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WA State Legalization and the 502 Barriers to Businesses

Many people saw dollar signs in the passage of Initiative 502, but the real business climate might prove treacherous.

Jessica Allen, a CPA with RainCity CPA, has already gained a wealth of experience dealing with interested entrepreneurs who want to take advantage of marijuana’s legalization. However, she has grown dismayed over hurdles the state has set in front of businesses trying to develop.

“A lot of people think that they are going to create a super profitable business,” Allen said. “But there are so many restrictions for those businesses to make money.”

The Tax Burdens of I-502

The main problem she sees with the current state of the industry lies in the heavy taxes the state has levied against all levels. She said the 25% cut demanded by I-502 was part of the strategy to get the initiative to pass, but it has the potential to hamstring producers, processors and retailers.

“That’s the biggest initial barrier,” Allen said. “We need to see some sort of way for these businesses to make money or break even.”

With the continued federal listing of marijuana as a schedule one controlled substance, businesses also cannot claim business expenses to the IRS. Furthermore, Washington State does not allow any exemptions. So producers cannot expect to get an agriculture exemption on state taxes.

Allen said to imagine a businessperson starting with $1 million. Out of the initial take, this unfortunate person would immediately have to give $250,000 to Washington State and then give another $250,000 to the IRS come tax time. With the other $500k, the business would have to pay for products, rent, employees, marketing and any other expenses needed.

Where this really hits home for retailers, Allen said, is in the gross margin. Businesses will have to inflate prices relatively high just to compensate for all the costs derived from state and federal taxes.

“You will have to have more than a 50 percent gross margin just to make it by,” Allen said. “We’re talking about retail here — I’ve never heard of such a high margin in retail.”

Though the demand could help the retailers survive with the asking price, she said the expected margins were still very economically unorthodox.

“Retailers have always been about the slimmest margins,” she said about typical businesses. “Restaurants usually have a 5 to 10 percent.”

Solutions to Survive 502

Though she painted a somewhat dire picture of the landscape, Allen had a positive outlook of the future and even offered some solutions for new businesses.

“Co-ops are the way to go,” she said simply. To her they solve three large problems, the first being supply.

“When you have a co-op, you have three to a dozen other people who make up your network and you’ll always have some supply,” she said. “There’s also the support you will have in the camaraderie.”

She said a co-op also offered a way to increase sales. With a larger number of retailers and their extended network of supply, the co-op can sell more and reach the margins needed to survive.

The third answer co-ops provide is branding.

“You can really create a strong message,” she said. “Customers are not going to go from shop to shop to try it all out, because they can’t afford it. Retailers have to brand.”

Other solutions to the industry’s hurdles involve creating partnerships. Allen said the law provided nebulous areas that could find retailers striking deals with various producers and processors.

“If the producer and processors can offer the retailer a lower price, the retailer can kick back some of the profits,” she said. “But that’s getting into the grey area of the law.”

Spreading the Word About 502

No matter what immediate solutions businesses can find, Allen remained convinced the state’s system needed a reboot.

“I think the first step is talking about it,” she said. “There are places where we need real direction and the state isn’t even acknowledging that. Yeah, we’re still in the infancy, but is there going to be accountability?”

The legislature’s continuing silence on developing the fledgling industry kept new entrepreneurs in the dark.

“There’s no uniformity of direction,” Allen said. “There are people trying to start a business who are just shocked at how many hurdles there are.”

Still, she believed opportunities would arrive for all businesses trying to make economic sense out of the government’s wayward course.

“I’m extremely optimistic about the future,” Allen said. “I think legal marijuana is a fantastic way to boost revenue and support social services because no one like raised taxes. It’ll stick around for sure.”

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