At first glance, it may seem that the cards are stacked up against cannabis business owners. Compared to other industries, cannabis companies must pay tax on almost all of their gross income, this can be up to a 70% higher cost. This is due the tax code 208E that penalizes cannabis businesses, even when they are regulated and in full compliance with state law. In other words, cannabis companies are left not able to make typical business deductions for things like employee’s salaries, rent, equipment, and electricity.
To really put this in perspective, let’s compare a non-cannabis business with a cannabis business. Both have a growth revenue of $1,000,00 and a COGS of $650,000 that yields a gross income of $350,000. The non-cannabis business is able to claim $200,000 as a deductible business expense, but the cannabis business is not able to do this. This leaves the non-cannabis business with a taxable income of $150,000 compared to $350,000 for the cannabis business owner.
This is a 40% discrepancy between two legal businesses, one who sells cannabis products and the other does not. With an average tax rate of 30%, the non-cannabis business owner pays $45,000 in taxable income relative to the cannabis business owner who must pay $105,000. Taking this into account, you can quickly see how something like this could render a business unprofitable.
All is not hopeless, there are ways that cannabis companies can relieve some of their tax burdens. Below we present our top 10 tips for cannabis business owners on how to save money.
1. Become a C-corporation
When setting up your cannabis business there are several different corporate structures to choose from. We recommend setting it up as a c-corporation, this will allow you to only pay taxes based on salaries and dividends.
2. Create Two Business Structures.
We recommend having at least two business structures. One for production and distribution and a second for legal responsibilities. With a shared service agreement, only the first structure is responsible for compliance with the 280E tax code. The second structure has the advantage of making ordinary deductions that 280E would normally not allow (e.g., payroll, rent, utilities, sales administration, promotion, and marketing).
3. Use technology to maintain work logs.
There are many granulations to cannabis business law, for example, duties related to cultivation can fall into different tax codes. It’s important, therefore, to log all job duties and the time spent working on them. If you have an employee who performs multiple tasks, then it’s important to track the time spent on each task. Having a detailed record will help you determine how many hours are deductible under a specific tax code.
There are many different apps that make it easier than ever before to keep track of employees. Würk cannabis business management software, for example, includes an easy-to-use time-tracking and attendance software. Their software can help you keep track of employee activities and produce records that will help with taxes and in case of an audit.
4. Create employee job classifications.
Having specific employee classifications is helpful to ensure each employee does not work outside their designated duties related to a specific tax code. Also, we suggest adding the specific job classification into the job description that is signed by the employee. This will save you time and money in having to go back through work logs and account for the various hours.
5. Be Ready for an Audit.
Rates of being audited are higher for cannabis businesses compared to regular companies. Basically, you are running a business based on a federally illegal substance, so it makes sense to stay prepared. Remember, you should always have thorough documentation of every penny involved from the farming to sales and everything in between and thereafter. Keep all of your receipts, any failure to prove your deductions will result in fines.
6. Increase square footage devoted to sales.
Something to think about when it comes to deductions is the distribution of your floor plan. An average cannabis dispensary’s square footage, for example, might consist of 50% sales floors and 50% lobby. Half of the building used for sales is considered the cost of goods sold (COGS) and allows you to deduct 50% of the rent. To learn more about COGS check out the blog on ‘The business owners guide to marijuana tax laws.’
7. Minimize inventory to match demand.
When the product is sitting in inventory and flowing through COGS, you’re putting yourself at risk for the higher tax liability. We recommend minimizing year-end inventory as much as possible to reduce your tax liability, but also have enough to meet market demands.
8. Stay up-to-date on tax laws.
Tax changes happen frequently and may result in changes for your business. It’s important to stay informed on the tax laws and to know if any changes happen that may impact how you structure your business. To learn more about cannabis tax laws, check out- The business owners guide to cannabis tax laws
9. Decide your Business Accounting Method.
Whether your company accounting method should be ‘cash’ or ‘accrual’ depends on your business and the state that you live in. As a general rule of thumb, we recommend that cannabis businesses use an accrual accounting approach. Unlike with cash, the accrual method enables you to work with an experienced CPA who can help to reduce your taxable income by boosting COGS.
10. Work with a tax professional
If you are a cannabis business owner or someone who is interested in becoming one, we highly recommend working with a reputable CPA. Feel free to reach out to Herman & Company – Accounting & Consulting for help with your cannabis business tax needs.