Cannabis Accounting: Expert Advice to Scale

Cannabis Accounting: Expert Advice to Scale

The marijuana industry is growing, and there’s no denying cannabis accounting is becoming increasingly important. The space is booming as more laws pass and new companies sprout up every day. It looks like the space will only continue to improve, too!

But the cannabis industry comes with its own unique set of challenges that you would never encounter in other industries.

In this article, we cover some of the most common, unique cannabis accounting challenges that make hiring an accountant specializing in cannabis essential.

Unique Cannabis Industry Challenges to Consider

State Law vs. Federal Law

While legal at the state level, the U.S. federal government still prohibits cannabis – and most related operations – from conducting business. This means cannabis businesses that choose to accept credit cards for payments, open bank accounts, get loans, or other financial transactions from the federal government can still be at risk of prosecution by the feds.

In fact, there are cases of banks shutting down cannabis business bank accounts – and dispensaries getting their payment processors shut down without warning – even in states where both medical cannabis and recreational marijuana are allowed.

Because of this issue, many small businesses operating in marijuana either don’t get set up with a traditional merchant account or get one but deposit and withdraw cash to/from each sale using a “cash-only” policy to keep it entirely off the books.

In some cases, other cannacompanies will actually decide not to take all forms of payment because they run the legal risk of confiscation by federal agents.

The Point

Cannabis business owners have trouble scaling as they are ultimately forced to operate in cash-only transactions. They also must account for their earnings in a whole different manner than traditional businesses. This results in a need for expert guidance from marijuana accounting professionals.

Furthermore, this means that cannabusiness operators cannot claim their income on tax returns, which can be problematic given the high taxes associated with legal sales of marijuana (even at state levels solely). The money that would be saved through tax returns could be allocated towards scaling, but without this option, cannabis business operators must either find a workaround or take the loss in stride.

Because cannabis is federally illegal, operators can’t claim it as an expense either. This creates another set of problems, especially when cannabis companies want to reinvest their profits. In many cases, they have no legitimate way to write off or reduce the cost of purchasing some equipment that might run into thousands or even millions of dollars.

Opening a Business Banking Account

Opening a business banking account for a cannabis company is another challenge that cannabis businesses interested in scaling face – especially at the federal level.

The Federal Deposit Insurance Corporation (FDIC) recently announced they’d be making an exception for banks that want to provide banking services to cannabis companies. Michigan supports banking for cannabis, too. But it’s not a full-on guarantee like their other guidelines for banks.

The FDIC encourages banks and credit unions to consider “cannabis activity” when deciding whether or not to open an account with a marijuana business – however, this is only advisory, as FDIC guidelines are merely suggestions rather than hard rules.

Regardless of such, advisory firms can point you in the right direction to open an account. And cannabis banking is crucial to scale your operation.

Learn more about banking strategies for cannabis now.

The Point

This kind of uncertainty makes it challenging for cannabis entrepreneurs looking to accept tax payments or write-offs from the IRS as legitimate businesses operating within state laws. This difficulty encourages more self-employment taxes for the cannabis industry, along with other complications – which again makes hiring cannabis accounting professionals essential for scaling.

Not All Expenses/Adjustments are Tax-Deductible

Marijuana-related expenses in the United States aren’t always deductible as business expenses. And most marijuana businesses can deduct only cost of goods sold (COGS) – not operating expenses.

This means that ancillary business activities like marketing are off-limits for tax deduction purposes, and they don’t even qualify for an ordinary deduction. Accounting and tax services are complicated for this sector for this reason, among others.

To make matters worse, COGS is generally calculated by subtracting beginning inventory from total inventory at the end of a business’s fiscal year; this could cause some cannabis companies to pay higher taxes than non-cannabis companies (as COGS isn’t always the full accounting value).

The Point

Cannabis businesses have limitations regarding how they can lessen their tax obligations, even for ordinary business expenses. This is why it’s essential to work with an expert specializing in tax planning for the marijuana industry.

Our cannabis clients receive fractional financial accounting services, including tax preparation, with specialization in the cannabis space.

