1. Separate Your Cannabis Business Activities
A business that is subject to 280E can divide its operations into two parts to help reduce taxes. The first business can be responsible for producing and distributing cannabis. This business would file a tax return with COGS as the only deduction.
The second business would perform business activities not subject to 280E. This way, you can take business deductions on your tax return, like payroll, rent, and marketing expenses.
When combined, these two companies pay fewer taxes than a company operating as a single entity.
This 280E strategy may sound complicated. But partnering with a company like Northstar can give you more insight into the nuanced rules and guidelines of Code 280E, helping you save more money in the long run.
This 280E tax strategy is legal under the 2007 Californians Helping to Alleviate Medical Problems (CHAMP) federal court case. But before you establish a second company, you must be able to state the business purpose and revenue source clearly.
Working with an expert is important here. Otherwise, you might face the risks of tax penalties and violations, as was seen in the Harborside case.
2. Use Smart Corporate Structuring
Before determining the corporate structure for your cannabis business, consider the benefits and drawbacks of each entity option. Your three options include a C-Corporation, S-Corporation, and Limited Liability Corporation (LLC).
For a large-scale cannabis business, legal advisers and CPAs generally recommend setting the business up as a C-Corporation. Since a C-Corp is a tax-paying entity, the corporation itself pays taxes on the company's gross profit and the business owner only pays taxes on salaries or dividends.
3. Track Employee Time by Individual Activity
Certain hours worked by employees are deducted under COGS if those tasks relate to cannabis production. This means that accurately tracking time could make a big difference in your COGS number.
To make this process easier, consider installing a time tracking system. It should allow the employee to record time by individual activity.
For instance, if an employee works as a budtender, their hours should be recorded under that activity. Employees involved in inventory, packaging, or cultivation would record their time as such.
Accounted for correctly, time spent cultivating, packaging, and managing inventory is deductible in COGS under Code 280E.
4. Be Prepared for a Possible Audit
As a cannabis business owner, your company is more likely to be audited because you are selling a federally illegal (Schedule 1) substance. Audit preparation is therefore essential. This is why staying organized, staying current on tax laws, and tracking employee hours is so important.
Section 280E of the IRC requires your business to document all gross receipts and expenses. This includes revenue numbers for products sold in-store and online. It also includes cultivation expenses, marketing costs, seeding, inventory management, and more.
The IRS expects you to keep receipts for all transactions as evidence on your tax return. Every bit of revenue and expense, no matter how small, must be accounted for.
Since 280E only permits the deduction of COGS, this number is often the most scrutinized by the IRS. If the deduction is incorrect, your business may be subject to a fine.
5. Work with an Experienced Cannabis Accountant
Section 280E applies to federal tax treatment for legal cannabis businesses, but that still leaves state taxes in question.
State and local taxes vary depending on the state you operate in.
This means it is up to you or a reputable tax advisor to understand and adhere to state laws, and this is just one more reason to work with an experienced cannabis accountant.
Expert accountants in the cannabis industry know the laws better than anyone else. They understand the details of Section 280E and how to correctly minimize your taxes. They can help ensure your tax return is filed accurately and has the proper supporting documentation.
This kind of specialized service mitigates the likelihood of being audited and can ensure better cash flow.
Expert accountants can also offer advice on what qualifies under COGS and what does not. For example, they know that businesses may deduct electrical bills for designated inventory spaces, but not for electricity used in sales spaces. In some cases, the shipping costs related to the cannabis product can be deducted as well.
Only specialists with deep 280E experience have this information readily available.