Cannabis Knowledge & Insights

280E & Insider Tips on Structuring Your Cannabis Business for the Most Financial Benefits

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Hey guys this is Derek at GreenGrowth CPAs! I am really excited that you’re watching our webinar if you have any questions with the webinar please feel free to reach out to us green growth CPAs column or you could give us a call welcome everyone really excited for the webinar i see we have people from all over the US which is insanely exciting hello Tamsin you are tuning in from Humboldt Southern humble looks like Kaelyn you are with green rush Alliance is really exciting let’s see Jennifer hello from Alaska wave all the way over there I’m glad you guys have internet and I think you guys still have one last blockbuster left super jealous about that one hey Tyler from Denver Colorado really good to have you here Theresa from Oregon welcome Claudia from Oakland hello there what’s up David from Nevada County hey Allison from Santa Rosa wow this is great Holly from Pacifica hey Holly hey Jeff from Newport I actually grew up in Newport Beach as well graduated from Newport Harbor High School back in the early 2000s mark Huntington I love surfing in Huntington great waves see Tanoa welcome from DC the nation’s capitol drew what’s up from LA if you’re ever in the mid Wilshire’s area stop by our headquarters we are right next to the Grove San Diego grad ooh blue Newport oh come on you guys are the sea Queens no um let’s see Dave from San Diego what’s up Dave I actually just moved back from San Diego we were in University Heights which is such an awesome part of town see Dad hey Dad Jude from Mendocino welcome so guys were really excited to present our topic today which is taxes and tweet what are your responsibilities just as a quick disclosure the information contained in this PowerPoint is meant for guidance purposes only and is not professional legal or tax advice remember we are a CPA firm and unfortunately cannot give legal advice we can only talk to the tax issues further we unfortunately cannot get personalised legal tax investment or any business advice in general during this PowerPoint presentation we can simply talk about the issues themselves let’s jump into it the topic for today’s discussion will be taxes and 280e what are your responsibilities so a little bit about our agenda today we’ll go over who we are as the CPA firm we are called green growth CPAs and we are a full-service CPA firm servicing the cannabis industry will briefly talk about business structuring 101 which will include nonprofit mutual benefit corpse as well as cannabis tax responsibilities we will cover 280e and cost a good sold we will then chat about what deductions you can and cannot claim and then we’ll briefly talk about penalties and benefits as well as bookkeeping best practices so with that let’s get started we are green growth CPAs I personally and Derrick Davis I’m a CPA at the firm I personally been licensed since 2012 as a CPA licensing in the beautiful state of California I have almost about a decade of corporate taxation experience and I started my tax career at Deloitte tax as well as PricewaterhouseCoopers in 2015 I was fortunate enough to testify on Capitol Hill regarding tax policy reform and I’ve been quoted in several tax policy and tax referendums as well as my personal involvement in cannabis starting in 2010 when it was previously on the ballot to be folding legalized in the state of California and it’s also when – EEE came out as many of you know unfortunately cannabis was not passed in 2010 but we did finally pass full-scale recreational licensing in 2016 so let’s talk about business structuring we’ll briefly talk about nonprofits or cooperatives as they are usually known some pros of these structures is that they may be subject to lower tax benefits but one thing that’s really important to remember is that even if you are a non-profit you will generally not be allowed nonprofit tax exemption so a lot of clients will come to us and say hey we’re a non-profit therefore we don’t have to pay tax unfortunately that has never been the case with cannabis operators if you are a cannabis operator we have never seen a case or they have been granted not-for-profit status so it’s really important to remember that even if you are legally incorporated as a non-profit you will still have to pay taxes as a for-profit company one of the biggest cons of being a non-profit is that you cannot take a distribution and you also cannot buy and sell your nonprofit entity which also includes a ton of additional paperwork that goes along with being a non-profit so one of the drawbacks of that is that if you are nonprofit and let’s say you build up a huge brand name and you have a great brand and you have you know tens of thousands of customers that love your product being a non-profit will not allow you to sell your company so you can’t cash out at the end of the day because technically under the nonprofit rules you don’t own the company another type of business structure that a lot of companies look at is be corpse really the only really good tool that we’ve seen for be corpses at the their great tool from marketing so a lot of people like to see be corpses you know be more economically resilient and sometimes it is more attractive to potential investors as well as hiring and retaining top talent the obvious cons of B Corp of course though is that it’s really hard process to go through and again B Corp certified they also face