Whether handling the cannabis plant or offering ancillary services to the cannabis industry, many cannabis businesses save tax dollars with proper accounting expertise leading the way.

High Margins and Low Favorable Accounting Standards

Because marijuana businesses are federally illegal, cannabis companies’ financial statements may be governed by U.S. Generally Accepted Accounting Principles (GAAP) rather than IFRS (International Financial Reporting Standards).

Compared to IFRS, GAAP standards allow for wider leeway in how costs can be calculated – which could make it more difficult for cannabis companies to have lower tax liabilities or favorable tax deductions.

The Point

Federal rules against selling cannabis cause this emerging industry to be characterized by high margins and low favorable accounting standards. This is troublesome for businesses interested in scaling.

Until federal legalization happens and the Controlled Substances Act no longer impacts cannabis tax administration, a cannabis accountant will remain essential to ensure cash management bypasses common accounting issues plaguing the industry. Whether you owe back taxes, need someone to handle your excise taxes, or want someone who understands the tax code in relation to the marijuana industry, these financial services offer a full spectrum of benefits to business operators in this space.

In-House vs. Outsourcing Cannabis Accounting & Bookkeeping Services

Cannabis accounting is a relatively new territory, especially as we’ve seen changes within state laws over time, along with the federal government’s recent announcement regarding banking regulations and their oversight of cannabis businesses.

The market for marijuana accounting is still young, but as more cannabis companies grow and expand (and need to comply with tax laws), the need for marijuana accountants has increased substantially in recent years.

Outsourcing Cannabis Accounting & Bookkeeping: The Right Choice

Cannabis businesses can benefit from hiring in-house cannabis accountants and bookkeepers. However, there are several potential drawbacks to hiring in-house accounting personnel, as well.

Hiring in-house is more costly, which is a step backward as you’re scaling your operation. While you have a professional down the hall, the additional expense of paying for a cannabis accounting professional could take away from your overall profits. And let’s not forget that with a fractional CFO, you’ll use the services as much or little as needed, further decreasing the cost.

Because managing accounting operations in-house requires more administrative and financial personnel, this could potentially limit your business’s ability to expand and hire new employees.

While hiring an in-house expert will cost you more at the outset, it’s important to consider the long-term costs of keeping cannabis accountants on staff. In contrast, a cannabis tax advisor or firm can help your company meet its legal requirements while also allowing you to avoid penalties down the road.

Should I outsource my CFO service? This could be a good idea.

Learn more about the benefits of outsourcing cannabis accounting and tax specialists now.

Cannabis Tax Laws & Audits

One of the biggest challenges that cannabis entrepreneurs face is handling tax payments and writing off business expenses – especially when it comes to filing returns with state governments. These taxes range from corporate income taxes to sales taxes based on gross revenue – which can be tricky given how much money cannabis companies have been bringing in as a result of legalization efforts.

In California, where recreational marijuana was legalized via Proposition 64, there’s a 15% excise tax on all non-medical marijuana sales, and this marijuana sales tax is applied at the point of sale when cannabis products are delivered to a customer.

The state also charges cannabis companies per ounce for cultivation taxes, which must be paid in full before the end of each fiscal quarter (and if you’re late paying it off by even one day, there’s a penalty fee that adds on top of that).

An in-depth audit can reveal problems, and without the right internal controls in place, these problems can compound during an inspection. To keep your business on track to scale, a CPA firm will ensure you’re always audit-ready, ensuring your business continues operating and earning.

Inventory & Manufacturing vs. Retail Storefronts

Although both types of businesses have inventory and manufacturing costs associated with their respective services/products, retail storefronts involve much simpler accounting practices when it comes to selling goods directly to customers.

Since retail storefronts don’t manufacture or produce their own product(s), they aren’t required to track as much inventory. While tracking is still essential, these business operators can calculate the money they’ve received from customers and determine their revenue in conjunction with cannabis tax laws.

