Cocaine dealers can’t claim deductions on their year-end tax forms—that should be a no-brainer.
Unfortunately, the same holds true for cannabis companies. Section 280E of the Internal Revenue Code, enacted by Congress in 1982, states that deductions and credits are not allowed for any expenses paid during the tax year for business activities that involve the sale of controlled substances, which includes cannabis.
Until the federal government removes cannabis from the list of Schedule I substances, cultivators will need to find other ways to reduce their tax burdens. Below is a recap of some key points addressed by Rachel Gillette, partner and chair of Greenspoon Marder’s Cannabis Law Practice, and Dean Guske, CPA, Dean Guske & Co. Inc., during a panel discussion at the 2019 Cannabis Conference.
1. Keep a good accounting system.
“If you don’t have a good accounting system, you’re not going to be successful in trying to ... maximize your deductions,” Guske says. 280E has less of an impact on growers than it does on retailers, he says. “The vast majority of your expenditures incurred that go into that product are direct expenses, and they go right into the cost of goods sold[, which are allowable deductions under 280E]. Compare that to a retailer, who the vast majority of their expenditures are selling expenses, and selling expenses are not qualified to go into cost of goods sold.”
2. Understand how 280E impacts your business.
[Cannabis business owners] “need to know in real time what is going to be a disallowed expense that they are potentially going to have to pay tax on because one of the worst things that can happen to a cannabis business is come Tax Day, April 15, they do not have their correct amount of estimated taxes that have been paid or they do not have enough money set aside to pay their tax bill,” Gillette says. “That happens very, very often, and oftentimes, it happens as a result of cannabis business owners not knowing what their disallowed expenses are or the dollar amount of their disallowed expenses, and therefore, the taxes due based on disallowed expenses at the end of the tax year. So, it becomes a big surprise, and they haven’t planned accordingly. That is the biggest problem that I see that faces especially smaller businesses in this industry.”
3. Be honest.
Cultivators should track all inventory and be mindful of potential penalties. “If you fail to report your income by 20% or more, you’re going to get a substantial understatement penalty,” Gillette says. “It is a huge penalty. So … you need to make sure you’re reporting all your income correctly.”
4. Hire a bookkeeper.
“I need to be able to see [the expenses] to prepare a tax return,” Guske says. “If the inputs are terrible, ... I’m going to give you a call [and say] what’s this? What went in here? All those sorts of things that I need to be able to file an accurate tax return. So get yourself a bookkeeper. Pay for it; it’s worth it.”
5. Understand corporate business structures.
S corporation, C corporation or LLC? That’s a question many cannabis companies must answer for themselves to minimize their tax burden. It’s a complex decision that may require outside consultation to make the best decision. For instance, there are situations where a company would not want to be an S corp vs. an LLC. A cultivator with multiple partners who are operating different parts of the business, such as accounting, sales and cultivation, may not want to be an S corp because all three owners would be required to pay themselves a reasonable salary, Guske says. The salesperson and administrator/accounting salaries are non-deductible to the S corp; the employee-owners, however, must claim the salaries as income and pay taxes on it, so the owners are paying taxes twice on the same dollars. “If you just elected to be an LLC, there’s not a requirement for us to pay ourselves a salary at all,” Guske says.