higher levels of scrutiny both internally and externally and shareholders generally tend to have more power than a normal C Corp or escort in determining you know if a B Corp is right for you you really want to determine if that additional certification will really move the needle in terms of your sales if you really believe that you can increase sales by being a B Corp then that may be of interest to you but otherwise it’s just a lot more paperwork and it’s a lot more restrictive C corpse and S corpse are obviously the two most common business structures that we see the pros of a C Corp is that it reduces the potential liability of the individual owners the cons of the C Corp of course is that there’s double taxation and there’s higher federal and state filing fees generally in the cannabis industry you generally see a retail based operator being a C Corp specifically because if they ever were to be audited by the IRS and the IRS disallowed a lot of their expenses and said that these are non deductible under 280 e that the liability may become so big on the owner that the company goes out of business and if your C Corp generally speaking you will have that tax liability absorbed by the C Corp itself and it won’t be passed on to the individual owners but again for these specific legal requirements we suggest that you talk to a lawyer as as we are not a law firm and we cannot give legal advice we can only speak to the top tax implications escorts are generally good companies for product producing companies so you know whether you make your pre-rolls you are a cultivator you are manufacturer anytime you produce a tangible product s corpse usually make sense because of the main Pro that it is not subject to double taxation so you as an as an owner of the S corp and as of the company all the profits and losses will flow through to you individually there’s also some personal liability protection which is also great to have the real big con of an S corp is that there’s there’s rules and fees that apply and you’re required to pay yourself a reasonable salary so let’s say at the end of the year you net a hundred thousand dollars generally speaking you want to pay yourself at least a sixty to seventy percent salary so sixty to seventy thousand dollars will be a w-2 wage and the remaining amount will be taken as a distribution which will not be subject to self-employment tax and those are really the benefits of S corp sand and luckily we can model out what the two different scenarios will look like whether it be escort or c-corp and while your potential taxes would look like and then we can also talk about what a potential tax liability would look like if you were in the event of an IRS audit and there’s a huge adjustments with penalties and interest sole proprietorship is another form of an entity which is really no entity at all and as sole proprietor just means that an individual’s like hey I’m gonna start my own you know let’s say pre-roll brand and I’m gonna go out into the marketplace and I’m not gonna set up any legal entity the pros of that is that’s really simple because you you know you may have to file you know some respective filings based on how you’re operating but beyond that all of the profits and losses will float your Schedule C the main con of course of a sole proprietorship is there’s a huge level of personal liability so if you were ever potentially sued they could just go after you personally and they could potentially take away your house if you owned one your car any and all assets that you do own if you were to be sued they would just come after you individually the next type of business structuring is a general or limited partnership and LP there are a lot of tax benefit for partners of NLP generally a limited partner and a limited partnership can have very favorable tax benefits and they may not be subject to self-employment tax so they can just take a distribution so there’s definite advantages for limited partners the cons are that there’s compliance challenges and the risks may be passed on to the general partners so in any limited or general partnership you always need to make sure to have one general partner and that general partner can also be personally liable for the death of the company so if you’re a general partner and you get sued they could potentially go after your personal assets so depending on who you’re working with and what your team structure looks like well dinner will generally dictate the terms of that arrangement and last but not least let’s talk about LLC’s and LLP is I’m starting to see a lot of questions coming in the chat box and we’ll try to answer all the questions at the end of our webinar but of course if we’re unable to get to them please reach out to us green growth CPAs com our phone number will also be listed at the end of the slide deck so please don’t be a stranger and please reach out to us LLC’s are probably one of my most favorable enemies from a tax perspective simply because it allows for flexible management structure you do have some limited personal liability and you have various different tax options available to you so for example you can be an LLC and taxed as an S corp or C Corp so it or you could just be taxed as a general partnership so there’s a lot of different ways to be taxed and an LLC will give you that flexibility the only cons of course is that there may be special taxes levied at the state level and it is also less structure and investors aren’t as comfortable with LLC’s as they generally are C