An experienced CFO is critical for ensuring compliance with the many rules, laws, and regulations that govern all aspects of legal cannabis.
As the legal cannabis industry continues to grow, so does the demand for professional business-to-business services such as finding an experienced and passionate chief financial officer or a bookkeeper that understands your unique challenges. And in the cannabis space, these services are essential for success.
But the option to hire a full-time business advisor or chief of financial operations isn’t always available. Whether it’s because of budgetary limitations or it’s too early to justify bringing full-time financial professionals into your business, a cannabis company doesn’t always need a full-time CFO.
Fractional CFO for Your Cannabusiness
So, how can cannabis operations obtain the business accounting, strategic planning, long-term CFO partner they need?
Northstar’s Fractional CFO Service for Cannabis
Keep reading to learn more about what we do as fractional CFOs and how we’re accelerating growth for business operators in the cannabis space.
Looking for an extraordinary outsourced CFO firm? Northstar has the financial professionals you need.
Contact us now to learn how our fractional CFO services save your business money while we scale your operation with services specifically for the cannabis space.
Northstar’s Fractional CFO Model
You don’t need to hire a full-time bookkeeper or CFO. In-house CFOs demand high salaries estimated up to $578,054 annually with benefits. And let’s not forget the added cost for overtime.
A fractional Chief Financial Officer will handle your operation’s needs at a fraction of the price. Rather than paying for a bunch of services you don’t need, you get what you need when you need it, with expert precision from Northstar.
You don’t have to spend hours looking for finance professionals. The interview process is long and challenging; in some cases, you might have to try multiple candidates to find the right fit.
With fractional CFOs, you can try before you buy. Rather than going through the entire hiring process, you’ll be able to make a quick hire for the services you need.
If it doesn’t work out, you don’t have to start that long process all over again. Simply move on to the next fractional candidate until you find the right fit.
Scale Up or Down Quickly
It’s easy and affordable to scale your operation with our fractional CFO model. This is the entry point cannabis businesses need to begin scaling.
Some seasons are busy. This is when you’ll want to scale fast with more services.
However, there will be times you’ll need to scale down. For example, your business might have other financial demands it needs to fulfill. By scaling back these services, you can allocate those funds appropriately to support your operation.
Immediacy to Cut Costs
The time spent hiring a new team member costs your business money. With this in mind, the immediate placement we provide saves time and money by limiting the time you devote to hiring.
Your business’s financial needs are critical; you need immediate assistance with business accounting, raising capital, and more.
Through Northstar, you fulfill immediate necessities. For example, if your current CFO leaves suddenly, you can replace them fast and continue operations without delays.
New Perspectives for Your Cannacompany
It’s always ideal to have fresh perspectives for your business. And the experience we have in cannabis will offer ideas that your team might not consider.
Goals and plans can limit the way your team thinks. But someone who isn’t involved in the daily operations will offer a viewpoint only achievable from the outside looking in.
For difficult decisions, this is valuable. Our impartial advice will help you navigate challenges that hinder success, allowing you to scale more easily.
More Expertise & More Knowledge
Expertise and knowledge go a long way in the cannabis space. This is especially the case for operations that don’t want to pay the hefty price tag of a full-time team.
You don’t just get one person working on your business’s success. Instead, you have our entire team with experience operating in the cannabis space.
Fractional CFO Services for this Elevated Space
The right fractional CFO service can provide the niche-specific business expertise your cannabis company needs to grow while keeping your access to these services within financial reality.
A fractional CFO service is just that: a handful of talented professionals who act as “sub-CFOs” for small businesses and startups. They share responsibilities with an outsourced general accounting team, bookkeepers, and other financial experts all while working under one cohesive fractional business consulting service.
Our fractional CFO services are the perfect solution for cannabis companies that do not need a full-time finance advisor or team to run operations. As your fractional CFO partners, our professionals offer experience in assessing business plans, managing virtual teams, and creating actionable strategies for growth.
Fractional CFO vs. Full-Time CFO Services
While a fractional CFO and a full-time CFO focuses on accelerating growth, the fractional CFO model comes with an assortment of benefits.
Full-Time vs. Fractional CFO Cost
Traditional CFO services are more costly on a month-to-month basis when compared to our fractional CFOs. This is because they provide CFO services, even when they might not be needed.
The fractional CFO model allows cannabis operations to overcome financial challenges as they arise. Rather than paying for a full-time CFO, you receive cost savings because you use the services as needed.
Not all cannabis businesses are ready to bring in a full-time team. Thus, hiring one in-house tends to be more expensive than most fractional CFOs.
However, fractional CFOs are ideal for many cannabis operations because these services give the business owner the capacity to scale up or down as needed. This freedom allows cannabusinesses the ability to overcome financial challenges like raising capital and cash management when needed. But it also helps with optimizing resources.
For example, your operation might need assistance from finance experts during the busier time of year. But when your growing business is having cash flow issues, you have the option to scale back the finance and accounting services for the time being.
Fractional CFO FAQ
What is a fractional CFO?
A fractional CFO is a finance professional who partners with small businesses and large-scale operations to offer financial services. In the same manner as a full-time team, fractional CFOs provide business owners accounting expertise and financial guidance.
