Should a municipality that derives revenue from marijuana include that source in its revenue calculation?

Neither the American Rescue Plan Act of 2021 (“ARP”) nor associated regulatory guidance regarding the Coronavirus State and Local Fiscal Recovery Funds (“CSLFRF”) directly address the issue of marijuana revenue. However, the Internal Revenue Code’s treatment of similar revenue streams for taxation purposes indicates, though not to a definitive or certain extent at this time, that marijuana revenue may be included in revenue calculations for the purposes of revenue replacement calculations.

The U.S. Department of the Treasury (“Treasury”) has not explicitly addressed revenue derived from marijuana or other federally controlled substances. The CSLFRF Frequently Asked Questions (“FAQs”) include sales tax and license tax in their definition of tax revenue and a component of “General Revenue,” as shown in its appendix chart. The chart contains no stated exclusion for revenues from products that may be illegal at the federal level.[1]

While several states have legalized marijuana, the Internal Revenue Service (“IRS”) has long considered receipts from the sale of illegal substances as revenue. Notably, the Internal Revenue Code addresses the issue of deductions for the cost of conducting illegal drug sales:

[N]o deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances…which is prohibited by Federal law or the law of any State in which such trade or business is conducted.[2]

The IRS also uses more explicit language: “Income from illegal activities, such as money from dealing illegal drugs, must be included in your income on Schedule 1 (Form 1040), line 8, or on Schedule C (Form 1040) if from your self-employment activity.”[3]

While this standard relates to income tax rather than a municipality’s calculation of revenue for CSLFRF purposes, it offers some indication that the federal government generally considers revenue from the marijuana industry to be reportable revenue for purposes of taxation. It is possible, although not certain, that a municipality could argue that the same reasoning should apply to marijuana revenue under the ARP’s revenue replacement rubric. Ultimately, given the lack of regulatory guidance directly addressing marijuana revenue under the CSLFRF, it remains unclear whether a specific municipality may include marijuana revenue in its calculation of “General Revenue” for purposes of revenue loss calculation. Municipalities should consider submitting queries regarding their individual circumstances to Treasury as well as consulting with local, licensed attorneys and certified accounting professionals to determine the best approach for their respective jurisdictions.

Last Updated: March 31, 2022