corbs generally an investor will like to have special terms and preferences and those can oftentimes be more easily laid out in a C Corp let’s say on the event of the dissolution you know the investor may get paid out first or they have may they may have first rights to the ass so there’s various different structures that a c-corp can provide that a LLC may not but of course you can always operate amend the operating agreement so you know if an investor wants specific preferences you can put that in the operating agreement to provide that to them but overall I think LLC’s are generally a safe choice so we’re gonna briefly talk about mutual benefit nonprofit corporations these were prevalent in California pre this year and so we still see a lot of these entities sitting around so we want to talk about the structure and the assets associated with these corporations but more often times none especially going into 2019 you want to dissolve your your nonprofit mutual benefit corporation and turn it into a for-profit entity as we previously discussed early on the slides some defining characteristics of course of nonprofit mutual benefit corpse is that the assets of the corporation will only be distributed to the members upon dissolution of the corporation not during operations so what that means is that if you are set up as a non-profit mutual benefit Corp and you know you you’re one of the partners of the company or when you’re one of the potential directors and you want to exit the company you fortunately can’t get your assets you know let’s say you have a large co2 extraction machine you cannot get that asset and tell you until the corporation dissolves so you know when thinking about structuring and dissolution more often times than not nonprofit mutual benefit Corpse are not to go to entity so as a cannabis operator you may be responsible for four different levels of taxes so you’ll obviously have your sales tax you’ll have your federal and state income tax you’ll have your state corporation filing fees and then you’ll have your normal cannabis taxes that are generally assess at the local level the best thing to do more oftentimes not if you do have a non-profit mutual benefit corporation is generally to dissolve the corporation and not convert it but of course if you’re looking at both options you want to read through your articles of incorporation often times a more sophisticated attorney will hat will set up a c-corp and they’ll have a non-profit section and generally our attorneys that we work with have recommended that structure because if you wanted to convert all you’d have to do is acts that section out of your articles incorporation but again check with your attorney as that is more legal based and we can only speak to the tax finance and money related issues some other things you may want to look at is the depreciation of fixed assets sometimes you know if you depreciate your co2 extraction machine you’ll get a great tax benefit but upon dissolution if you have to sell it there may be a gain that you sell it for and you’ll have to pay taxes at that game some other things you may also look at is the basis of the property so you know if you’re specifically looking at whether to dissolve or convert definitely check with your lawyer as well check with your tax advisor to make sure that you won’t be subject to a ton of taxes upon dissolution okay guys so now we’re gonna talk about taxes and 280e so as you can see in the side-by-side comparison you have an ordinary business and the cannabis business they molt they both make a million dollars in sales and they both have $400,000 and cost of goods sold they both also have $500,000 in sales and marketing expenses but the ordinary business can deduct that and the cannabis business cannot deduct that so what you can see is that and this is simply at the federal level it also flows down to the state level as well but the ordinary business only pays $35,000 in taxes while the cannabis business has to pay over two hundred and ten thousand dollars in taxes so the discrepancy between the two is huge and without proper tax planning and tax structuring you may find yourself at the wrong side of the on the wrong side offense come tacs in time so it’s really important to understand what to EEE and how do you work with it 280 is pretty much a federal regulation that forbids your sales and marketing expenses it is there because of the Reagan era just say no campaign that allowed drug dealers to sell their cost of goods sold but not did not allow them to sell their sales and marketing expenses and this is unfortunately because the case because cannabis is still a Schedule one drug for ete to go away it would have to go from schedule 1 miss schedules 3 so let’s talk about potential sales and marketing expenses any amounts that you pay to weed Maps is not deductible any amounts you pay the Leafly or any other marketing platform is non-deductible any type of sales brochures sales catalogs product catalogs those are all generally not deductible as well as the head count you know if you have a sales team those expenses are not deductible so it’s really important to understand how 280e negatively affects your business and it’s really important to understand how to structure it correctly so when it comes time for April 15th you don’t have this massive tax liability this is unfortunately the case you know from our perspective for the foreseeable future so you know unless you know the midterm elections Congress flips and they decide the schedule