High-Priced Bongs, and Other Ways Pot Businesses Handle Cash

With medical marijuana now legal in 23 states and recreational marijuana legal in Colorado, Washington, Alaska and Oregon, cannabis is a legitimate growth industry generating substantial income. In Colorado alone, the pot industry is expected to pour an estimated $120 million in tax revenue in the state's coffers for 2015. Nationwide, medical and recreational marijuana as an industry is expected to net between $2 and $3 billion per year in revenue.

You might think banks would be lining up to do business with these cash-rich entrepreneurs, but nothing could be further from the truth. The banks, rightfully so, in my opinion, assume they are putting themselves at risk with the federal government by engaging in marijuana-based businesses, as marijuana is still considered an illegal substance on the federal level. And the reality is today's banking industry is all about risk mitigation, especially when it comes to cash-based businesses and the potential for rampant money laundering.

Yet, as I stated above, this is a quickly growing and legitimate industry in the states where it is legal. In its infancy, however, marijuana entrepreneurs are facing a mountain of regulatory and financial issues. The biggest of these issues is the lack of access to banking services. Here are what I'd consider the good, the bad and the ugly stories related to legal marijuana banking and taxation.

The Good

A number of local credit unions and banks in states where marijuana is legal have stepped up to provide financial services to the industry, although the costs for both financial institutions and marijuana providers can be high.

Financial institutions providing such services include Fourth Quarter Credit Union, O Bee Credit Union, Group Health Credit Union and Salal Credit Union in Washington State; and First Security Bank of Nevada. The majority of these banks and credit unions supporting marijuana businesses are limited to working with recreational producers, processors and retail outlets.

Yet even participating institutions reveal concern about the risk they face in terms of what they charge marijuana outlets for services. According to the manager of Seattle's Ganja Goddess, the recreational marijuana store is one of a few in Washington State that accepts debit cards for payment. It then charges the customer a $5 service fee per transaction, the same fee the bank charges Ganja Goddess. As the manager put it, "we simply ask for our customers to give us an arm now so we can give them a leg later."

The Bad

But some stories about how marijuana business handle money will probably give additional banks and credit unions pause about getting involved.

An investigative Buzzfeed report last year shed light on how some marijuana entrepreneurs are essentially laundering huge supplies of cash as a result of not being able to deposit it at a bank. The article focused on marijuana sellers — in both states where the drug is legal and where it is illegal — investing money from sales in expensive glass pipes, bongs and other smoking materials, and then reselling them at exorbitant prices.

According to the article, "Most transactions involving bongs and rigs ... happen off the books, among friends, at trade shows, or between connoisseurs who meet online. Then, anyone who paid five figures for a pipe using drug money, including dealers in states where weed is very illegal and businessmen in states with medical or recreational cannabis laws, can resell the same pipe with all of the appropriate receipts, paperwork, and taxes. Presto, change-o: Now the money is clean."

If these deals happen off the books, then there is likely no authoritative record of the transaction — such as a dated paper receipt — which seems like an open invitation for the FBI to investigate. Pouring cash into glass is not a heady trend for legitimate cannabis-related business owners, as the Buzzfeed story would have you believe, but rather a misguided strategy that invites corruption on many levels.

The Ugly

There are a number of ugly cases to highlight when it comes to banking and the marijuana industry, but by far the most disturbing situation originated in Colorado. Denver-based Allgreens, a medical marijuana dispensary, recently settled a lawsuit against the Internal Revenue Service to have a $25,000 levy removed after the IRS accused the company of not paying employee taxes. At least that is what the media headlines would have you believe.

Digging a bit deeper into this story, however, reveals some ugly and complicated details. Since Allgreens did not have a bank account, it tried to pay its payroll taxes to the IRS in cash, which is illegal according to the law. Today, businesses are required to deposit payroll taxes using the Electronic Federal Tax Payment System. Meeting that obligation, however, requires a bank account. There is a loophole in the law though providing that a business can avoid using the EFTPS if it can provide it did so because of a "reasonable cause, and not because of willful neglect."

Allgreens' owners asserted to the IRS that the company had reasonable cause for not using the electronic payment system, which was its lack of access to a bank account. But the IRS disagreed, and that's when things turned sour for everyone. According to the Denver Post, "the IRS told Allgreens that [marijuana] companies have two alternatives to pay electronically — each of which required Allgreens to funnel the cash to a third party who could then make the tax payment on its behalf."

I echo Allgreens' attorney Rachel Gillette's statement when she said that the IRS' suggestion to her client was "the very definition of money laundering."

Ultimately, Allgreens received its penalty refund of $25,000 and was allowed to pay its payroll taxes in cash going forward, until that time when it is able to establish a bank account. However, this ruling does not apply to the multitude of other marijuana-related businesses in Colorado, which at this point are forced to go through the same scenario as Allgreens if they want to pay their taxes legally.

I am pro-business. If the legal marijuana trend is here to stay, and it looks like it is, then we need to figure out a way for these entrepreneurs to pay taxes and use financial services under the same scrutiny that all business customers face. Because right now, there's a pile of cash out there and the longer it lingers under someone's mattress, the more likely it is to be mishandled.

Richard Paxton is the founding partner and CEO of Alacer Group, a consulting firm and technology solutions provider.