As the cannabis industry continues to grow, many are looking to transmute their skills into the budding field. While building a company from the ground up is scarily exciting, cannabis is a whole different world with hurdles you should know about before you take that leap.
For businesses already operating in the cannabis sector, Section 280E of the US Federal Tax Code has proven be a pain in the ass.
The federal statute enacted during the Reagan Administration denies sellers of Schedule I or II controlled substances the right to deduct business expenses– meaning tax season for you will be no fun. Most businesses pay their taxes on net income, you know, minus all of those business expenses. For cannabusinesses, only the cost of goods sold (COGS) is allowed to be subtracted from taxable income.
What does that mean for you? You can’t claim anything, basically. Since marijuana by definition is considered “drugs that have no currently acceptable medical use and a high potential for abuse,” expenses you’d usually deduct such as office supplies cannot be. That’s thanks to an internal memorandum placed in effect January 2015 by the IRS Chief Counsel. Yes, it sucks. Even worse, these companies pay tax rates that are 70% or higher. Yo, 70%! For some, that’s double the amount of what their business makes and a formula for a horrible financial future. In 2017, the government racked up on an estimated $4.7 billion in taxes from hardworking cannapreneurs. Also, many marijuana-product firms were forced to pay in cash while an estimated 70% of cannabusinesses remain unbanked. That means customers, employees, and taxes are all paid in cash. Ridiculous, right? It’s no secret that the government thinks cannabis consumers are drug traffickers– and they’re acting like the mob.
What can’t you claim under 280E?
Many things. For starters, employee salaries, health insurance premiums, the costs of marketing and advertising, repairs and maintenance, rental fees for facilities, routine repair and maintenance, costs of utilities, costs of telephone services, and payments to contractors are among the no-gos. According to thecannabisindustry.org, below is a comparable tax structure for a canna business as opposed to a regular one.
As you can see, trash.
How do you get around 280E?
The potential loophole: IRS Section 263A which allows businesses to capitalize on indirect costs such as indirect transportation, storage, etc. along with the amount paid in state excise taxes and deduct them under COGS. Through this strategy, some businesses have seen profit because of the opportunity to capitalize costs. Leading tax attorney Bob Carp explained to Leafly that “280E is a very arcane rule… It has a very small fit. Most people, even skilled accountants haven’t work with it before. They don’t know how to handle it, and before you know it they’re getting audit notices.” We don’t want no problems with the IRS. So here are some ways to minimize your company’s liability.
Figure Out Your Corporate Structure
When setting up your corporate structure, there are three types of entity options you can choose from. C-Corporation, S-Corporation, and Limited Liability Corporation commonly known as an LLC. If you choose the C-Corp option that most lawyers prefer you do, that means that you, the owner, would only pay taxes based on his, her, or their salary or dividends. The other two are better if you have a smaller business.
Consider Operating Under Two Entities Through Protection of CHAMP
If 280E only deals with businesses run by drug dealers (rolls eyes), it only makes sense that you separate your structure from your services. So while one will handle the production and distribution of canna, all of the not-totally-legal tings, the other will take care of everything above board including counseling, providing care services, selling goods that are marijuana free, and managing your spot. By doing it this way, one company will play nice with 280E while the other cashes out on ordinary deductions. Doing this is perfectly legal. Californians Helping to Alleviate Medical Problems (CHAMP) says so. The only thing– don’t lie. If you’re going to set up a second company, do it right and do it legitimately. The last thing you want is to be in violation because these auditors will scrutinize and penalize, okurr?
Keep Records of Everything Including Employee Tasks
Whether in cannabis or not, you should do this. Document todos! The last thing you want is to sell a half of an ounce of GSC. not document it, then have zero answers when the IRS asks how you calculated your cost of goods sold. That 20% penalty if your books are not in order is a little biatch. More importantly, make sure your employees are doing the tasks outlines in their job descriptions and keep record of how much time they spend doing it. Say you have a grower who sometimes comes into the dispensary to serve as a budtender. You can deduct the cultivation since it’s plant-touching but the tending bud, not so much. Our good friend Bob Carb suggests, “to pay your dispensary employees minimum wage, and then make up the difference with a paycheck from one of the other [legitimate] companies sharing the same space.” From seeding to sales, collect those receipts, chile. Again, you don’t want any smoke with the IRS.
Capitalize on Costs
Under IRS 263A, you’re allowed to capitalize certain indirect costs that can be attributable to your finished product. In other words, did you install new door locks to protect your inventory? Capitalize that cost. How many square feet are used for storage of your inventory? Capitalize it. This is the sort of indirect cost that requires a simple formula, such as the number of square feet used for storing inventory divided by the total square feet of the dispensary. Add a piece of common area maintenance charge for your storage facility, the cost of the electricity to light it, cleaning costs, things like that. Many of the charges may be small, but they quickly add up and can produce significant savings.”Bob Carp
Ask an Expert Who’s Been Around This Tax Block
If you’re not a lawyer, when it comes to law, the last thing you want is to be confused. That’s why God created accountants and compliance folks. Lord, bless ’em. Through their expertise, they can offer reliable advice and insight so you can boost your business. Those who’ve been dealing with cannabis-related companies know everything there is to know, leaving you less stress and not as consuming as much for your anxiety.
The best thing about cannabis is the community, and by finding the right people for your company’s purpose and goals, bullies like 280E won’t hurt your pockets as much. Hopefully as laws continue to get with program, these angels providing us with Earth’s natural medicine can earn the money they deserve.