Weighing the Taxes on Legal Weed

Illinois legislators have rolled out the foundation for a legal recreational cannabis industry — with no shortage of taxes to go along with it.

In Illinois’ ongoing effort to cultivate new revenue sources, the state has joined a growing number of others across the nation in legalizing recreational cannabis use in hope of sparking a new industry and the economic benefits that could follow. With Illinois’ medicinal cannabis program being deemed a success, and Gov. J.B. Pritzker’s budget counting on significant cannabis revenues, the Illinois General Assembly passed the Cannabis Regulation and Tax Act, HB 1438, which legalizes sales and possession of adult-use recreational cannabis.

The new legislation establishes a tiered tax structure that imposes a variety of taxes at both the wholesale and retail levels that will be administered and collected by the Illinois Department of Revenue (IDOR).

CULTIVATORS AND CRAFT GROWERS 

The first tax is imposed on licensed cannabis cultivators and craft growers. Beginning Sept. 1, 2019, a tax of 7 percent is imposed on their gross receipts of cannabis sales. The statute provides that a cultivator must be licensed by the state to be eligible to register with the IDOR. What’s notable here is that the legislation allows the IDOR to set the selling price if it determines, for some reason, that a cultivator’s or craft grower’s transaction is not an arm’s length sale.

Cultivators may recover the tax by stating it as a separate charge on the bill to their customers. This right of reimbursement is a recognition that the tax is not a tax that is the responsibility of the purchaser. In that respect the tax is like locally imposed retailers’ occupation taxes — the tax is on the seller with a right of reimbursement from the purchaser. What this means as a practical matter is that a purchaser with enough bargaining power could actually decline to reimburse cultivators.

Cultivators are required to file tax returns monthly with the return and payments both due on the 20th of the month following the month in which the sales were made. All returns and payments are required to be filed electronically. However, the legislation allows for cultivators to petition the IDOR for an exemption to the electronic payment requirement based on hardship in recognition that entities in the cannabis business have a difficult time establishing traditional banking relationships. Because cannabis remains a Schedule I drug under the federal Controlled Substances Act of 1970 — deeming the use, sale, and possession of cannabis illegal — federally insured banks must follow federal laws governing banking that involves illegal activities. Meaning most banks currently cannot serve, or choose not to serve, the legal cannabis industry.

Cultivators are also subject to specific requirements for invoices. The invoices must be maintained in Illinois and must always be subject to IDOR inspection.

INFUSERS

The next tier in the tax process applies to companies that infuse cannabis into other products, like edibles. “Infusers,” as they are known in the legislation, may be required by the IDOR to file information returns with the department. The requirement of information returns by infusers appears to be a mechanism by which the State of Illinois can ensure that all cannabis raised and sold by cultivators and craft growers is not diverted to the black market.

RETAILERS 

The next tax imposed is the Cannabis Purchaser Excise Tax. This tax is imposed and collected by cannabis retailers on sales to end users. The tax rate varies by the type of product, and in the case of smokable cannabis, by the amount of THC.

All cannabis-infused products are taxed at 20 percent of the purchase price. Other cannabis with a THC level of 35 percent or less is taxed at 10 percent of the purchase price. Cannabis with a THC level of greater than 35 percent is taxed at 25 percent of the purchase price.

The Cannabis Purchaser Excise Tax must be stated separately on customers’ bills. It is also worth noting that the Cannabis Purchaser Excise Tax is not a portion of the tax base used for calculation of the Retailers’ Occupation Tax, aka sales tax, on cannabis purchases. Sales of cannabis to end users are still subject to all general state and local retailers’ occupation taxes. The state tax rate is currently 6.25 percent of the selling price and local tax rates obviously vary by location.

The Cannabis Purchaser Excise Tax is also required to be electronically reported to the IDOR under requirements that mirror those for cultivators.

Another point to be mindful of is that the legislation contains a specific prohibition of bundling cannabis sales with non-cannabis products. In other words, cannabis retailers cannot bundle sales of cannabis with smoking paraphernalia.

HB 1438 also imposes two new local retailers’ occupation taxes on cannabis sales to end users. The first is the Cannabis County Retailers’ Occupation Tax. The tax can be imposed in .25 percent increments, and the maximum tax rate that may be imposed by a county depends on the seller’s location. Sales in an unincorporated area of a county may be taxed at a maximum rate of 3.75 percent. Sales made in a municipality located in a home rule county, namely Cook County, may be taxed at a maximum rate of 3 percent. Sales made in a municipality in a non-home rule county (every county other than Cook) may be taxed at a maximum rate of .75 percent. These county taxes are also collected and enforced by the IDOR.

The legislation also authorizes the imposition of the Municipal Cannabis Retailers’ Occupation Tax. These taxes can be imposed in .25 percent increments up to 3 percent of gross receipts.

In effort to satiate Illinois’ craving for legal cannabis revenues and the broader social and economic benefits of a newly legal industry, the Illinois General Assembly has attempted to develop a recreational cannabis taxing scheme that will maximize state and local revenues. At the same time, the state is attempting to avoid setting tax rates that are so high that, when combined with the cost of cannabis, consumers continue to find black-market cannabis more attractive from a price standpoint. We will have to wait and see whether the drafters of the taxes got it right.

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Keith Staats, JD, is the executive director of the Illinois Chamber of Commerce Tax Institute. He has been an ICPAS member since 2001.