But because these professionals are only available part-time, they help you pursue growth strategies when your needs arise.
Why should I choose a fractional CFO over a full-time finance team?
By hiring Northstar as your fractional CFO partner, you get access to experienced accounting and financial professionals at a fraction of the cost. But what’s more, the connections we have acquired by working with the cannabis sector are conducive to scaling your operations.
Rather than hiring a freelancer to handle your accounting, you have a team dedicated to your success. Our industry connections make it easy to obtain the financing and other services your growing business needs to scale.
Let’s say your hope is to build your company to the point you can offer stock options. Or perhaps you need help creating and implementing a financial strategy that will work for your operation.
Strategic planning is our bread and butter, and since we’re knowledgeable about cannabis nuances, we can act as your trusted advisor every step of the way!
How much does a fractional CFO make?
You’re probably wondering how much a fractional CFO earns. This varies from industry to industry, as well as how much time they dedicate to each company.
The beauty of the fractional CFO model is that the individual can also work with other businesses. This means that rather than being limited to one company, a fractional CFO can service other businesses on a part-time basis.
Many fractional CFOs will work on a project basis. However, at Northstar, we want to be your long-term CFO partner instead. This means we get to know your company, the people that make it great, and your plans.
Whether you hope to make an exit strategy a few years down the road or want to build something sustainable, we’re here to help with expert accounting and other financial services on a fractional basis. Our mission is to set your company for scaling its operations as your fractional CFO partners.
Why is a CFO a fractional?
So, why is a CFO a fractional CFO as opposed to a full-time accounting and finance expert? Some choose to become freelance CFOs for additional freedom. However, at Northstar, we believe that a fractional CFO stands to help most companies operating in cannabis with the specific challenges this industry presents.
Top companies operating in the cannabis space are overcoming obstacles daily. But what about the small business that’s just starting out? Or the small companies that have highs and lows throughout the year?
This is why we provide high-level fractional CFO services as opposed to full-time or interim CFO services.
Cash management is one of the most significant problems a cannabis business will face. But these operations still need a trusted advisor to lead board meetings, analyze current finances, and ensure exit strategies prioritized are on track in accordance with the company’s financial statements.
We want to make sure every cannabis business has access to a trusted advisor when a company needs a high-end CFO. General accounting is important, too. However, without specialization in the cannabis space, hundreds of millions of dollars can be lost as these organizations implement without the right guidance.
Fractional CFO Financial Strategy for Cannabis
The fractional CFOs at Northstar work exclusively with businesses operating in cannabis. We understand how financial forecasts and financial strategy should work for this space.
Financial modeling for the cannabis sector must consider the specific financial challenges of this industry. This, of course, includes all compliance-related issues that can come up.
Optimizing cash flow is especially important for this space. And for large-scale organizations managing multiple companies in this industry, operational strategies, maximizing shareholder value, and planning for exit strategies are all important considerations for maximizing profitability.
For a privately held company with diverse management projects, private equity funding could be essential to financing real estate and other large purchases. But other diverse management projects within the company might need accounting and other financial services, too.
Northstar’s Fractional CFO Service
As your fractional CFO, we can serve as your interim CFO between hires. But we want to become your strategic planning partners long-term!
As your fractional CFO partners, your success is our priority. Rather than bringing in a full-time Chief Financial Officer, you’ll have our professional team focused on accelerating growth with a proper cannabis-specific financial strategy.
With Northstar, you never have to worry about compliance-related risks. We remain vigilant in our data acquisition, ensuring we always have the right answer at the right time.
Looking for a part-time CFO to help your cannabusiness navigate this space? Northstar is here to guide you!
Contact us now to find out how our services will help your cannabis operation scale in this budding space.
More often than not, cashing in on the cannabis industry can be tricky, especially when you’re new to this type of business. It is also very likely that you’ll need assistance with organizing and filing your taxes if you come from a background in non-cannabis-related businesses.
Keep reading to learn how our experts minimize tax liability and maximize cannabis company profits with the right systems and procedures in place.
Looking for a cannabis CPA in California? Let Northstar lead the way!
Contact us now to speak with one of our tax and accounting experts about how to scale your operation with financial expertise.
What is a Cannabis CPA?
A cannabis CPA offers tax and financial services for the people and companies operating in the legalized medical and recreational cannabis spaces in states throughout the country. These services involve handling taxes, business structuring, and obtaining financial support.
What does a cannabis CPA firm do for cannabis CEOs?
A CPA that exclusively serves cannabis companies understands the industry and the federal and local laws surrounding it. It’s always best to go with a specialized cannabis CPA firm as cannabis companies need more than generalized tax services.
The cannabis industry is a special sector, and as such, it demands industry expertise to ensure compliance. Accounting from public accounting firms has the potential to cause problems, even with something as simple as tax preparation.
While working with a cannabis CPA firm, cannabis CEOs partner with an accounting firm that understands cannabis accounting. From tax services to assurance services, someone who specializes in cannabis accounting will provide the proper guidance to ensure compliance with internal controls and industry-specific professional advice.
How do these ancillary services help cannabis CEOs scale their operations?
