By Carol Ryan

Pot stocks have skyrocketed since President Trump made promising noises about cannabis reform in recent weeks. But the Internal Revenue Service could spoil the party and upend the hopes of pot companies that think the agency might simply forgive a mountain of back taxes.

Trump said he might reclassify cannabis as a less dangerous drug. Right now, marijuana is a Schedule I substance, alongside heroin and LSD. The White House is considering changing it to a Schedule III substance. This would group cannabis with less harmful but still restricted drugs such as ketamine and anabolic steroids.

The AdvisorShares Pure US Cannabis ETF that tracks a basket of American cannabis companies is up 40% since then.

Rescheduling won't solve all of cannabis companies' problems, but they hope it will be a first step toward full legalization. Not being lumped in with heroin, for example, should make it easier for pot companies to refinance a wall of debt they have maturing in 2026.

And institutional investors who currently avoid the industry might be more willing to own shares in cannabis companies after a rescheduling. Pot stocks' near-total reliance on individual shareholders makes them volatile.

What's more, many of those investors have been badly burned by the stocks, which rode a wave of euphoria in early 2021 during the meme-stocks rally. The cannabis ETF soared during that period but is down about 80% over the past five years.

The most immediate impact of rescheduling would be to change how cannabis companies are taxed. A rule known as 280e forbids businesses that handle Schedule I drugs from deducting day-to-day expenses such as rent, wages and marketing from their taxable income.

This means effective tax rates for cannabis companies are anywhere from 60% to 90%. If the industry was taxed normally, profit margins and creditworthiness would look a lot healthier.

The catch is what will happen to the unpaid 280e taxes these companies already owe. Their liabilities are at least $2 billion, based on an analysis of 10 major U.S. cannabis stocks by Frank Colombo, a managing director at Viridian Capital Advisors.

"These are very significant, very big numbers," he says.

Why do they owe so much back tax? Instead of paying on time, pot companies have been letting their bills pile up on their balance sheets as "Uncertain Tax Liabilities."

It is cheaper for cannabis companies not to pay the Internal Revenue Service because their cost of debt is so high. Pot businesses regularly pay interest rates of 16% or more on loans because the drug is illegal at the federal level.

The IRS charges interest of between 7% and 9% on unpaid taxes, depending on the size of the company. So it makes sense for cannabis businesses to hang on to their cash rather than borrow to settle tax bills.

They are also struggling to pay those taxes because sales are in a funk. Cannabis companies boomed during the pandemic, but the industry's top line is expected to be flat this year and next.

Some companies are holding back on paying tax based on advice from their lawyers that they will be able to challenge the 280e tax liabilities in court. Others are betting that if cannabis is rescheduled, the IRS will forgive the taxes they have racked up or at least negotiate the number down. If that happens, cannabis companies' current liabilities could turn out to be inflated.

Investors should still take a closer look at these liabilities. Not paying their taxes is making pot businesses look more cash generative than they really are.

Take Trulieve, a large cultivator with operations in multiple states. In the first six months of the year, 84% of its cash flow from operations came from booking reversals of tax expenses. Trulieve's unpaid tax liabilities total more than half a billion dollars.

Several big listed pot companies don't have enough cash on hand to pay their outstanding tax bills, including Curaleaf, Verano and Ascend Wellness. One business, Jushi, has a bigger unpaid tax bill than its market capitalization, Viridian's Colombo points out.

Green Thumb Industries is an exception and is up to date on its federal taxes. It is one of the most creditworthy cannabis companies in the industry and pays around 9.5% on its borrowings, which is exceptionally low for the sector. The gap between Green Thumb's cost of debt and the IRS's interest rate is so small that not paying its taxes isn't worth the risk.

Some cash-strapped companies might get leniency from the IRS if settling their historical taxes would literally mean going out of business.

But it's hard to make the case that the liabilities of companies that are able to pay will simply be forgiven. What a downer for wishful thinkers.

Write to Carol Ryan at carol.ryan@wsj.com

(END) Dow Jones Newswires

September 05, 2025 05:30 ET (09:30 GMT)

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