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Preface: Any information provided in this article should not be construed as Tax or Legal advice. Specific Tax and Legal strategies for your business should be discussed with your Legal-Council, CPA and/or Accounting Team.
Taxes and reporting compliance can either be a source of stress or comfort for cannabis business owners. From Income Tax and 280(e) to Cultivation (ending 6/30/22), excise, sales taxes and 8300 reporting, there are many hoops to jump through to keep the State, Uncle Sam (and investors) happy. Business owners in the space can help themselves by surrounding themselves with a team of experts to put these strategies in place. In each of the following sections we will discuss a specific area of cannabis tax compliance and where TGG has seen businesses struggle or succeed with compliance, to help you avoid the pitfalls and set up your business for success.
For tax years beginning on or before January 4, 2021, cannabis business owners have often utilized a management servicing-entity legal strategy. In this formation, licensed cannabis business would perform ordinary operations and earn Revenue, and incur COGS and Operating Expenses for financial purposes. However, under IRC 280(e) these licensed cannabis businesses would not be able to deduct any expenses other than Cost of Goods Sold in determining taxable income. This would result in a business that may have otherwise had a 10% net profit margin, now be charged tax based on a 50% gross margin.
This is where the management services organization comes in. A Management Company would be organized to provide services typically considered operating expenses (professional services, insurance, etc.) to the licensed cannabis business and charge a management fee to the licensed entity. In this strategy formation, the licensed entity would then be able to inventory the expenses and management fee under IRC 471© (allowing businesses generating under $25M in revenue to account for inventory in any method so long as it is well documented) and expense them through Cost of Goods Sold.
This specific general strategy discussed above would often be recommended and organized by a combination of legal council and a trusted CPA. While tax laws surrounding the use this structure may expire, the success or failure of compliance will be helped by several factors. Accounting and Tax should be meeting quarterly to check in on success & adherence to tax strategy and make any adjustments mid-year based on estimated tax burden.
Optimizing tax strategy in cannabis businesses requires trusted advisors in Legal, Tax and Accounting. Any cannabis business plan will have (or should have) included financial modeling lead by the CEO that includes input from Cultivation (or Supply Chain for Distribution/Retail), Sales, HR and Accounting amongst other departments. Having Accounting involved in this component of business planning will provide targets for Standard Cost per Pound, Average Price per pound (or eighth/gram for retail), and begin building financial strategy for Cultivation and Excise Taxes.
Once the business has an effective financial model and target profitability (EBITDA) is set the CEO will have more tools in working with Capital and Debt Partners based on their strategic and financial goals. At this point, Legal Counsel and CPAs should work together to advise on appropriate legal structure for the business based on the goals of individual Partners and legally minimize tax obligations. At this point Legal Counsel should be writing Operating Agreements and Management Service Agreements that allow for flexibility in management services to be provided to a licensed entity and markup rates charged.
As the business is in day-to-day operations, Accounting should take the lead again to perform the following:
A mistake that is seen in the cannabis industry is that Distributors and microbusiness will charge Excise but treat as receipts on revenue and “borrow from Peter to pay Paul”, or in this case (delay paying Excise to CDTFA to instead use the funds for operations). If accounting is not tracked appropriately, it can also be the case that these funds received are recorded as true revenue, skewing tax preparation if the CPA is careful and failing to accrue a liability on the balance sheet which will create an unseen “cash-cliff”. Failing to withhold and release Excise tax withholdings to the CDTFA will put a business in hot water akin to charging sales tax and retaining as revenue or withholding federal or state taxes from employees and utilizing for operations. The CDTFA offers payment plans to cannabis taxpayers that extend payment due dates. These can come with a heavy cost of a 60% penalty and interest. Penalties can be requested to be waived after payment in full, but it’s possible your business could be stuck footing the bill.
FINCEN the (Financial Crimes Enforcement Network) and the IRS require the filing of 8300 forms via the BSA E-filing platform within 15 days of receiving cash payments of $10,000 of greater. Often, Cannabis Banking Partners will also require proof of these filings prior to accepting cash deposits (and will check during regular due diligence). Failure to file and retain 8300 forms increases the risk of audit and the loss of banking service.
A common issue in maintaining a good 8300 process is that team-members, vendors and customers trusted to handle cash deliveries & pickups are often not familiar with the importance of this process unless coached. They can often be wary of signing an IRS document that would include their name, company name and/or social security information.
Surviving and thriving in the cannabis industry requires working within the regulatory environment, putting the right trusted advisors in place, and setting an appropriate tone within the business. TGG is industry agnostic and has been serving the cannabis industry among others, since 2005. TGG actively works with fully vertically integrated Microbusinesses, Cultivation, Distribution, Retail and Delivery businesses as well as cannabis-adjacent businesses. TGG also works in partnership with Attorneys and CPAs to build accounting departments for successful compliance in Cultivation, Excise, Sales taxes. TGG’s mission is to help make business-owner’s lives better through excellent financial management.
This post was reviewed by our team of accounting and financial experts. TGG’s mission is to make business owners’ lives better through excellent financial management. We strive to provide the most up-to-date and objective information on accounting-related topics so our readers can make informed decisions based on factual content. All posts undergo a review process with at least one member of our Leadership Team to ensure accuracy.
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