Cannabis accounting is a specialized field and should be treated as such. While the federal government has placed various restrictions on our cannabis clients, our mission is to handle all regulatory challenges in place to ensure appropriate tax planning and other services to cannabis companies.
Cannabis CEOs can rest assured that federal-level accounting issues never become a problem. By working with Northstar, CEOs operating in this industry are guaranteed compliance and ensure their businesses are always audit-ready.
The California Board of Accountancy (CBA) on Cannabis
The California Board of Accountancy (CBA) understands that a certified public accountant interested in providing accounting or advisory services to cannabis-related industries will need to understand this space. However, some advisory firms also have an interest in operating with cannabis clients.
At this point, the CBA is not able to issue legal opinions on cannabis accounting services. With this being the case, no position statement is to be issued by the CBA on this topic.
However, the CBA has issued some insight into operating a CPA firm that serves the cannabis industry. Here’s a quick FAQ that answers questions an industry-specific CPA firm might ask:
CBA Cannabis Industry CPA Firm FAQ
What is the new California law about cannabis that just passed?
California Governor signed Assembly Bill (AB) 1525, which took effect January 1, 2021. This bill provides a safe harbor for licensed individuals or firms that practice accounting if they render services to California’s cannabis industry.
The bill states that authorized persons or entities do not commit a crime under California law if they receive deposits or provide transportation and financial services to people licensed in commercial cannabis activity. However, the authorizations can be rescinded by the licensee at any time.
Can we accept a Licensed Cannabis Business as a client?
AB 1525 will take effect on January 1, 2021, and it provides that those who practice as a Certified Public Accountant in California can offer services to cannabis entities without it being considered criminal.
What are the potential risks of providing services to a Licensed Cannabis Business?
While it is legal to use cannabis products from state-licensed businesses in California and more than half the other individual states, they remain illegal federally.
Federal law states that any entity that supports illegal activity or accepts fees from it is engaging in racketeering. This means accounting firms, banks, insurance companies, and financial institutions may be breaking federal laws by doing this. It’s important to consult legal counsel before entering into such an arrangement because of the consequences.
Any other factors to consider when choosing to accept a Cannabis client?
In August 2016, the 9th Circuit Court ruled that medical marijuana laws are legal in accordance with state law. The federal government cannot prosecute people who grow and distribute medicinal marijuana under state laws because it would be unconstitutional to do so.
The decision to allow medical marijuana in the state of Arizona was based on a few factors. One factor is that Congress has passed laws preventing federal agencies from interfering with states’ implementation of their own statutes regarding medical marijuana.
As the differences between states and federal laws persist, Certified Public Accountants (CPA) are becoming more concerned with their professional liability insurance policies. In order to reduce the risk of a lawsuit or claim against them, CPAs should take note that there may be exclusions in their policies.
Cannabis Companies & Federal Law
Cannabis companies must comply with state and federal law. But when it comes to laws at the federal level, cannabis accounting firms must know how to navigate them appropriately.
Business expenses for adult-use and medical marijuana-related operations are the same in both of these spaces. However, when it comes to deductions for expenses, these operations need a crafty accounting method to minimize tax liability.
As mentioned earlier, public accounting firms can cause problems with things as simple as tax preparation or filing returns. Accountants may be unwilling to work with companies working with or selling cannabis due to a lack of education and knowledge about the industry.
Accounting Services for Cannabis Business in Cali
Our cannabis accounting firm has a combined 120+ experience working with cannabis. As a full-service financial firm, we handle everything accounting-related for our clients.
From tax planning and compliance advisory services to ensuring our clients are committed to compliant practices, we’re here to help any legal business operators working in the cannabis industry.
Financial Services for the Cannabis Industry
Bookkeeping & Internal Accounting
We encourage efficiency and increase scalability long-term with our virtual accounting and tax offerings.
Here’s what you can expect:
Comprehensive & up-to-date books to offer the IRS everything they need to see in case of an audit.
Historical financial records cleanup to ensure all taxes and money owed have been handled appropriately.
Monthly reconciliation pack to ensure audit & investor readiness that helps companies bypass potentially critical issues.
Auditable & accurate cost accounting, including payroll management and other aspects of your operation that the IRS wants to see in your documentation.
Present monthly financial statements to keep the focus on your company’s success.
Controllership, Financial Processes, & Controls
The economic impact of COVID-19 has made these business accounting services more important than ever. With these our expertise in the cannabis sector, your business will meet its financial goals through improved governance and due diligence.
Here’s what you can expect:
Optimize financial systems in preparation for tax season.
Create & manage financial policies & procedures.
Internal & external audit preparation to satisfy the IRS and minimize tax liabilities.
ERP and IT system integrations to maintain adequate records of everything from the cost of goods sold to taxes.
Assess & manage financial risks to minimize tax liability and optimize money.
Chief Financial Officer (CFO) & Treasury
Northstar provides value to your business by improving inefficiencies, reduce expenses & enhancing earnings.
Here’s what you can expect:
Accounting and financial oversight for your cannabis business.
Cash-flow planning & management for your business.
Financial modeling & forecasting to set a roadmap for your business.
