Three Ways Cannabis Businesses Can Save Money This Tax Season
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Tax season looms. For those in the cannabis industry, it’s always better to be over prepared rather than under. Plant-touching companies -- dispensaries, cultivation sites, infused product manufacturers, cannabis concentrate producers -- are all heavily scrutinized by the Internal Revenue Service (IRS).
Entrepreneurs who work with the plant were responsible for $2.8 billion federal in taxes in 2018, New Frontier Data estimated. Marijuana-centric businesses have a higher chance of being audited than standard businesses. Plus, the cannabis industry is forced to pay the IRS predominantly in cash as companies await the passage of the SAFE Banking Act.
There are multiple moving parts to keep track of in addition to running your day-to-day business -- it’s easy to feel overwhelmed. Here’s what you need to know to be prepared for tax season.
What is 280E?
One reason taxes can be such a headache for cannabis business owners is IRS Code 280E. This federal statute forbids companies from deducting business expenses for gross income associated with the trafficking of Schedule I or II substances, as outlined by the Controlled Substances Act. While cannabis remains a Schedule I substance in the eyes of the federal government, businesses are stuck navigating these tricky tax circumstances.
A bit of history: 280E was created in 1982 following a court case in which a convicted cocaine trafficker asserted his right under federal tax law to deduct ordinary business expenses. The Reagan administration decided it needed to prevent future traffickers from following suit and created 280E.
280E still penalizes cannabis businesses, even when they are regulated and comply with state law. Where other businesses may be able to deduct things like employee salaries, rent, equipment, and electricity, cannabis businesses can only deduct expenses that directly relate to making a profit -- the cost of goods sold (COGs). Cannabis companies must pay tax on gross income, which can be as high as 70 percent.
Not giving enough attention to tax preparation and documentation can easily result in racking up interest, penalties, and fees. Plus, there’s a higher chance that your business will be audited. MJBizDaily data found 6.3 percent of marijuana businesses were audited in 2015, higher than average business at 1.4 percent. These are serious consequences – and have been known to take a business out overnight.
Staying informed can help your business save money this tax season. Here’s what you need to know.
How To Save
You can save money by determining your tax liability, finding deductions, and avoiding audits. Your business’s tax liability is what you owe to the federal government after deductions. Working with a tax professional can help cannabis businesses reduce liability, saving money and sleepless nights, when it comes time to file.
Common areas to secure deductions, reduce liability, and avoid an audit include:
1. Square Footage and Rent
When it comes to deductions, cannabis business owners should spend some time studying their floor plan. Why? An average cannabis dispensary’s square footage might consist of 50 percent sales floor and 50 percent lobby. Because 50 percent of your business is directly connected to COGs, you can deduct 50 percent of your rent. Deducting 100 percent of your rent can result in a penalty, since cannabis transactions do not occur in the lobby of your business. Utilities can be a little more complicated, but are important to consider for deductions. Seek the advice of a tax professional to help you calculate this aspect of your deduction.
2. Employee Classification
Payroll is closely scrutinized by the IRS, so you’ll want to make sure you accurately classify employees based on their responsibilities. This means you must clearly document what each employee is doing for your business. For instance, you might have an employee who works part-time as a grower and the remainder of time as a budtender. Their time spent in cultivation is deductible and included in COGs -- whereas their time as a budtender is not deductible. Technically, you could still sell cannabis without a budtender, but cultivators are considered necessary to tend to the plants. That’s how detailed and nitty-gritty 280E can be.
3. Record Keeping
Any business will want to maintain a paper trail. But it’s crucial for cannabis businesses to keep impeccable records. This will help tax professionals identify additional deductions and support the numbers if an audit does occur. Working with an experienced tax professional can assist you in record keeping or migrating your documentation to the Cloud, if needed.
The good news is, you don’t have to go it alone. In fact, you shouldn’t. Because of the complexities and nuances of 280E, it is vital to work with a knowledgeable accounting professional well-versed in cannabis. They can help you ensure your taxes are done correctly and your business is set up for sustainable, continued growth.
There are a growing number of Certified Public Accountants (CPAs) who specialize in the cannabis industry. Notable accounting companies that specialize in marijuana include RebelRock, GreenSpring LLC, New Approach, The Canna CPAs, Tax Center & Accounting, LLC, and PriceKubecka PLLC. Many cannabis companies will eventually form their own accounting department with legal compliance and taxing as the highest priority.