The legalizing of medical marijuana in 20 states creates an opportunity for new tax revenue in the form of additional income taxes and also with the levying of sales tax on the product itself.

Colorado and Washington are the only states that allow marijuana sales for both medical and recreational use. According to Jonathan Barsade, CEO of Exactor, a website that offers sales tax preparation services, Colorado’s marijuana tax revenue is far exceeding expectations.

“There is currently a 12.9% sales tax on recreational pot and a 2.9% sales tax on medical marijuana, which is exceptionally boosting the state’s economic status. Pot sales for the next fiscal year are estimated to be about $610 million with sales and excise taxes expected to produce roughly $98 million.”

The Great Recession left many states’ balance sheets bleeding, so this is sure to be a welcome revenue source.

“The legalization of the sale of marijuana will have a positive effect on the industry as a whole, including the marijuana farming industry,” Barsade said. “Increased state supervision and regulation will provide farmers with security and more confidence that they can engage in growing the crop without negative ramification from the authorities.”

Strong tax revenues coming from marijuana sales will also be a major incentive to states on the fence on the issues. Barsade explained that as more states adopt similar legalization, there will be an increase in demand and supply channels. “It will be in a very similar manner to what was witnessed by the legalization of the gambling industry across the country.”

If you are a marijuana farmer or dispensary owner in a state other than Colorado, you may expect that within the next decade you will be collecting and remitting sales taxes to your state government.

Hopefully, you do not fear the Feds when it comes to declaring your income and expenses for your activity. Whether you are a marijuana farmer, own a marijuana dispensary or sell paraphernalia, you are obligated under federal and state law (if your state levies an income tax) to declare your income from these activities. It would behoove you to treat your enterprise as a bona fide business venture and keep good books and records.

There is a provision in the IRS code that deals with this issue:

IRS CODE SECTION § 280E. EXPENDITURES IN CONNECTION WITH THE ILLEGAL SALE OF DRUGS: “No 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 (within the meaning of schedule I and II of the Controlled Substances Act) which is prohibited by Federal law or the law of any State in which such trade or business is conducted.”

The IRS however, has determined that it will allow deductions for cost of goods sold, and at this point in time will likely consider other administrative expenses as well. This nation is coming close to recognizing marijuana as a lucrative source of tax dollars and will eventually allow these enterprises without threat of prosecution in order to encourage those involved in the industry to file tax returns without fear of reprisal.

The IRS is not interested in the legalities of any enterprise – at least not in the sense of whistle-blowing or calling in prosecutors. They are more concerned with substantiating income and deductions to determine if the proper amount of tax has been paid. So be sure to file your tax returns. If you do not, it’s more likely you will serve jail time for tax evasion than for performing the activity itself.

Bonnie Lee is an enrolled agent admitted to practice and representing taxpayers in all 50 states at all levels within the Internal Revenue Service. She is the owner of Taxpertise in Sonoma, Calif., and the author of Entrepreneur Press book, “Taxpertise, The Complete Book of Dirty Little Secrets and Hidden Deductions for Small Business that the IRS Doesn't Want You to Know.” Her new e-book Taxpertise for the Creative Mind Murder, Mayem, Romance, Comedy and Tax Tips for Artists of all Kinds is available at all major booksellers. Follow Bonnie Lee on Twitter and on Facebook.