Key performance indicators & MIS dashboards to keep your business on track for success.
Strategic financial insight & analysis to keep the focus on your goals.
Investor & Board Management
Northstar gives advice and increases confidence for shareholders, board members, and company leadership. This leads to reliable partners that trust in your business as operators incorporate strategies that scale.
Here’s what you can expect:
Annual & interim reporting for sales, pay, distribution, and more.
Quarterly financials & business updates for the account.
Financial interface for board members & investors to focus on the success of the operation.
Board representation for partners.
Business decision support for everything, from costs and payroll to taxation, and more.
Fundraising & Development
Besides tax- and accounting-related services, Northstar will help you meet your short- and long-term capital goals. By structuring beneficial transactions and establishing crucial relationships, your operation will thrive.
Section 280e is notorious in the cannabis industry. This tax code inhibits most cannabis businesses to report their profits and gain recognition from the IRS.
Section 280e has been a roadblock for many operators in the industry. It has made it hard for these businesses to succeed. However, it’s certainly not impossible.
Despite cannabis’s status as a Schedule I Controlled Substance, it’s possible for cannabusiness owners to write some cannabis business costs off. The internal revenue code is a hindrance for cannabis entrepreneurs. But it’s possible to reveal deductible costs with the right insight.
In this article, we provide insight into Section 280e. We explain what it is, what cannabis businesses should expect, how to avoid an IRS audit, and more.
Looking for expert financial services to maximize your tax deductions? Northstar is here to guide you!
Contact us now for more information on how we help cannabusinesses relieve the tax burden of 280e.
What is Section 280e?
Section 280e is an IRC that dictates how the cost of goods sold and other business expenses work for the cannabis industry. It serves as a legal basis for the IRS to tax dispensaries on their profits because they believe it’s a trade or business without ordinary income or loss.
What is the History of the 280e Tax Code?
The 280e tax code was created in 1982. It was a time of intense public debate over drug laws. The 1980s War On Drugs prompted the implementation of stricter laws for marijuana and other substances.
The Reagan Administration created Section 280e after a court case during which a convicted cocaine trafficker claimed he should be allowed to deduct ordinary business expenses under federal tax law. Then, in 1982, Congress implemented 280e to ensure other drug dealers from doing the same. Through this law, no deductions are allowed “in carrying on any trade or business if such trade or business consists of trafficking in controlled substances.”
This was before the legal cannabis industry existed; a time when drug smugglers and kingpins were earning millions of dollars through the black market drug trade daily. The federal government used the 280e Tax Code to ensure that an illicit operation involved in trafficking could not obtain tax deductions.
However, some members of Congress now believe the government has taken Section 280e too far. They feel that it has had an “adverse effect” on legitimate cannabis businesses. But the bill is still in place.
What is the Controlled Substances Act?
The Controlled Substances Act (CSA) is the law that paves the way for 280e. It’s one of the federal government’s most commonly used tools to criminalize cannabis.
Through the CSA, the federal government regulates the manufacture, possession, use, and distribution of certain drugs. This system considers cannabis in the same category as heroin and LSD.
The Act created five schedules to classify controlled substances based on their risk for abuse: Schedule I drugs are deemed highly addictive with no medical value; whereas Schedule V drugs have a low potential for addiction and accepted medical uses.
Cannabis, however, has been placed in the most restrictive category: Schedule I. This puts every legitimate cannabis business in violation of federal law. And with Section 280e in place, legitimate cannabis business owners have accounting difficulties that stem from what would normally be considered ordinary business expenses.
What Does Section 280e Do?
Section 280e prevents cannabis businesses from deducting business expenses when filing taxes. This includes cost of goods sold. In short, it taxes cannabusinesses on their gross profit.
This is different from a normal business. A normal business can deduct its operating costs and other expenses under section 162 of the internal revenue code (IRC). Although cannabis cannot be deducted, section 280e allows for some cost deductions. However, it’s not ideal for most businesses and comes with a risk of an IRS audit if the federal tax isn’t appropriately accounted for.
Why Is 280e Harmful to State-Legal Cannabis Businesses?
One of the biggest reasons why marijuana businesses would rather not have 280e in place is because it taxes them at a higher rate than normal businesses. This makes it difficult for legitimate cannabis business owners to compete with unlawful operations and other industries in the marketplace.
There’s a relatively simple formula to determine federal income taxes. You begin with gross income, minus business expenses to determine taxable income, and then pay taxes on this money.
However, for a cannabis business, the operations must pay taxes on gross income. Generally speaking, this results in legitimate cannabis industry business operators paying tax rates of 70% or more. This is nearly double the amount the business actually earns in some cases.
How Does 280e Tax Code Apply to Cannabis?
Section 280e makes it harder for legitimate marijuana businesses to succeed. It prevents legal cannabis business owners from deducting expenses for producing, purchasing, or distributing their product.
In most cases, this results in a higher tax rate than the normal 25%. Because of this, some cannabis industry leaders have begun pursuing legislative solutions to change the code and allow deductions.
Tax Code 280e for a Legal Cannabis Business
Legal adult-use or medical marijuana operations are working with a controlled substance. At least, according to federal law. But just because cannabis companies work with cannabis does not mean they cannot avoid the tax court.