In contrast, manufacturing businesses have to account for cannabis stock on hand (which will decrease over time until it’s sold), as well as plant-growing costs associated with growing marijuana plants for sale – which must be accounted for when calculating sales taxes.

Put simply, cannabis businesses engaged in retail storefronts have an easier accounting process than those that manufacture/produce cannabis products. But tracking everything is still crucial for those operating in this space.

We recommend going beyond the minimum in accordance with cannabis compliance. Track everything and have your documentation in order in case of an audit. This is how you will ensure your business can continue scaling without accounting and tax-related troubles on the horizon.

Cannabis Accounting Software

As more states legalize recreational marijuana use and we observe changes made to federal drug policies along the way, cannabis dispensaries have had to ramp up their financial operations and ensure their work is compliant with state regulations. Internal controls, including but not limited to accounting software, are essential.

While the software does not replace a CPA firm, it can work in conjunction with one. For our clients, we usually recommend using spreadsheets to track the business’s financials and a licensed CPA specializing in cannabis operations overseeing them.

At this point, none of the software available is robust enough to fully manage the financials of businesses operating in the cannabis industry. Thus, we cannot recommend software unless it’s required by your state. For example, METRC.

However, having a fractional licensed CPA working on your business and controlling its cash flow is irreplaceable. While software can help with tracking seed-to-sale, business owners need a cannabis accountant to ensure the financial aspects of the business are conducted in a federally legal manner.

Besides the more in-depth knowledge of local laws and advisory services offered, a cannabis accountant or CPA firm offers insight into cost accounting. The software does not handle cost accounting for controlled substances as effectively, nor does it provide consulting services in conjunction with the tax services many cannabis businesses need to scale.

Protecting Finances & Inventory

Any cannabis accountant worth their weight in gold will advise you to protect your finances and inventory. The cannabis industry attracts people interested in taking advantage of the cash these businesses have on hand.

Thus, one of the first steps we recommend taking as a business operator in this industry is to ensure your highly regulated products and cash is protected.

Internal revenue can easily be taken by staff if you don’t have cannabis SOPs in place to safeguard your investment. Compliance demands of regulating authorities also require these controlled substances are locked away from potential thieves.

While those operating in the cannabis space can’t always deduct ordinary business expenses, it’s also challenging to make deductions based on stolen cash and product. With this in mind, many businesses in this industry already understand the need for protection that goes beyond the compliance demands of this budding industry.

Minimally speaking, if you sell cannabis in one form or another, you should have cannabis SOPs in place to ensure you have a log of everyone with access to your product and cash. This way, in case of a problem resulting in an audit, you know who to look at when it comes time to determine the criminal’s name.

Concluding on Marijuana Accounting to Scale

Cannabis is an evolving, premature space. But as it matures, we can expect more businesses to focus on scaling their operations.

The advice in this article will make tax planning and scaling for your business easier. Whether you’re in the beginning stages of your company’s operations or already conducting millions of dollars per year in business, the right cannabis accountant or CPA firm will ensure your business is on track for successful scaling.

Looking for cannabis accountant and CPA services to scale your operation? Contact us now to have our experts join your team!

 

An Alternative to PPP for Cannabis

An Alternative to PPP for Cannabis

The CARES Act, an acronym for the Coronavirus Aid, Relief, and Economic Security Act, implemented the Paycheck Protection Program (PPP). But is there an alternative to PPP that applies to the cannabis industry?

Yes!

The Small Business Administration (SBA) funded and administered the PPP. This was meant to offer potentially forgivable loans to businesses impacted by the COVID-19 pandemic. It was created to cover payroll and other costs associated with operations.

Unfortunately, cannabis companies have not been given the same opportunity to obtain PPP loans. Since cannabis cultivation and sales are still illegal federally, these operations cannot get PPP loans. Furthermore, the SBA published a Policy Notice in April of 2018 to outline how prohibition impacts direct and indirect cannabis businesses, thereby banning them from obtaining SBA loans.

In this article, we discuss an effective alternative to the PPP loan for cannabis.