cannabis it’s it’s probably here to stay for the next couple years another thing to be mindful of is that when thinking about either starting your company or operating your company you want to see how each city will tax their cannabis operators so for example if you’re thinking about going into the city of Los Angeles it’s important to remember that there’s a 5% generally 5% top-line tax that’s love even for the operators whereas if you go to Oakland there’s a 5% tax on medical but there’s a 10% tax on recreational so tax has become a really important issue because they can really muddy up your cash flow and if you want to charge out the taxes the city charges to you you’re obviously more than free to do so but then you’re gonna have to pass that cost on your consumer and so you know if the price if you decide that your cultivator and you know your price per pound is 1,200 but then you charge out all the cultivation taxes all of the city taxes to the respective customer your price is gonna go from you know twelve hundred let’s say seventeen hundred dollars and that may just price you out of the market so it’s really important when you’re thinking about running your business and starting it how the local taxes will affect you oftentimes you’ll generally see about three different types of taxes you’ll see a tax on the square footage you’ll see a tax based on sales and oftentimes that will be a absolute dollar amount and then you’ll also times you’ll oftentimes see a tax on a percentage of sales so you know it’s really important to evaluate you know how much is real estate how much your taxes and how long it will take to get started because these three factors will they’ll generally dictate and the long term whether your company will win or potentially lose so for example sometimes you know you can go out in the desert and they’ll be cheaper access to real estate but then the taxes that are levied on you are so high that you might not even turn a profit whereas you know if you go in the city the real estate may be more expensive but the taxes are lower and so you may be more competitive so it’s really important to understand how the taxes are being levied at the local level to determine if you will make a profit in the long term or you will make a loss in addition to all of these taxes you have to still be mindful of the sales and use tax so this is this is sales and use tax for everything so you know generally you go to any sort of store you buy any sort of product they’ll generally have a sales and use tax and so the sales and use tax is an additional tax and it’s different from the local cannabis taxes it’s another layer of tax so you know at times it’s a little bit you know disheartening that taxes are being levied on taxes but it’s really important to make sure that your company’s structured correctly so you don’t get slaughtered in all these taxes and not of course sales and use taxes generally based on your top-line revenue so say for example you sell hundred dollars worth of product and your local city tax is nine percent and then your local cannabis taxes five percent so you’re effectively paying fourteen percent which is a huge percentage amount of all your income to taxes whether it be to the local cannabis tax or the sales and use tax cost of goods sold is pretty much your best friend across the board in terms of saving money from taxes what you generally can deduct is your product packaging and anything directly related to the sale the cannabis product the invoice for cannabis is generally less any trade and other discounts that you provide so those are other deductions that you can take against your net sales electricity bills are obviously really great if you’re a cultivator and you have a high electricity bill high water bill those are things that can absolutely be deducted against your cost of goods sold some other things that you may also want to think about is your transportation cost picking up the product can be considered if you’re a distributor a cost of goods sold but then distributing the product to the end retailer that delivery is generally a cost of sales and cannot be deducted some things you generally cannot deduct or you need to be very clear on is payroll office supplies and anything that does not directly relate to the cost of the product so at the end of the year or towards the end of the year when you’re thinking about tax planning and you’re trying to figure out how much tax you owe make sure that you go line item by line item down all your expenses and determine whether you believe it’s a related cost of product or cost of sales and if you’re confused obviously reach out to your tax advisor reach out to us we’d be happy to help go through all your line items and determine what we reasonably think can be applied to cost of goods sold or what we reasonably think should be a selling expense unfortunately we always have to talk about penalties because they’re huge aspect of the space unfortunately if you are licensed operator we’re seen out of Colorado that are actually around 20 1% of operators are being licensed there’s a lot of rumors in space that it’s you know based on this new administration which we obviously can’t independently verify but what we’re seeing is that as licensed operators are really easy to get to get picked off and to be audited for those of you that are super geeks on tax taxes such as myself check out the alternate tax case this was a recent tax court ruling for a dispensary and unfortunately they went back to their 