How to Avoid a 280e Tax Code Violation
Avoiding a tax code violation as a state legal operation means a cannabis company must stay in compliance with its state’s laws. Because federal law takes priority over state law, this means companies must determine whether a violation exists in their respective states.
In many cases, cannabis operations are complying with the 280e tax code by splitting their marijuana companies in half. By operating two entities under one roof, some deductions are achievable.
Business One owns or rents the building. This involves handling the storage and transportation. It also offers employment benefits, hosts company events, and covers maintenance services. Non-cannabis products like t-shirts, keychains, and pipes can also be sold by this business.
The second related business handles cannabis directly. This can involve growing, curing, and packaging cannabis. It also should include minimal overhead-related expenses. The main expense that should be included in this operation should be the inventory itself.
Steps to Resolve 280e Tax Code Violations
To ensure your taxable year has as many deductible expenses as possible, your cannabusiness should avoid incorporating as an S-Corp or an LLC. This is because of the unique restrictions this code pushes on these U.S. operations.
Cannabusinesses in the U.S. should reduce their corporate tax liability and facilitate accounting by incorporating as a C-corporation. C-corp business operators get taxed on their salary and/or dividends. Since this is a different structure, you can reduce how your cannabusiness pays taxes. But you might only need to use this strategy for the second business if you use the split strategy.
How to Avoid Paying Taxes from Gross Income Under 280e
You cannot completely avoid paying taxes under this code. But a deduction or credit shall be possible if you know how to calculate goods sold COGS (Cost of Goods Sold).
Cost of Goods Sold
What is Cost of Goods Sold?
Cost of goods sold is a business expense that applies to most retailers. It’s an important accounting measure for companies like Canna Care Docs. COGS helps cannabis businesses keep track of how much they pay for individual products and materials.
COGS allows business operators to handle the indirect costs of doing business while bypassing some of these tax limitations.
Which Expenses Are Deductible Under 280e the Tax Code?
COGS are deductible under this code. But this varies throughout the marijuana industry.
Expenses directly related to your operations can be deducted. For instance, as a cannabis cultivator, raw materials and supplies are directly related to your operations.
But inventory costs should also be considered for cannabis entrepreneurs.
You can deduct COGS. But this is limited to the cost of the product and the costs related to obtaining your merchandise. You can deduct electric bills for inventory areas, too.
However, everything else is subject to this code’s limitations. You cannot deduct employee salaries, advertising costs, rental fees, etc.
Financial Services to Handle IRC 280e Issues
We recommend getting professional assistance. The right financial services have the potential to save some marijuana operations thousands, hundreds of thousands, and, yes, even millions of dollars.
Appropriately handling taxes and documenting everything gives marijuana operations the ability to scale successfully. But, most of the time, it’s easy for cannabusiness owners to push their obligations to the back of their minds until the season comes along.
This is why we recommend using our fractional CFO services. These services are especially beneficial to operations that don’t need a full-time CFO in-house and would prefer the flexibility we offer.
Looking for expert financial services to ensure your net income gets the best effective tax rate possible? Northstar is here to guide you!
Contact us now for financial services that will scale your marijuana business and guarantee your success in case of a tax audit.
Tax season in the cannabis industry comes with a unique set of hurdles. Of course, while challenging, preparing tax returns for dispensary owners is not impossible.
As every dispensary owner knows, cannabis laws are continuously evolving. Each change presents its own set of issues to handle.
Additional regulatory, legal, and financial scrutiny adversely impact cannabis businesses, impacting what can be deducted from taxes. The limitations placed on cannabis businesses’ deductible expenses make tax season frustrating, especially for those just breaking into the cannabis industry.
With this being the case, diligence and preparation are essential for navigating tax season successfully. However, a dispensary accountant can facilitate the process.
In this guide, we’ll cover tax deductions and what to expect while operating in the cannabis industry.
Deducting Business Expenses
Regardless of the industry, the Internal Revenue Service allows self-employed individuals to deduct a plethora of business expenses. A lot of times, these deductions are made dollar for dollar, enabling business owners to subtract every dollar spent from their taxable income.
To deduct business expenses, you’ll first need to calculate your gross income. IRC 61 defines gross income with several items, including (but not limited to) the following:
Compensation for services, including fees, commissions, fringe benefits, and similar items;
Gross income derived from business;
Gains derived from dealings in property;
Income from life insurance and endowment contracts;
Income from discharge of indebtedness;
Distributive share of partnership gross income;
Income in respect of a decedent; and
Income from an interest in an estate or trust.
Once you know your gross income, you’ll have to determine all of the ordinary and necessary expenses paid or incurred over the taxable year resulting from your trade or business. IRC 162 defines these deductions more in-depth, showing the general deductions you can use as tax write-offs.
For more information regarding applicable business expenses, make sure to check Pub 535 published by the IRS.
The 280E Tax Code prevents a business that traffics Schedule I or Schedule II-restricted substances from deducting business expenses. However, deductions are permitted if the costs are directly related to COGS, or the cost of maintaining your inventory. While creative accounting is sometimes utilized to define the COGS, strict enforcement of 280E tax law can result in back-taxes.
