Taxing marijuana – a quandary

Updated 11.18.2016

Residents of four states — California, Maine, Massachusetts, and Nevada — voted in favor of legalizing recreational marijuana on November 8, bringing the number of states where pot is legal to seven. With another three states approving medical marijuana on Tuesday, cannabis is now (or soon will be) legal in some capacity in more than 25 states.  In most states, the prospect of taxing sales of cannabis was an important selling point.

Although more states now permit legal use of some sort of marijuana than prohibit it, marijuana is still considered a schedule 1 controlled substance by the federal government. This puts vendors of marijuana in a pickle, as a recent case heard by the Court of Appeals of the State of Washington reveals.

The 2011 Washington State Medical Use of Cannabis Act (MUCA) doesn’t legalize the retail sale of medical marijuana but does permit “noncommercial production, possession, transportation, delivery, or administration of cannabis for medical use” and the operation of “collective gardens.” Nonetheless, the Washington State Department of Revenue (DOR) has been unequivocal since 2011 — before MUCA took effect — that “sales of medical marijuana are retail sales” subject to both retail sales tax and the business and occupation (B&O) tax.

Does collection and remittance of tax on sales of medical marijuana in Washington put the seller at risk from the state and federal government?

The case

According to the Court of Appeals opinion Nickerson v. Washington State Department of Revenue, Martin Nickerson filed a master business application for “Northern Cross,” seller of skin products, hemp products, and soap in 2011, and another for “Northern Cross Collective Gardens” in 2012. The applications indicated they were both retail businesses and the box for tax registration was checked on each. However, “neither he nor his businesses ever filed tax returns or paid taxes.”

In April 2012, the state charged Nickerson with multiple felony counts for delivery of marijuana, possession of marijuana with intent to deliver, and maintaining a place for controlled substances.

Then, in November 2013, DOR assessed taxes against Nickerson and his businesses for the years 2011-2012. Nickerson didn’t respond to DOR, file returns, or pay taxes, and on December 30, DOR issued warrants for unpaid taxes for Nickerson and Northern Cross Collective Gardens. The following year, Nickerson filed a tax appeal petition and eventually filed suit against DOR, “seeking declaratory relief and a permanent injunction against enforcement of the tax assessments.” Upon the trial court’s denial, Nickerson appealed.

According to the opinion, “Nickerson argues that the trial court erred in denying his injunction because (1) DOR’s attempt to collect taxes on retail sales of medical marijuana is preempted by the federal Controlled Substances Act (CSA), 21 U.S.C. §§ 801-971; and (2) requiring that he file tax returns and pay taxes on medical marijuana sales would violate his right against self-incrimination by providing the State with evidence it could use against him in his pending criminal prosecution for possession and delivery of marijuana.”

The Court of Appeals found that collection of B&O and retail sales tax on medical marijuana transactions is not a violation of the Controlled Substances Act because:

• “Such tax collection does not create a positive conflict with the purpose of the CSA as required for preemption” … and
• “Filing tax returns and paying retail sales and B&O taxes does not violate Nickerson’s Fifth Amendment right against self-incrimination because those actions do not require Nickerson to divulge any incriminating information.”

Under Washington law, the definition of “retail sale” does not distinguish between legal and illegal sales. Furthermore, while the gross amount of any sales must be included on the combined excise tax return, sellers are not required to divulge the type of product sold when remitting the applicable retail sales and B&O taxes.

Nickerson was unable to prove to the court that Washington law requires him to violate federal law. The state does require him to remit all applicable retail sales and B&O taxes, but the opinion notes that “Washington tax law does compel Nickerson to engage in conduct the CSA forbids — selling marijuana.”

This case reveals the fine line that must be walked in states that have legalized the use, possession, or sale of a product that’s illegal under federal law. The opinion acknowledges that “DOR’s tax assessments on collective gardens indicate that it is aware of the medical marijuana market” but reminds that “states have authority to tax illegal activities.” Nickerson must pay the taxes he owes, and eventually face any other consequences that come his way.

Additional details are available in Nickerson v. Washington State Department of Revenue.

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