The chart in this article was updated on Sept. 27 to correct a data entry error.
Ten publicly traded multistate cannabis companies are carrying over half a billion dollars in federal tax debts, according to an analysis of financial filings by Green Market Report.
All told, multistate operators (MSOs) Acreage Holdings, Ascend Wellness, Ayr Wellness, Cresco Labs, Columbia Care, Curaleaf, Green Thumb Industries, TerrAscend, Trulieve and Verano Holdings owe the Internal Revenue Service an eye-popping $507,193,000, according to their second quarter financial reports.
Just two of the companies, Curaleaf and Verano, hold the bulk of the tax debt. Combined they owe the IRS $286 million.
Not only that, but if the companies were forced to fully pay their federal tax bills, only one of the 10 – Green Thumb Industries – would have more than 10 months worth of cash left with which to continue operating.
Verano Holdings would be financially underwater in a big way, with $161.4 million owed to the IRS compared with its $92.8 million cash on hand – meaning it owes 78% more in taxes than it had in cash at the end of its second quarter.
And it’s not clear when the companies plan on paying.
Much, or perhaps all, of the tax debts have been deliberately not paid by companies so that the businesses can use the cash to fund operations or other plans, multiple sources said.
“Part of our capital allocation strategy is to lengthen our tax payment cadence,” Verano CEO George Archos explained to shareholders in an earnings call last month. “The strategy is not unique to Verano and has been utilized amongst other large U.S. companies. The cost of penalties and interest for this are significantly below the available cost of debt.”
Archos also noted that the company made a $37 million income tax payment in Q2, and that Verano has already paid $14 million in taxes for Q3.
“We continue to efficiently manage our income tax payable line and continue to manage as a cheap source of capital and generally keep about a trailing 12- to 18-month balance outstanding,” Archos said.
Still, the findings represent a troubling financial trend, first reported on by Seeking Alpha in May after first quarter financial reports were filed. And the trend likely extends to the broader industry, marijuana industry experts said, due to factors such as section 280E, the provision in the federal tax code which prohibits standard business deductions for those in cannabis.
That financial squeeze – which often results in a real-world tax rate of up 80%-90% for marijuana businesses and little to no profit – has led companies desperate for cash to undertake creative financing for expansion or even just to continue daily operations.
Delaying tax payments as a financing strategy can be a major risk in both the short and long term, several industry experts warned.
“I totally get it, and at the same time, I think it’s a very risky strategy, because it’s like Russian roulette,” said Roxane Peyser, a partner at Denver-based Fortis Law, who has worked with legal marijuana companies for over a decade.
“How are you going to justify that if you do wind up pulling the trigger that has the bullet in the chamber?”
Morgan Paxhia, co-founder at San Francisco-based Poseidon Investment Management, said he’s got “concerns” about the proliferation of that type of financing strategy, because he thinks it’s a high-wire act that’s tough to pull off.
“Intentionally now running up 280E tax debt as a means of conserving cash … ideally, that’s your last lever, or if you are going to pull that lever, it’s got to be very well-managed, tightly managed, there’s got to be a clear plan and a high probability of executing against it. Otherwise, I think you do get upside down,” Paxhia said.
Paxhia said the range of credit interests from private lenders these days is running about 12%-14% for those with good credit and upwards of 16%-20% for those whose credit is less than stellar. By contrast, IRS interest for deferred taxes is only 3% plus the prime short-term federal interest rate, which as of Monday was 6.25%, for a total of 9.25%.
That makes the IRS interest rates far cheaper than private capital, Paxhia pointed out.
“That’s why it’s interesting to some of these folks. Not that we’re justifying that,” Paxhia said.
The problem with the strategy of simply not paying the IRS is that the bill will eventually come due, perhaps as soon as next spring, although just when federal tax regulators will force the issue is the big question.
When that happens, the fallout could be catastrophic, said one tax attorney who requested anonymity due to his close work with several MSOs.
“They have to pay their taxes sooner or later,” the attorney said. “They’re going to fail, because so many of these managers are burying their heads in the sand, and what they should be doing is coming to grips with this and taking action. What they’re doing now is the worst of all possible worlds. They’re saying, ‘We admit we owe this tax, and we’re just not going to pay it.’
“That’s like alcoholic behavior. That’s like not opening your mail.”
The chart below provides details on each company’s financial health, according to Green Market Report’s analysis of the Q2 financial records. (Click on image to enlarge.)
This chart was updated on Sept. 27 to correct a data entry error.
Interminable juggling act?
Part of the problem, noted Peyser, is none of the MSO’s are actually profitable; every one of them posted multimillion-dollar cash flow losses in the second quarter, which at this point is an industry standard.
“It stems from the fact that, if you don’t have enough cash flow, you’re robbing Peter to pay Paul,” Peyser said. “So where do you get the money? How can you do that? What can you juggle?”
Not paying taxes is part of the juggling act, Peyser said. Which raises the question, how long will the IRS wait before the agency will decide it’s waited long enough?
That’s about as clear as mud, said Nick Richards, a former IRS tax attorney who is now a partner at Greenspoon Marder in Denver, but he added that the agency won’t wait forever.
What the IRS will most likely do, he said, is work with companies to get them onto payment plans or the like, akin to the deal struck by Statehouse Holdings this past summer.
“If you have the money to pay the taxes, your options are really to pay the tax,” Richards said. “The IRS isn’t going to take all your money. They’ll let you into a payment plan. That’s what they did for (Statehouse).”
But, the IRS also won’t let companies keep not pushing out their tax bills in perpetuity, he said, pointing to Curaleaf’s $125 million tax debt and its $187 million in the bank.
“(The IRS) is going to want them to get onto a payment plan” if Curaleaf or others aren’t already making some payments regularly, Richards said. “If Curaleaf can identify why it’s necessary for their ongoing business, then the IRS will cooperate with that, so long as it’s being used to generate income-producing assets.”
The longer-term question, Richards and others said, is whether the MSOs will eventually start turning a real profit. If they don’t, and the income tax bills keep piling up, the IRS may eventually lose patience.
“Year after year after year of losses becomes a problem in working with the IRS. The IRS is going to say, why save that business?” Richards said.
Paxhia noted that each company has to be evaluated individually, based on more than just cash flow or tax debts.
He pointed to Green Thumb Industries as a leader among MSOs for its low tax debt and high cash balance ratio, and said the company’s relatively cautious approach to expansion thus far is serving it well.
Even Verano, Paxhia said, could likely “sell off a ton of assets” if the company really needed more cash with which to pay its debts, so he doesn’t see the business as being in immediate danger, even with the relative lack of cash and its sky-high tax tab.
“It really kind of runs the gamut,” Paxhia said.
There are other factors that are worth taking into account, however, Paxhia and others noted, including rising federal interest rates and an upcoming hiring spree at the IRS, with a macro-level plan to increase audits and federal revenue.
There’s also an industry-wide sales slowdown that’s happening, following the COVID bump that much of the cannabis sector enjoyed for over a year.
Interest rates going up has already made capital even more scarce and expensive, and the new IRS agents could in part be targeted at cannabis companies, since the IRS knows the marijuana sector is a particularly lucrative one for them.
Which means, according to the relatively optimistic Paxhia, that high tax debts are “going to be a problem” for at least some of the major MSOs.
Managing Editor Jenel Stelton-Holtmeier contributed to this report.