Since cannabis businesses cannot obtain federal tax deductions, some find themselves forced to pay more than twice as much in taxes. This is why most cannabis businesses should avoid incorporating as an S-corp.
As an S-corp, cannabis businesses generate a “phantom income” that can cause double taxation. To lessen your corporate tax burden, it’s better to incorporate your business as a C-corp. C-corporation business owners’ taxes are based on their own salary and/or dividends.
Also, the C-corp is currently the only structure that protects business owners for 280E. If the company can’t afford to pay taxes, the government can go after the owners if not C-corp.
How To Avoid 280E
The right 280E strategy will save you money. Whether you choose to bring on a 280E management company to handle the corporate structures for your cannabis businesses or conduct research yourself, a little preparation will go a long way.
The financial terrain resulting from 280E can be tough to navigate. However, some strategies, other than incorporating as a C-corp, will help you bypass 280E.
One of the smartest moves to avoid 280E is to split your cannabis business. This is where you’ll split the business in half and run two entities under the same roof. The first business handles business expenses. This includes the cost of owning or renting the building, providing transportation, and paying for storage. The business also provides employee benefits, handles maintenance services, and hosts company events. The first business also sells non-cannabis products. However, this is not so cut and dry, as observed in the Harborside case.
The second business handles cannabis directly. This business handles growing, curing, and packaging cannabis. Distribution to consumers is also a part of this business. Through the second business, you’ll have as little of the total business overhead as possible, ensuring most of this business’s expenses are composed of inventory. These expenses can be included in the COGS.
Another strategy is to be prepared for an audit. Since the IRS openly admits it’s specifically looking for errors in cannabis business taxes, it’s safe to say this organization will strictly enforce 280E. If your business isn’t prepared for an audit, the IRS could reject your tax returns, demand back-taxes, and charge large penalties and fees. Again, as observed in the Harborside case, preparing by keeping excellent accounting records is essential to ensure that you can avoid paying penalties during an audit.
In IRS Code Section 471 and IRC 263A, small business taxpayers would no longer have to cope with the IRS’s complex inventory accounting provisions. However, 263A does not apply to taxpayers operating cannabis businesses.
One argument is that companies under $25m/year in average sales for three years can operate on a “cash basis,” deducting everything as it’s incurred. This is different from GAAP/accrual accounting in which things are placed on the inventory balance sheet. But businesses still have to consider the potential risks of taking on a position like this as it could be challenged during an IRS examination.
The new Section 471(c) is especially attractive to taxpayers who have been subjected to the harsh deduction disallowance provisions that came with Section 280E for cannabis-touching enterprises. This, of course, includes dispensary operators.
This addition to IRC 471 is significant because before, the IRS had power over inventory accounting methods. Through a Supreme Court case, Thor Power Tool v. Commissioner, the IRS was granted broad discretion under Sections 446 and 471 to make taxpayers adopt another accounting method. With the application of Section 471(c)(1)(A), the IRS can no longer cite Thor Power, giving taxpayers the ability to utilize whichever inventory accounting method is best suited for their audit.
Section 471(c)(1)(B) can provide small business taxpayers with some powerful protection, as well. This protection comes in the form of treating inventory as non-incidental materials and supplies or changing its accounting method change to meet its applicable financial statements or, if no applicable financial statements exist, the books and records will suffice.
If the taxpayer is subject to Section 280E, it’s challenging to treat inventory as non-incidental materials and supplies. With this being the case, these expenses could be treated as current deductions, meaning they’re disallowed under Section 280E.
With Section 471(c)(1)(B)(ii) in place, the IRS cannot force small business taxpayers with a method of accounting that’s reflected in its applicable financial statements to change their accounting method. Dispensary owners and other cannabis taxpayers subject to IRC 280E can adopt a method of accounting to allocate expenses, regardless of whether direct or indirect, to the cost of goods sold (COGS). These expenses lessen taxable income, and the IRS cannot do anything to prevent this from happening.
How A Dispensary Accountant Can Help
Dispensary accounting professionals understand what it takes to prepare your dispensary for taxation, beginning with cannabis business formation. The key here is to have your business situated for tax season long before you’re even on the IRS’s radar.
Cannabis accounting will provide you with the financial or legal guidance you need. Whether it’s through a dispensary organizational chart or a simple consultation, a knowledgeable cannabis accountant will analyze all available corporate structures for cannabis businesses to determine what will work best for your unique situation.
Do you need financial or legal guidance for your dispensary? Contact us today for a friendly consultation.
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Opening and running a cannabis business in one of the legal states involves a unique set of obstacles and challenges. As any cannabis business owner knows, the ever-changing tapestry of cannabis laws can make it hard to stabilize the finances. There is a constant stream of new requirements for packaging, labeling, location, production, and now taxation. The current hubbub in the cannabis business world is Tax Code Section 280E.
You may have heard this term floating around related to panicking cannabis business owners facing a doubled tax burden. Don’t panic! Section 280E is an interesting legacy law from the 80s. Currently, it is a sticking point between federal and state cannabis businesses’ legality. It’s going to be a challenge, but the cannabis industry is already developing ways to work around the increased expense from Section 280E enforcement.
