Collecting cannabis taxes from marijuana farms

In November 2016, when the state of California passed Proposition 64 legalising recreational use of marijuana for adults, the tax implications were a bit murky. Seemingly everyone wants a piece of the billion-dollar-plus tax bonanza that legal cannabis is expected to provide, but the law – which came into effect on 1 January 2018 – only spells out what the state's cut of the tax will be. Local cities and municipalities have the freedom to create and enforce their own cannabis tax ordinances and governing bodies all over California have responded by doing just that, asking voters to approve a wide variety of cannabis-related tax proposals.

These new, voter-mandated cannabis taxes are presenting a variety of challenges for local governments, particularly in areas where cannabis has been a large part of the economy for decades. In Mendocino County, officials are working hard to educate growers about the steps they need to take to comply with the state's new regulations, a shift that involves changes in both policy and culture. One big change is a new tax on growers and cannabis-related businesses, the revenue from which will be used primarily for road repairs, youth drug prevention efforts and mental health services.

New taxes require new systems. Soon after Mendocino County passed its own cannabis business tax measure, the county asked Thomson Reuters for help developing a system to deal with the law's new regulatory framework and tax structures. Mendocino County is one of many in California that have contracted with Thomson Reuters for its Aumentum property tax and business revenue modules. The challenge was to configure the modules for a new type of tax entering the formal economy in barely more than a year, as the people of California had only approved legalisation in November 2016.

As it is, the logistics of registering growers and enforcing new regulations are formidable. In Mendocino County, for instance, voters approved a 2.5% tax on cultivators' gross receipts, one of 5% on dispensaries, and a $2,500 annual flat tax on the cannabis supply chain – manufacturers, labs and distributors. When the measure passed, Mendocino County tax collector Shari Schapmire's first thought was, "We've got to have some kind of software to accommodate this. What are we going to do?"

Located three hours' drive north of San Francisco, Mendocino County is, along with Humboldt and Trinity Counties, part of the so-called Emerald Triangle, the largest cannabis-producing region in the USA. In Mendocino County alone, there are more than 5,000 independent growers, all of whom are now required by the state to register so they can be properly regulated and duly taxed.

Collecting that local tax revenue is Schapmire's job – and it is a big one. Those who want to grow cannabis legally must obtain permits from both the state and local authorities, as well as complying with strict regulations concerning water sources, setbacks, drainage, pesticide use and other restrictions. Getting growers to register is the first challenge. "People want to be compliant. They want legitimacy. But there's a trust issue now, because there's still the concern that growing cannabis is federally illegal," Schapmire says.

That may sound routine, except that one of the complicating factors with the new cannabis business tax is that it will be collected quarterly. Also, because cultivators do not generate revenue every quarter due to their crop's growing cycle, the county has imposed a minimum fee of $1,250 to $5,000 per growing cycle, depending on the size of the plot. "The biggest issue we have right now is that this is a gross receipts tax, first and foremost, but due to the minimum requirements there will be true-up issues at the end of each fiscal year," Schapmire explains. "This is very challenging, but we are moving forward."

Furthermore, there are the taxes and assessments being received from other sources that have nothing to do with cannabis. "In addition to collecting property tax, we also collect a transient occupancy tax, a tourism assessment and issue general business licences," Schapmire says. "I wanted a software product that could accommodate all of our taxing and licensing needs which is why we chose Aumentum."

Another challenge Schapmire faces is that cannabis is largely a cash business. Banks are still reluctant to participate in the cannabis economy, so, for instance, many of Mendocino County's residents pay their property taxes by showing up at Schapmire's office with large bundles of cash. Her office has cash-counting machines, and an armoured car shows up every day to take the money away. Schapmire estimates that at least 60% of the cannabis economy is cash and until some sort of banking system is created for the industry, it is expected to stay that way.

Managing all these regulatory changes would be even more difficult if Mendocino County didn't already have a head start on the rest of the state. Before Proposition 64 passed, the county's board of supervisors had already spent years crafting local cannabis regulations to address issues related to the medical market. The cannabis business tax went into effect on 1 January 2017, but the only taxable businesses at that time were medical dispensaries because they were already licensed. The cultivation business tax did not begin until 4 May 2017, following the adoption of the Cultivation Ordinance – and even that was complicated by wildfire damage in October.

"Some of the cannabis was affected by the fires because it was still in the ground," Schapmire says. "We heard reports about fire damage, smoke damage and theft because of mandatory evacuations." First-quarter returns were due 31 October, she says, but the county gave affected residents an extension to 30 November to remit their taxes.

As a result, everything was ready on 1 January 2018 when the state regulation went into effect. "The tax is already in place, and our systems are in full swing," Schapmire says. Revenue from the tax will go into the county's general fund, and voters have already indicated that they want the money spent on cannabis enforcement, road improvement and mental health services.

"Thomson Reuters was extraordinarily responsive in allowing us to have the business revenue module first, and in helping us figure out how to make it happen," Schapmire says. While the rest of California grapples with the logistics of legalisation, Schapmire and her team are confident that the transition in Mendocino will continue to be smooth, and that collection and distribution of the county's new taxes will become relatively routine. For them, the hardest part is already over.

Tad Simons is an award-winning technology journalist who writes about communications, workflow issues, corporate efficiency, artificialintelligence, government administration and ethics. This article was first published by the Thomson Reuters Foundation  tadsimons@comcast.net

Related competencies include: GIS (geographical information systems), Legal/regulatory compliance, Valuation