Saw this coming....

'Teetering on the edge': California pot shops owe $1.3 billion in back taxes

There are growing concerns over industrywide solvency problems

By Lester Black

San Francisco’s Vapor Room cannabis dispensary has faced plenty of foes since it opened in 2003. It brawled in federal courtrooms with the IRS and was hit during crackdowns by the U.S. Justice Department. But now that weed is legal, it appears the one thing the storied dispensary can’t survive is California’s legal weed market.

The dispensary is at risk of going out of business because of $250,000 in tax debt it owes to the state of California, according to founder Martin Olive. He blamed the pot shop’s tough financial situation on slumping sales caused by street problems in his SoMa neighborhood, as well as high cannabis taxes and penalties from the state.

“We’re at a crunch point now where things are looking more dire than they’ve ever been,” Olive wrote in a LinkedIn post last week where he called for “lenders, credit lines, investors, angels, and/ or a miracle to get us out of some critical debt.”

The Vapor Room’s problems come as cannabis businesses across the state struggle to stay alive, with thousands of companies going out of business and taxes going unpaid. The industry owes the state nearly $1.3 billion in late taxes and penalties, according to the California Department of Tax and Fee Administration. 

High cannabis taxes are frequently blamed for making the state’s legal pot industry unsustainable, yet state tax rates are set to move even higher. Come July, the state plans to increase cannabis excise taxes by 25%, a prospect that is sending panic across the industry, with some warning that it could be the “nail in the coffin” for many legal weed businesses.

“We’re already teetering on the edge. A tax increase is going to kill us,” said Jerred Kiloh, the owner of the Higher Path Dispensary in Los Angeles.

‘You’re basically charged more than what you owe’

Cannabis companies across California have been struggling for years to stay profitable, thanks in part to an extremely difficult business environment. The costs of running a pot company are astronomically high compared with most businesses, with companies facing expensive regulations, banking fees and security. 

Just as costs continue to rise, revenues are also taking a hit as wholesale prices for pot plummet and legal cannabis sales decline year over year. Legal cannabis sales in California have been dropping for the past three years, and that’s particularly true in San Francisco, where per capita cannabis sales have declined over 34% since 2021.

Businesses like the Vapor Room are left squeezed in the middle between rising costs and falling revenue with no profit left over to survive. Olive said he’s prioritized paying his employees and his vendors, which has left him unable to fully pay his state tax bill. 

That bill has grown even larger because California has a particularly punitive tax law for cannabis businesses. Most companies face a 10% penalty if they don’t pay their taxes on time, but cannabis businesses face a 50% penalty if they’re late. Olive said the principal he owes is roughly $125,000, a fraction of his total $250,000 bill to the state.

Olive said this penalty makes it nearly impossible to get out of tax debt. 

“You’re basically charged more than what you owe,” Olive said. “It compounds, which makes it completely overwhelming to catch up.”

Olive also blamed local problems in his shop’s SoMa neighborhood, which saw decreased foot traffic after tech workers left the downtown core of San Francisco during the pandemic, and an increase in street disorder filled the void. 

“We’ve been beset by illicit drug sales outside in our neighborhood,” Olive said. “There’s been a real lack of support in the community. I’m sympathetic to what people are going through with addiction, but it’s made it very difficult to operate.”

A growing problem

The Vapor Room is far from the only pot shop in California that owes the state taxes.

Cannabis companies owe the state nearly $1.3 billion in unpaid taxes and penalties as of Oct. 31, according to data shared with SFGATE by the Department of Tax and Fee Administration. The agency said “a large portion” of that total is due to penalties and interest on unpaid taxes.

Industry observers have been saying for years that the industry couldn’t support California’s tax rates, especially after a 2023 law changed how taxes were calculated and collected. One observer told SFGATE at the time that the shift would cause an “extinction event,” with pot shops unable to pay their taxes and then getting knocked out by the state’s mandatory 50% penalty.

That “extinction event” could be unfolding, with widespread company failures in recent years, including the largest pot distributor and the largest delivery company in the state and thousands of pot farms. It’s not clear how many pot stores are at risk of closing. The Department of Tax and Fee Administration said it cannot calculate how many cannabis retailers are behind on their taxes because “a single taxpayer may have multiple liabilities for one or more periods or for multiple taxes.” 

However, the unpaid tax bills continue to increase. Not including interest and penalties, pot companies owed the state $354 million in taxes on Nov. 18, which is up from $287 million in back taxes in February of this year.

Tax hike coming

Ironically, the tax rates themselves could be partially blamed for the taxman not getting paid. 

Legal cannabis taxes, which can climb over 40% in some jurisdictions in California, make legal cannabis more expensive than illicit market weed. California’s illegal market is thriving, and many observers say that’s because customers are balking at paying legal prices when they can find cheaper weed outside licensed stores.

Kiloh, the Los Angeles pot shop owner, said this is particularly true for younger people who will “just go to the cheapest price.” 

“You have a very nimble demographic in the under-35 demographic that is just one Instagram post away from leaving the legal industry,” Kiloh said. 

That problem could get even worse this summer when the state plans to increase the cannabis tax rate from 15% to 19% in July, which will be added to a list of other local and state taxes. Kiloh estimated that the increase will push cannabis taxes to over 50% in Los Angeles, where there’s an additional 10% sales tax. Kiloh said that would be the “tipping point” that will destroy even more legal businesses. 

For Olive, it’s not clear if he can hold on to his Vapor Room until the summer. He is organizing an auction to raise funds to keep his shop alive while he negotiates with the state to try to get on a tax payment plan.