Interested in getting relief during the COVID-19 pandemic for your cannabis business? Contact us today to learn more about what we can do for your operation!

beware of ppp loans for cannabis businesses

Beware of PPP Loans for Cannabis

PPP loans first became available in early 2020. They were extended by the American Rescue Act and have quickly become one of the most commonly discussed provisions for businesses across the country’s COVID-19 relief packages.

These loans are forgivable for some small businesses and enable them to continue paying employees without issue. However, even though many cannabusinesses would qualify for these loans, plant-touching cannabis businesses should avoid PPP loans. While some might encourage these operations to apply, the federal government’s classification of cannabis is problematic for this type of loan.

Since the SBA has its own application process, we need to look at that to determine whether or not cannabis applicants can successfully get a PPP loan. During the application, the SBA requires affirmation that they are not violating federal law under penalty of perjury. Due to the state-legal cannabis businesses’ unavoidable violation of federal law, it’s impossible to truthfully affirm that the operation does not violate federal law.

Cannabis businesses have always had trouble interacting with the government, so it should come as no surprise that applying for relief funds can be challenging. However, the Employee Retention Credit and State Small Business Credit Initiative allow struggling cannabusinesses to receive assistance from government agencies.

The ERC: An Alternative to the PPP for Cannabis

The ERC: An Alternative to PPP for Cannabis

The Employee Retention Credit (ERC) is a provision of the CARES Act. Though the ERC has not been given the same attention as PPP because companies cannot get both the ERC and PPP funds simultaneously, it’s still an option. Many businesses could not qualify for the PPP or obtained PPP funds and had to return them to the government not long after.

Now, the ERC offers a fully refundable payroll tax credit that employers can use. However, it doesn’t come without the following limitations:

  • Half (50%) of qualified wages and health plan expenses had to have been paid to the company’s employees in a calendar quarter.
  • This credit only applies to qualified expenses paid between March 12, 2020, and January 1, 2021.
  • The highest amount of qualified wages that can be taken into account for the ERC with respect to each employee for all calendar quarters throughout 2020 is $10,000. The maximum credit for an eligible employer for qualified wages paid to each employee $5,000 (half of $10,000).

For your business to qualify for the ERC, it must experience some suspended operations due to the restrictions the government has imposed or a significant decline in gross receipts. Thus should be either a partial or complete suspension of operations.

A decline in gross receipts can be considered “significant” if the employer’s gross receipts for a given quarter at some point in 2020 drop below 50% of their gross receipts for the same calendar quarter in 2019.

Companies qualifying for the ERC need to determine how many average monthly full-time employees (FTEs) worked for them in 2019. If your company employed beyond 100 average monthly FTEs, it’s only allowed to claim the credit on wages and health plan expenses paid for your employees that weren’t working over the course of the eligible months. However, if your company had 100 or fewer employees, then you’re allowed to claim the credit for all employees, regardless of whether they were working or not.

To claim the ERC, you’ll do so on IRS form 941, “Employer’s Quarterly Payroll Tax Return.” If your company is eligible, you can reduce its federal employment tax deposits by the permissible ERC amount. However, if your ERC is in excess of the remaining federal employment tax deposits for that quarter, your company can file Form 7200 to claim an advance refund.

IRC Sec. 280E: Does this affect cannabis business eligibility for the ERC?

Yes and no.

At this point, IRC Sec. 280 does not allow federal tax deductions and credits from gross income if the taxpayer engages in business relating to the manufacturing, distribution, or sale of controlled substances classified as either Schedule I or Schedule II drugs. This is the result of the 1970 Controlled Substances Act.

Since cannabis is still classified as a Schedule I drug, the sales activity is viewed as trafficking under federal law. With this in mind, IRC Sec. 280E keeps cannabis businesses from benefiting from typical business deductions.

However, equally important to note is that IRC Sec. 280E is an income tax provision of the Internal Revenue Code. The ERC operates as a payroll tax credit. Furthermore, the CARES Act does not explicitly exclude cannabis businesses from claiming the ERC.