What Is the Section 280E Tax Code?
Tax Code Section 280E originates from a 1981 court case. A cocaine dealer tried to claim a tax deduction on business expenses for his cocaine selling business. As a result, Section 280E prevents any business that trafficks in a Schedule I or Schedule II-restricted substance from deducting any business expenses.
The only tax deductions permitted under Section 280E are those directly related to the “Cost of Goods Sold” which means the cost of maintaining your inventory. This can sometimes result in creative accounting to define the cost of goods sold. However, strict enforcement may create back-taxes for those who try.
Section 280E denies cannabis businesses the right to federal tax deductions. With these limitations, a cannabis business can be charged more than double the tax burden. So it’s easy to see why the industry is on alert about this enforcement.
How 280E Impacts Cannabis Businesses
So how, exactly does Section 280E impact a cannabis business? The rules are very specific to ensure that it is enforced fairly and in line with the constitution. However, strict adherence cuts both ways. The IRS has made it clear that they plan to very precisely audit cannabis tax deductions to ensure that only the cost of goods sold is included.
Any business that trafficks (creates or sells) a federally controlled substance (cannabis) cannot file for any tax deductions other than the direct cost of sold inventory. The cost of sold inventory can include growing, curing, and packaging.
All other tax deductions including wages and benefits, facility and utilities, and business overhead are barred and full taxes must be paid because the business itself trafficks in cannabis.
State Laws Caveat
It should be mentioned that state taxes do not apply under Section 280E because 280E is part of the federal tax code. States each have their own approach to taxing a cannabis business and some don’t have any special rules or restrictions at all. Your federal taxes will need to be managed with 280E in mind. However, your state business taxes and income taxes will need to be calculated based on the state laws where you are located. Every state is different.
Strategies to Manage 280E Cannabis Taxes
Fortunately, the cannabis industry isn’t taking this increased tax burden lying down. Enforcement of Section 280E has created an interesting financial terrain for cannabis businesses, but there are ways around bearing the brunt of the restrictions. Discovered by other cannabis businesses and similar industries with controlled substances, these strategies can allow your business to thrive despite the financial burden.
Split Your Business in Half
With a corporate lawyer to consult with, the cleverest move is to split your cannabis business right down the middle and run two entities under one roof. Business number one handles all the business expenses. Business One owns or rents the building, it provides transportation and storage. Further, Business One provides employment benefits, maintenance services, and hosts company events. It also sells all non-cannabis products like pipes and t-shirts.
The second business works directly with cannabis. Business Two grows, cures, and packages the cannabis if you cultivate. Business Two bud-tends and sells the cannabis directly to the customers. Further, Business Two includes as little of the total business overhead as possible, so that the mass of Business Two’s expenses are the inventory itself and, thus, included in the “Cost of Goods Sold”.
Done correctly with legal guidance (and in accordance with your state laws), the two-business approach is a court-approved way run one non-cannabis, non-280E business that can file normal tax returns, and one highly focused cannabis businesses with limited expenses to match its limited deduction capabilities.
Incorporate as a Corporation
Most cannabis businesses are inclined to incorporate as an S-corp or an LLC. These are most suited to small businesses and usually include generous allowances for tax deductions. However, due to the unique restrictions of a cannabis business under 280E, the “phantom income” that is generated by the S-corp and LLC is then double-taxed.
In order to reduce your corporate tax burden, it’s smarter to incorporate your business as a C-corp. A C-corporation owner is taxed on their own salary and/or dividends. It’s a different structure that changes and reduces the way your cannabis business will pay taxes. But remember, you may only need a C-corp for the second business in a split pair.
The IRS has openly said that they will be picking over Cannabis business taxes with a fine-tooth comb. The intent to enforce 280E as strictly as the law allows, which means they intend to reject many tax returns and demand back-taxes for any cannabis business that does not perfectly pass inspection.
So be ready to perfectly pass inspection. Have a lawyer and other necessary consultants on-hand. Build your business structure carefully and, most importantly, keep meticulous records.
Calculate the Exact “Cost of Goods Sold”
The first step is to calculate very precisely what your “Cost of Goods Sold” is. Determine how much acquiring, packaging, and selling your products has cost the business and create a receipt-record of that cost. You can deduct small related costs, but they have to be directly related. The final number will equate your total tax deductions for the cannabis business.
Be Precise With Job Task Tracking
Second, track job tasks very closely. If an employee does things related to “trafficking” cannabis, these hours need to be tracked separately. Many cannabis business owners who use the split-business trick actually hire their employees with both businesses and pay them from each. Your employee’s time cultivating, producing, or selling cannabis can also be included in the cost of goods sold.
Are you ready for Section 280E enforcement? Do you need financial or legal guidance for your cannabis business? Thus, contact us today for a friendly consultation and your financial plans for the future.
Every entrepreneur’s dream is to grow a successful business. For most, that means steadily increased sales and profits, with a healthy balance of income and expenses. As an LA-based distributor, increased sales and momentum comes with a catch—the more sales you get per month, the more complicated the tax requirements of your cannabis distribution company become. That’s why it’s essential that you get acquainted with the ins and outs of tax requirements for a Los Angeles Cannabis distributor.
