Cannabis sales high, but so are costs

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GREAT BARRINGTON — From the outside, Berkshire County's first legal pot shop appears to be fattening its accounts, as money rolls in without a hitch.

But open those high-security doors and the inside story at Theory Wellness is different, as it is for all legal cannabis operations in this nascent industry — there's a big hitch come tax time under a federal law that won't allow deductions for business expenses.

And with tight and changing regulations, extreme market volatility, and a steep fee to the town, it's not the green rush that it appears.

"People see the lines at Theory and they read the headlines," said Nick Friedman, Theory co-founder and chief financial officer. "But it's a world where costs are high and they can't be deducted."

In January, Theory was the first recreational pot shop to open in the Berkshires after the state's legalization took effect in 2018. The company had made a quick pivot from its already-established medical marijuana business on Stockbridge Road, which opened in 2017.

The company's growing and manufacturing facility is in Bridgewater, as is another medical dispensary. Another recreational shop is about to open in Chicopee, and a medical dispensary will eventually follow. And Theory now has an outdoor farm in Sheffield, in partnership with a local farmer.

But the intricacy and sheer volume of state regulations hampers the industry — as some say it should — and even local officials across the Berkshires are still stumped by decision-making about a product still stigmatized by longtime prohibition. Five other retail shops are in Great Barrington's permitting pipeline. And rural towns also don't want to stifle this new source of revenue.

A weird Catch-22

Friedman has just written a check to the town for $414,000. That's the company's third quarter "Community Impact Fee" under its host agreement contract with the town, in which 3 percent comes off gross sales.

Another check, for $357,274, had just arrived at Town Hall. This one, from the state, was the town's 3 percent cut from the taxes Theory paid to the state this third quarter.

Since it opened, Theory has padded town coffers with $1.54 million in taxes and fees. It its first six months alone, it grossed $16 million.

Friedman is not complaining. He's passionate about his work, his interest sparked by his father's recovery from paralysis during a ski accident, and his recovery due in large part to medical cannabis. But he said he wants people to understand the built-in economic obstacles for pot retailers, including competition on the horizon.

"What happens when the neighboring state goes legal?" he said. In Theory's case, there are two state borders about 20 minutes away — New York and Connecticut.

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And there are straightjackets, he said. That the host agreement is structured as a royalty, which comes off of gross revenue, is tough, Friedman said.

"Many startups don't even realize profits for the first several years," he said. "Companies might have to borrow more money just to pay off host agreements. Three percent of gross revenue equates to 30 percent of profit."

Then there is the lending landscape, with higher-than-usual interest.

"Borrowing costs aren't on an even playing field because [cannabis] is federally illegal," Friedman said. "We can't just go to a bank and get a loan — we have to raise money privately."

Market volatility and price swings are part of the picture. It's happening now, for instance, because of the state's new vape ban, which has caused inventory costs to double.

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Other operational costs like rent, payroll, payment processing and "digital blacklisting" in marketing hike expenses because of the "shadow of federal illegality" and the the ensuing "predatory pricing" for cannabis retailers, Friedman said.

None of the inflated costs can be deducted, and this is where federal tax code crimps hard.

It's known as Internal Revenue Code 280E, a law that won't allow business expense deductions for retail marijuana. It was born out of a 1981 court case to stop a cocaine trafficker from writing off business expenses. It covers all controlled substances, and its aim is to make drug dealing untenable.

"It's the biggest pill," Friedman said. "Greater than the risk of crop failures or market volatility."

For decades, no one even thought about 280E. But then states began to legalize.

"It creates a weird Catch-22-like situation," he said. "You have to pay taxes, but to pay taxes you could be putting yourself out of business."

Retailers can only deduct the cost of goods sold, and this also applies to state taxes, since the state follows IRS code.

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"In the eyes of the IRS, we're no different than that 1981 cocaine dealer," Friedman said.

Trafficking vs. retail

Erik Williams, co-owner of Canna Provisions in Lee, said another cost for retailers is having to hire accountants and lawyers who can help the business minimize their tax exposure, and structuring job descriptions, for instance, to reduce what according to federal law is "trafficking," which is the "actual handing over of cannabis."

A former political consultant, Williams said he's spoken to hundreds of people in government about a change to the tax code since be began working in the cannabis industry nine years ago.

While the courts have not brought relief — in June, the U.S. Supreme Court wouldn't even entertain a challenge to the law brought by a Colorado dispensary — there was a tiny spark of hope in a U.S. Tax Court judge's Oct. 23 partial dissent in an opinion that ruled against a California dispensary on the 280E issue.

But federal lawmakers plan to take up the matter. A spokesman for U.S. Rep. Richard Neal, D-Springfield, said that Neal, who is chairman of the Committee on Ways and Means, says he and his colleagues are going to take a close look at the code in the context of a "comprehensive approach toward a "sensible Federal cannabis policy."

Neal thinks changes to the tax code are an important part of this, said spokesman William Tranghese.

"As that project moves forward, he intends to work with the members of the Committee," Tranghese wrote in an email. "These discussions will likely include section 280E, taxpayer compliance issues, the potential to tax these products at the federal level, as well as other issues that arise based on member input."

Friedman, 31, who started the business with his college friend and Theory CEO Brandon Pollock, said that none of this might get resolved until cannabis is legalized at the federal level. But that's OK — Friedman is not in the business just to make a buck. He says Theory has helped people obtain medical cannabis, advanced policy and science and brought a new economy and employment to the community.

He also suggested that the industry is disrupting a historically menacing public policy that borders on social engineering.

"What keeps me doing this is the legalization of a substance whose illegality has been used to discriminate."

Heather Bellow can be reached at hbellow@berkshireeagle.com or on Twitter @BE_hbellow and 413-329-6871.


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