While ERC eligibility is questionable and the IRS has not offered guidance just yet, there’s a chance that cannabis businesses that meet all eligibility requirements of the ERC could be eligible.

More About The ERC

At Northstar, we’re helping cannabis businesses save on payroll taxes with the COVID-19 ERC. If your company has been adversely impacted by the pandemic, we’re ready to help you at no upfront cost. Simply put, we only get paid if you do! This includes 3-year FREE ERC audit support!

Here’s a quick summary of the ERC and how it offers relief to cannabis businesses:

ERC Eligibility Explained

Through the COVID-19 Employee Retention Credit, cannabis businesses can get a payroll tax credit to help ease the adverse impact of the coronavirus. The ERC is an option for employers, as well as tax-exempt and some government organizations, as long as they satisfy ANY of the following conditions:

  1. Operations were either fully or partially suspended as a result of the orders from an appropriate governmental authority.
  2. Its gross receipts for a minimum of one calendar quarter were less than 50% in 2020 or less than 20% in 2021 of the gross receipts they had in 2019.
  3. The company qualifies as a recovery start-up business.

ERC Opportunity Explained

The ERC offers up to $33,000 per employee. This is meant to offset employers’ 6.2% FICA liability from March 12, 2020, through June 20, 2021, as well as 1.45% Medical Tax from July 1, 2021, through December 31, 2021. Any remaining credit gets refunded.

Your ERC is calculated quarterly as long as your business satisfies quarterly eligibility requirements. You could also capture retroactively if you didn’t capture in prior periods, as well.

With subsequent ERC changes, the availability expands, and the benefits increase in the 2020 and 2021 tax years.

ERC Process Summarized

To get started, we’ll need to determine if you’re an eligible employer for the ERC for any quarter. This will involve applying each test separately.

We’ll check your company’s employment level in 2019, as well. This will determine your ERC-eligible wages.

From there, we compute your ERC-qualified wages. This involves excluding wages used for PPP forgiveness and other tax credits.

Once we have this information on hand, we can calculate the ERC and work with your payroll provider to determine options to claim benefits. Then, we’ll complete an audit file to substantiate ERC.

Notable ERC Changes for Jan. 1, 2021, to June 30, 2021

The ERC for January 2021 to June 30, 2021, experienced the following changes:

  • The ERC rate per employee increased by 20%, resulting in its expansion to 70% of qualified wages. In the past, this was 50%. Furthermore, the per-employee wage limit rose from $10,000 annually to $10,000 quarterly for 2021.
  • Employers are now eligible based on their gross receipts of less than 80%. Previously, it was less than 50% compared to the same quarter in 2019. With this in mind, if your gross receipts drop by beyond 20% in 2021, your business is eligible for the payroll credit.
  • Right after the calendar quarter, you can choose to use ERC immediately rather than Q1 and Q2 of 2021 compared to the same quarter in 2019 to determine your eligibility.
  • For companies that didn’t exist in 2019, we’re now allowed to compare 2021 quarterly gross receipts to the same 2020 quarters to determine business eligibility for ERC.
  • 2021 ERC credit is now accessible by public colleges, universities, organizations giving medical or hospital care, and some organizations that Congress has chartered.
  • The definition of a large employer changes from more than 100 employees to beyond 500 employees in 2021. Thus, companies can use this broader definition of qualified wages if they are within this threshold. As a company, this allows employers to count wages paid to their active (working) employees and those who aren’t currently working.
  • The Consolidated Appropriations Act (CAA) removed the limit on employees’ qualifying wages. Previously, the limit on qualified wages was the sum the employee would have been given during the 30 days prior to the qualifying period. Now, the ERC will allow companies to pay a bonus to their essential workers.
  • If the company has less than 500 full-time equivalent employees, they can advance ERC payments during the quarter that the wages were paid to these employees. This also includes seasonal employers, employers who didn’t exist in 2019, and part-time employees.

Save on Payroll Taxes with the COVID-19 ERC

Ready to soar your business to new heights with tax incentives? Contact us today to partner with Northstar’s experienced tax professionals.