In order to begin running a legal and compliant cannabis distribution business, you need to receive
A business license. This is standard for all businesses to legally operate.
A seller’s permit from the CDTFA
A cannabis tax permit from the CDTFA
A distributor license from the BCC (Bureau of Cannabis Control), a sub-agency of the California Department of Consumer Affairs
A seller’s permit is required if you sell any physical cannabis plants or products within the state of California. As a distributor, you are likely selling products to retailers or fellow distributors or microbusinesses. There are a few instances where you may not be required to obtain a seller’s permit. In those cases, you still need official documentation from the CDTFA clearly stating that your business is exempt. Learn more about the Seller’s Permit here.
The cannabis tax permit requires you to regularly file tax returns. For a business that is fully-operational, that can mean reporting every month on the last day of the month, during which the transactions you are reporting took place.
Filing Monthly Tax Returns
This is where things can get complicated.
However, as you become well-versed in LA cannabis tax laws, you will be able to develop an SOP (standard operating procedure) for efficiently and thoroughly documenting all of the necessary information needed in every transaction for your monthly tax returns. Incidentally, this is a major factor in the decision of many cannabis distributors to hire or outsource CFO services.
As a fully operational cannabis distributor, CDTFA requires you to do the following in order to file for monthly tax returns:
Collect cultivation tax
Collect cannabis excise tax
Document all transactions with an official receipt or invoice for the tax records of businesses you are collecting either of the above taxes from
File your Sales and Use tax with the CDTFA, pay the amount due, in addition to the above cannabis tax returns
Calculating and Collecting Cultivation Tax
Cultivation tax is collected from any cultivators or manufacturers of any harvested cannabis products that you purchase. Cultivation taxes are calculated based on the weight and the state of the cannabis plant at the point of the transaction.
As for rates, the CDTFA will begin accounting for inflation by annually adjusting cultivation tax rates on the first day of this coming new year. Cannabis businesses will receive notices of every adjustment directly from the CDTFA.
Dry cannabis flowers: $9.25 Dry cannabis leaves: $2.75 Fresh cannabis plant, where the weight is recorded within two hours of harvesting: $1.29
When you are documenting the amount of cultivation tax you received, be sure to record the category and exact amount of cannabis you purchased.
Calculating and Collecting Cannabis Excise Tax
The cannabis excise tax is collected from cannabis retailers you sell or transfer cannabis plants or cannabis products to. This is a 15% tax that’s “imposed upon all purchasers of cannabis or cannabis products sold at retail.”
There are three categories of purchases that deem this tax applicable or not:
Arm’s length purchases indicate that the transaction is taking place between two consenting parties who have no relationship outside of that transaction. So the lounge on .. street purchases a supply of cannabis oil, or a batch of recreational marijuana, from you, you deliver, and the story ends there. Perhaps they are regular customers, but neither one of you receive any further benefits from your relationship aside from the transaction of the goods.
In these cases, the calculated tax is the whole cost of the product, plus the 15% markup. This would be an example of the standard market price.
Non-arm’s length transactions, also known as arm-in-arm transactions, are, as you can imagine, the opposite. Perhaps the transaction is between family members. Or perhaps it is done between two companies that have the same shareholders or umbrella company. In this case, the cannabis excise tax is calculated based on the retailer’s gross receipts, with no fixed markup. This transaction does not reflect the market price of the product.
You are also not responsible for collecting cannabis excise tax in cases where you are selling products to another distributor or microbusiness. These transactions should be documented to clearly state the following, as indicated on the CDTFA’s website:
The selling distributor’s name and license number,
The purchasing distributor’s name and license number, and
A statement that no cannabis excise tax was collected.
California Cannabis Track-and-Trace Metrc System
The state of California requires that all compliant distributors implement the track-and-trace Metrc system by using the Wholesale Manifest for each transaction with a retailer. This means recording the wholesale cost of each unit the retailer has to pay, and as of January 1st, 2020, this includes the cost of transportation.
Sales Tax and Resale Certificates
As a distributor, you are required to collect sales tax when selling products to retailers. But, given the nature of your business, most if not all of your transactions with retailers will be resales. In the state of California, sales tax is not required for products that have been resold. So be sure to obtain valid resale certificates from retailers you supply to, declaring that you did not receive any sales tax.
This, among other reasons, is why it’s crucial that you only engage with other licensed businesses, you need this official documentation to present to the CDTFA when declaring monthly tax returns so that you won’t be penalized.
Keep in mind that, even if all of your transactions are resales, you’re still required to file your sales tax returns, stating that you have not collected any sales tax.
Reap the Rewards of Running a Compliant Business
There’s no doubt that running a compliant cannabis business is challenging. Keeping your finger on the pulse of current regulations and tax policies, maintaining a rock-solid paper trail, and developing a business model and budget that accounts for tax increases is no simple task.
That is why we do recommend having a go-to for all your tax-related questions. Top financial advisors like the team at Northstar that specialize in the cannabis space can give the best financial advice on how you can run a business that is both successful and compliant.