2013 tax period I think the biggest takeaway from that Tax Court ruling is that they had no documentation or very little documentation to support their cost of goods sold expenses and so what happened as a result of that is that the IRS came and said ok you have no documentation on your expenses we’re gonna disallow all of your expenses that you took on your tax return and we’re gonna assess a huge penalty plus interest plus the adjustment itself and I believe it pushed them out of closed or two out of business and what we found is at least 90% cannabis companies aren’t doing the cost accounting throughout the year and they’re not properly documenting as well as keeping track of all the records that they need to make sure that in the unlikely event of a tax audit that they can have all the supporting documentation that they need ok so now we will chat about cost of goods sold best practices one of the best practice is to create separate account ledgers for cost of goods sold expenses as well as your regular business expenses you really want to break out your expenses into two categories things that you can reasonably deduct as cost of goods sold and other business expenses that you don’t believe would qualify under cost of goods sold and it’s really important to reconcile the two and determine you know can you reasonably allocate this to cost of goods sold or is this really sales and marketing expense the next thing you want to do is you want to set up a system for of checks and balances to verifying your cash flow and making sure that reconciles to your point-of-sale system often times because it is a cash based system we’ll see that a lot of the there’s a lot of points of failure along the way where cash can be siphoned off maybe intentionally maybe not intentionally but because we operate in a strictly cash-only environment there are many points along the way or cash can be potentially stolen so it’s really important that you set up independent checks to making sure that all the cash reconciles to your point of sale system the next thing you want to think about setting up is a strong inventory management and record-keeping system it’s always great to have backup records and documentation for all your expenses in the cloud or off off-site that’s not just paper what we find with a lot of our clients is that the paper trail and keeping all your receipts and you know keeping all the paperwork will get lost and so when it comes to getting audited you know you can’t find any of your paperwork so it’s always important to keep digital copies and digital backups of everything the next thing is you want to obviously set up controls to prevent fraud and theft whether that be the cash or the product itself and making sure you have clear reporting and clear reports on who handles what and making sure that you know if you have an inventory manager that they own the inventory and people are independent auditing their work the last thing you want to do is make sure you reconcile your general ledger with the different accounts either on a daily weekly or monthly basis I would generally say a bi-weekly basis depending on the volume of your transactions is usually the best but you know if you’re doing less than let’s say 250 thousand a month then maybe you can do that weekly or monthly the last thing you want to do is you want to make sure to keep a strong paper trail with receipts signed by the vendors as well as the payslips signed by the employees this is really really important when it comes down to the resale certificate so let’s say you are manufacture for example and you don’t provide timely resale certificates if you were to undergo a sales and use tax audit they could come in and say hey we don’t know if you sold these products to dispensary or you sold it to then consumer and because there was not a timely resale certificate provided that you know you’re gonna be subject for the sales and use tax even though you you provided it to the end retailer and what they’ll then do is they’ll say okay now you owe nine percent sales and use tax plus penalties plus interest and assess a huge amount so it’s really important that you have backup and you have a really strong paper trail generally in a cloud environment to make sure that you know five years down the road if you do get audited you can easily pull all your back files so some key takeaways is that nonprofits regardless of if it’s a California cooperative or nonprofit mutual benefit is that you still have to owe tax tax code to ete generally only means you can deduct your cost of goods sold and your cost of goods sold is limited to certain specific business expenses you know unfortunately you if you’re a licensed operator you may likely be subject to an audit so make sure you keep really strong records and you also keep digital backups of all your file and when in doubt you know consult with this cannabis a specific expert you know oftentimes cannabis operators and I’ve heard this time and time again or cannabis consultants charge more money but in the long term they’ll save you the headaches that an own cannabis operator just doesn’t have the industry insight so I do see that we have a bunch of questions coming in but I do see that we’ve also ran over our time so if you have any follow-up questions please reach out to us green growth CPAs com feel free to give us a call we’re here to help and I hope you enjoyed the webinar if you have any future recommendations or suggestions always reach out to us we’re here on the help thanks all!