It’s common among the cannabis industry to hear stories of business owners getting hit with a crushing tax bill or an IRS audit. The industry has expanded quickly with legalization in individual states and the questions of tax implications arise among industry stakeholders – more so business owners. However, with an in-depth knowledge of key taxes codes and planning, you can take proactive steps to reduce your tax liabilities.
Taxes are often complicated to navigate, especially if you are trying to figure out the specific tax obligations for your business. So, when you throw into the mix a business entity that is legal in your state but illegal under federal law, taxes get even more confusing.
Worry not as this article looks at eight business-specific topics that you need to be familiar with as a cannabis business owner irrespective of whether or not you hire a tax professional, accountant, or a CFO service. So keep reading.
1. 26 U.S. CODE SECTION 280E
Section 280E is the one place you want to start if you are looking to stay abreast with your tax obligations. The federal statute states that businesses engaged in the trafficking of either a schedule I or schedule II controlled substance is barred from taking tax credits or deductions.
In short, as a cannabis entrepreneur, you cannot use your business expenses to reduce the amount of your taxable income. You must pay taxes on all your revenue.
2. THE COST OF GOODS SOLD (COGS) EXCEPTION
When Section 280E was passed, Congress feared and anticipated possible constitutional changes to the law in the future. Therefore, it added the cost of goods sold (COGS) exclusion, which allowed a deduction for COGS even where the assets involved are illegal under federal law. COGS refers to inventory costs that include the cost of the product, its shipment into the country, plus any other directly related expenses.
Unfortunately, even though COGS is still deductible, the IRS applies it more narrowly to cannabis businesses. This means that you may not freely use the same accounting methods applicable to other businesses.
3. THE SECTION 280E LOOPHOLE
There is a way to get around Section 280E and maximize your tax deductions using smart business restructuring. Cannabis business accountants advise their clients to divide their business into two separate entities.
The first entity is directly responsible for the production and distribution of cannabis. It files its tax return without any deductions as outlined by Section 280E.
The second business entity holds all legal activities under federal law and does not trigger Section 280E. These activities include selling ancillary products, care services, or the ownership and management of the building housing the first business. It, thus, qualifies for all ordinary deductions when filing its tax return.
4. HOW STATES TAX CANNABIS
States allowing legal cannabis sales have adopted several tax regimes that are built around the product’s price, weight, or both.
- Weight-Based Tax Systems: California and Alaska presently employ a weight-based taxing system on cannabis. The state of Maine also approved a weight-based taxing system, but retail sales are yet to begin.
- Price-based Tax Systems: All states, except for Alaska, allow a price-based excise tax on recreational cannabis sales. These include California, Nevada, Oregon, Colorado, Massachusetts, and Washington. The states of Maine and Michigan have also approved this tax system but have not begun retail sales.
5. GENERAL SALES TAXATION FOR MARIJUANA
Adult marijuana use for non-medicinal purposes is legal in a total of nine states but taxable in only seven. The marijuana excise and sales tax imposed is as follows:
- California has a $9.25/oz and $2.75/oz grower tax for the cannabis flower and leaves respectively. Its charges excise and sales taxes by locality.
- Alaska has a $50/oz and $15/oz grower tax for the cannabis flower and leaves respectively. It charges excise and sales taxes by locality.
- Colorado has no grower tax but imposes a 15% sales tax from grower to retailer and a 15% tax on retail sales.
- Nevada also has no grower tax but imposes a 15% sales tax from grower to retailer and a 10% tax on retail sales.
- Massachusetts has no grower tax but imposes a 10.75% state excise tax and a local sales tax capped at 3%.
- Oregon has no grower tax but imposes a 17% state excise tax and a local sales tax capped at 3%.
- Washington State has no grower tax but imposes a 37% state sales tax.
6. CASH VS. ACCRUAL BASED ACCOUNTING
Cash-based accounting refers to the recording your business revenue and expenses when you receive cash and pay your bills. Whereas, under accrual-based accounting, you record your revenue and expenses when earned, regardless of when actual payment changes hands.
Your accounting method ties in heavily with when and what you record as your income, which also affects your tax return. In this case, what is best for your company depends on the type of business as well as your sales volume.
7. REMITTING TAX PAYMENTS
It is common for many cannabis businesses to remit their taxes in cash, given the cannabis-related banking challenges that the industry faces. However, some states require or prefer tax payments made via electronic funds transfers (ETFs).
Therefore, it is imperative to plan how you will pay taxes. You should check with your local and state jurisdictions regarding any special programs available for the transfer of funds.
8. REVIEW YOUR BOOKS AND TAX RETURNS
While the help of a tax professional or accountant is undoubtedly essential, you also need to take some time to review your books. Never be satisfied with only knowing your bottom line and never put complete faith and trust in a preparer. This is because some accountants tend to take aggressive stances on Section 280E without their clients’ knowledge.
THE BOTTOM LINE
Due to the complex and evolving cannabis taxing systems, it is not enough to learn how to file returns. You also need the services of a reputable tax advisor. At Northstar Financial Consulting Group, we provide your cannabis business with top-notch accounting and CFO solutions to lower your tax liability. Contact us today at (424) 274-3188 to find out how we can help.