Estate and Gift Tax Valuation of Cannabis Business Interests

Abstract

Approximately half of all American adults have used cannabis at some point in their lives. Whether or not any one estate planning professional falls into this particular demographic, it is crucial for all advisors understand the estate planning uncertainties and complexities facing owners of legal cannabis businesses. Eighteen states have legalized cannabis for adult recreational use; thirty-seven states have legalized the medicinal use of cannabis (often in conjunction with permitting adult recreational uses). Experts estimate that legal recreational sales in the United States were $18.9 billion in 2021 and that, by 2026, sales in the United States alone will reach $41.8 billion or more. As the legal cannabis industry expands, estate planners are more likely to have clients who own interests in legal cannabis businesses. After providing a brief introduction to the important federal banking and income tax limitations on cannabis businesses, this article turns to the more complex—and unpredictable—issue of how interests in legal cannabis businesses should be valued for estate and gift tax purposes.

One’s immediate reaction might be that familiar valuation rules should apply. For federal gift and estate tax purposes, the Treasury Regulations consider what a hypothetical buyer and seller would agree is an appropriate sales price. But when, as a matter of federal law, the asset cannot be legally sold, these rules apply uneasily. In the case of a legal cannabis businesses, one might base valuation on the price being paid by market participants, i.e., buyers and sellers in the state where the business is located, or, in the case of interests in multi-state operators, the prices paid for those interests on the Canadian stock exchanges or in the secondary over-the-counter market in the United States. A taxpayer might even argue for a significant valuation discount to reflect the difficulties in operating such a business, given that cannabis is a Schedule I drug for federal purposes and is restricted from taking ordinary and necessary business expense deduction IRC Section 280E. Yet with illegal or “illicit” assets, case law and IRS guidance suggest that the IRS has broad discretion in valuating such assets. Thus, even if a cannabis business is legal for state law purposes, it is difficult to predict with certainty how the IRS would seek to value the assets. In many ways, conventional valuation principles are fundamentally at odds with any system for valuing assets that are illegal for federal purposes.

Keywords: cannabis, marijuana, gift, estate, tax, valuation

JEL Classification: K1