The cannabis industry is booming in the US, and it’s only going to go up from here. More and more states are hopping on with full-recreational legalization, and it’s only a matter of time before the MORE Act passes, removing cannabis from scheduling in the US, and opening up our country to more opportunities for cannabis growers.
Whether you are an established, new, or prospective owner, partner, or investor in a grow operation ––– it’s critical to get professional financial and tax guidance on how to structure your cannabis cultivation business.
There are certain advantages and disadvantages of each entity type, that affect the risk profile, tax implications, and cash flow of your cannabis grow operation.
Entity Options: How to Structure Your Cannabis Cultivation Business
There are a lot of different ways you can structure a cannabis business. The most common entity types we see in our industry are:
- Sole Proprietorships.
- General Partnerships, Limited Partnerships, and LLCs.
- And S-Corporations
Our clients frequently ask us: “When it comes to cannabis cultivation ––– is there one corporate structure that works better than the rest?”
The answer: “Not typically.”
The ideal entity choice for your business could be the worst for another grow operation. The best option for YOU depends on the unique needs, financial position, and goals of YOUR business ––– and there are hundreds of variables that can go into making that decision.
So what’s the best way to decide how to structure your cannabis cultivation business?
Don’t settle for a low-cost accountant or financial advisor with ZERO experience in the cannabis industry. This path often leads to risky, uninformed accounting and finance decisions that could ruin your business down the line.
You need to partner with an accounting firm and reliable financial advisors that specialize in the cannabis industry. So to help you get started, let’s take a look at different corporate structures and how to structure your cannabis cultivation business
Sole Proprietorships for Cannabis Cultivation Businesses
Many new cannabis growers gravitate toward starting as a sole proprietorship. This is mostly due to the inherent simplicity of this entity type. If you aren’t familiar with sole proprietorships, this would be a cannabis grower that is owned and operated by one person.
The primary benefit of a sole proprietorship is that they are quick and easy to set up. You don’t need any documents, forms, or agreements to get up and running.
The unique disadvantage of setting up your cultivation business as a sole proprietorship is that you have no liability protection. If you get sued, your personal assets (like your home, vehicles, and personal possessions) can be subject to liability.
General Partnerships, Limited Partnerships, and LLCs for Cannabis Growers
General Partnership Structure for Cannabis Cultivators
A general partnership is similar to a sole proprietorship, in the sense that you don’t need to fill out any paperwork to start one. The biggest differentiator between sole proprietorships and partnerships is that there’s more than one business owner.
Limited Partnership Structure for Cannabis Cultivators
Limited partnerships can have both general and limited partners. General partners are typically responsible for making key business decisions. They are the partners involved in the day-to-day operations of running the business. In line with that, general partners are typically liable for the debts the business incurs.
Limited partners are investors who do not have a hand in daily operations. Their personal liability in the business is limited to their individual contribution to the partnership.
In the context of a Limited Liability Partnership (LLP), business income is passed through the business, to the partners. This results in taxes that are only paid once ––– on the individual income or loss reported by each partner.
LLCs for Cannabis Cultivation Businesses
Unlike sole proprietorships, Cannabis LLCs and LLPs must be registered with the state they do business in. In LLCs and LLPs, individual members are protected from liability, as long as the company is operating within state regulations.
One of the main benefits of partnerships and LLCs for cannabis growers is that it spreads responsibilities, taxes, and liabilities amongst the owners or partners. LLCs are also easy to set up and are very flexible when it comes to taxes and tax distribution amongst the owners.
The biggest drawback to general partnerships, limited partnerships, and LLCs for cannabis cultivation businesses is if you build up tax debt, the courts may go after you or your partners, personally.
C-Corporation Structure for Cannabis Cultivation Businesses
How would a cannabis cultivation business operate as a C-Corp?
C-Corps are structured in a way that the business is owned by shareholders. These shareholders have stock in the company. Unlike S-Corporations, C-Corps are not subject to reductions from non-deductible expenses that are passed through to the owners.
One of the biggest advantages to cannabis cultivation businesses structured as C-Corporations is that they tend to be the most defensible to debt. If the company builds up debt, most of the debt will generally be absorbed by the legal entity –––NOT the shareholders ––– with the exception of sales and payroll taxes.
Another benefit of the C-Corp structure is that each of the owners’ respective investments, results in a different individual tax basis.
*For example, a shareholder who invests $100,000 into a cultivation business is going to be subject to a different tax basis than one who invests $50,000, $25,000, $10,000, and so on…
The downside of C-Corps is that they are taxed on corporate earnings as well. Cannabis growers filed as C-Corporations pay taxes in two ways:
- First: On any income that is generated by the activities within the business entity.
- Second: By partners and/or owners that report and pay taxes on any distributions of earnings (or “dividends”) paid out to them, from the corporation.
This is what we often refer to as “double taxation,” since taxes can be paid twice on the same source of income.
S-Corporations for Cannabis Cultivation Businesses
Unlike C-corporations, S-corporations are set up in a way that avoids double taxation.
S-corporations still have to file a separate income tax return. However, whatever net income ––– or loss ––– they show at the end of the year is passed through to each of the shareholder’s individual income tax returns. This tax rate would be relative to the percentage of ownership, of each of the individual shareholders.
One of the biggest benefits of S-Corporations for cultivation businesses is that they can get favorable tax treatments. This means you can take a distribution that is not subject to self-employment taxes. S-Corporations can also have the benefit of lower Medicare and Social Security taxes.
One major disadvantage for cannabis cultivation businesses set up as S-corporations is that non-deductible business expenses are passed through to the business owners. This is the result of IRS tax code 280E.
If you aren’t familiar with IRS tax code 280E, be sure to check out our YouTube videos and blogs on 280E, and how they affect cannabis businesses:
- IRS Cannabis Business Tax Guidance on IRC 280E, Cannabis CoGS and IRC 471c.
- 280E and Cannabis Business Structuring for the Best Financial Benefits.
- Cannabis Accounting: IRC 280E Case Study on Licensed Cannabis Business Taxes.
Another drawback of S-Corps is that they have specific requirements on who can be an S-Corp owner and who cannot. In many cases, businesses set up as S-Corporations can’t seek outside funding, which is another unique limitation of this structure.
Get Help on How to Structure Your Cannabis Cultivation Business
We hope this gives you a better understanding of business entity options for cannabis cultivation businesses and growers. Keep in mind that this does not constitute personalized legal or tax advice, and shouldn’t be used as such. This is purely a general overview of some options you have available to you as a new or expanding cannabis grow operations or business.
If you need help with structuring your cannabis business, developing a tax strategy for your cannabis business, or are interested in accounting or financial services, contact our cannabis tax and financial experts at GreenGrowthCPAs.com or call us today at 800-674-9050.