Because marijuana remains illegal on the federal level, transporting it across state lines is a federal crime. It is therefore understandable then that most marijuana companies consider their state tax obligations to be limited to just one state. However, as the cannabis industry expands, out-of-state investors need to consider the state income tax impact of their investment activity.
One example is licensing. After talking with a number of marijuana companies that are licensing their product across state lines, it is clear that marijuana companies engaged in such licensing arrangements rarely realize that they also have state tax issues outside their own resident state.
A number of dispensaries and producers have entered into licensing agreements with out-of-state retailers and producers to leverage their marijuana branding outside their own state. In addition, a number of marijuana businesses will soon be up and running in states like Illinois and Oregon, both of which currently allow non-residents to invest in their emerging cannabis marketplaces.
Licensors and other investors need to be aware that the income they receive from a cannabis enterprise is probably subject to income tax in the state from which they receive that income. This is because the law has evolved to permit a state to impose income tax on businesses that have continuous and systematic economic contact with that state (or its residents). This contact is called “economic nexus” and does not require a company to have a physical presence in the state such as an office or employees. Oregon and Illinois both apply an economic nexus standard.
Oregon regulations provide that a licensor of intellectual property (such as a logo) would be subject to income tax because the logo is used by an Oregon licensee/retailer. For example, a Colorado processor of a cannabis-infused brownie that licenses to an Oregon bakery the right to use their logo and recipe would be subject to Oregon income tax. The Colorado processor is subject to Oregon income tax even if the processor has no other connection to Oregon. Oregon casts a very wide net to subject a business to income tax; its regulations suggest that even licensing and regulation by an Oregon administrative agency, such as the Oregon Liquor Control Commission, could subject a business to income tax.
Illinois regulations explicitly state that the following licensing arrangements subject companies to Illinois income tax:
Entering into franchising or licensing agreements; selling or otherwise disposing of franchises and licenses; or selling or otherwise transferring tangible personal property pursuant to such franchise or license by the franchiser or licensor to its franchisee or licensee with the State.
As in Oregon, the Colorado processor would be subject to Illinois income tax solely by virtue of its licensing agreement with an Illinois medical cannabis cultivation center.
Because each state’s tax laws are unique, you must look at the laws of each state in which you planning to do business or are doing business. Other factors regarding income tax need to be considered as well before investing in a cannabis enterprise. For example, though Oregon allows a deduction for expenses, those same expenses are disallowed for federal tax purposes. In addition, states such as Illinois and Oregon will often tax related legal entities as one business enterprise. As the cannabis industry grows, participants in this marketplace will also need to consider the state income tax consequences of their activities outside their resident state.