (R-Lino Lakes), two bills currently being combined via the conference committee process.

Because they aren’t allowed to deduct such expenses, medical marijuana companies are now taxed at an effective rate of about 70 percent. That’s the highest effective tax rate of any industry doing business in the state.

How did the rate get so high? Well, it’s because of Section 280E. That piece of the federal tax code came about as a result of a 1981 lawsuit brought against the Internal Revenue Service by a Minneapolis drug dealer named Jeffrey Edmondson.

Rep. Paul Marquart

In his suit, Edmondson argued that he tried to claim a deduction for business expenses for tax year 1974, but that the IRS wouldn’t allow it. Edmondson’s business? He acted as a supplier on consignment for amphetamines, cocaine and marijuana. That year, he listed his cost of goods sold as $105,300, including mileage, packaging costs, phone calls and a portion of his rent.

In 1981, a court determined that he could do so. That inspired Congress to pass Section 280E, which banned businesses trafficking in Schedule I or Schedule II substances from deducting business expenses. And marijuana is still classified as a Schedule I drug by the U.S. Drug Enforcement Administration.

Hence, the state’s two medical marijuana companies – Minneapolis-based Minnesota Medical Solutions and Cottage Grove-based LeafLine Labs – are not able to deduct rent, utilities, insurance or maintenance on their taxes. The only adjustment they can make is “cost of goods sold.”

This is among the reasons that LeafLine Labs lost $12.2 million in the first three years of legal marijuana sales, although a 2017 supply shortage blamed on lab testing delays also contributed to its difficulties. Minnesota Medical Solutions, a division of New York-based Vireo Health, also posted losses in its first few years in operation.

According to Vireo Health’s chief financial officer, Amber Shimpa, the company’s inability to deduct business expenses is the chief reason for its losses.

“We’re very encouraged by the number of chronic pain patients who have been able to reduce or eliminate the use of dangerous and addictive opioid medications through cannabis-based medications,” Shimpa said at a March House Taxes Committee meeting. “But cost remains a top concern relayed to us by our patients throughout the state. For many Minnesotans, our medications are simply too expensive, despite our efforts to make them more affordable through competitive, compassionate discounts and loyalty programs.

“The reasons are many, including the fact that health insurance doesn’t cover medical cannabis. Therefore, all patients must cover the full cost of these medications out-of-pocket.

“But there is another layer to the cost equation, the very unusual tax treatment of medical cannabis manufacturers in Minnesota,” Shimpa said. “The Minnesota tax code demands the same exclusion, and this dramatically drives up our combined state and federal taxation rates. … As could be expected, we are forced to pass the exorbitant cost of these taxes on to our patients, making Minnesota medical cannabis prices among the highest in the nation.”

Shimpa said Minnesota would not be blazing a new trail by approving the state subtraction.

“Other states that allow for the medicinal use of cannabis have taken this step,” she said, “and we are hopeful that, as more states tackle this issue, there will eventually be change in the federal tax code.”

Also speaking at the March hearing was Cory Parnell, chief executive officer of the Bloomington-based accounting firm Boeckermann, Grafstrom & Mayer LLC. He spoke of how such prohibitions on business expense deductions might affect another company, such as Walmart.

“A Walmart would pay tax on their gross profits,” Parnell said, “so their revenue less the cost of their merchandise. And then would not be able to deduct their store rent, their general and administrative expenses. So you can probably imagine that Walmart wouldn’t exist today if they operated under that statute.”