New Perspectives on Navigating IRS Cannabis Tax Policies
Following the release of cannabis tax compliance reports from the IRS, pursuant to a FOIA request filed by Marijuana Business Daily, we revisit strategies for dealing with examination and oversight.
The most advantageous middle ground between paying a high effective tax rate and a tax rate similar to your stated taxes could refer to the following example.
Let’s assume $2.5 million in revenues, a 40% COGS, 15% operating expenses, a California state tax rate of 8.84% and a C Corporation rate of 21%. (Please note, this is just an illustration!) Remember that in California, the state has given a break to cannabis businesses in that it does not charge state tax on gross income, but rather on net income before tax. Notice the effective tax rate in this example:
Gross Revenues $2,500,000
40% Cost of Goods Sold 1,000,000
Gross Income 1,500,000
15% Business Expenses 375,000
Income Before Tax 1,125,000
280E Taxable Income 1,500,000
State Tax @ 8.84% 99,450 (Income before tax, not Gross income)
Federal Tax @21% 315,000
State and Federal 414,450
Effective Tax Rate 37% (Much better than a 70% effective tax rate)
Income After Taxes $710,550
The IRS has stated that they favor the bulk of expenses reflected in the Cost of Goods Sold category, and the taxpayer must be careful in his accounting/bookkeeping records to only reflect expenses that are qualified under the category of general business expenses as applicable to IRC 280E.
Accordingly, this applies to the Cost of Goods Sold, as well.
The example above shows a good mix between Cost of Goods Sold and general expenses to illustrate that good accounting can result in a favorable effective tax rate when applying IRC 280E.
It is interesting to note that several states within the U.S. do not charge a state income tax. Now, if a cannabis owner were to form their corporation in a state with no income tax, they have just saved themselves a load of money. Many states that allow cannabis have decided to give their cannabis entrepreneurs a state tax break by not charging the state tax rate on the gross income; rather, they charge just like they would on a normal federally legal business—on the income before tax.
Which states do not charge a state income tax? Here are the ones listed as of this publication: Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington and Wyoming.
It could be quite advantageous to incorporate a plant-touching business under the umbrella of a “C” Corporation.
The reason for this is because a “C” Corporation does not have personal liability falling back to the owners. Since plant-touching businesses are federally illegal, it’s beneficial to insulate the owners from as much personal liability as possible.
Of course, each cannabis business is different and has different owners with their own personal requirements of ownership, but it would be wise to consult with an attorney before structuring the entity to best maximize tax savings and reduce risk to the owners.
Another excellent tax saving strategy and a way of increasing the value of a cannabis company significantly is by separating the tangible properties from the intangible properties, commonly called the intellectual portfolio.
In order to do this, the cannabis owner should consult with an IP analyst who is adept at identifying the intellectual properties within a cannabis company. For example, to name but a few, a cannabis company may have such intellectual properties such as recipe formulas, sales techniques, customer lists, business plans, website content, client data, architectural drawings, etc.
It is important to note that the intellectual property portfolio is made up of intangible assets, that are not subject to 280E taxation; therefore, it is imperative for a cannabis business to identify these important assets for increasing the value of the business, but also an incredibly good tax reduction strategy.
In summary, three pertinent pointers have been given to help a cannabis business owner face the issue of IRC 280E, but it is up to the business owner to reach out to accountants familiar with cannabis accounting and look for attorneys who will help in the proper structuring of the cannabis business.
One must remember that an ounce of prevention is always better than a pound of cure.
William Fowler is a retired IRS large case exam officer.