Cannabis Knowledge & Insights

R&D Tax Credits for the Cannabis Industry

In this article and video, we discuss the details on Research and Development Tax Credits for the cannabis industry, and how these tax credits affect cannabis businesses.


Hey y’all how you doing my name is Jim Breese from GreenGrowth CPAs and I’m glad you could join us we have a great webinar today talking about R&D tax credits for the cannabis industry very excited to share a lot of tactical and practical information for you so you can improve your tax situation for your cannabis company what do you think R&D is what’s gonna be revealing about this presentation is that R&D is not all lab coats and making bits and bytes and little boards and all this world groundbreaking things it doesn’t have to be new to the whole world but new to you the tax payer and that’s one of the best nuances of this that I’ll get into hey everyone thank you again for joining for today’s webinar we’re gonna be talking about R&D tax credits for the cannabis industry my name is Jim briefs and I’m the chief marketing officer here at Green gross CPAs and I want to give you a little bit of color in context around who we are at green growth CPAs so we are a cannabis only compliance tax finance firm right we only work with cannabis clients nobody else and so we specialized in technical accounting operations finance audit services IPO services business formation pretty much anything that has to do with the cannabis industry we can help you out with we’ve helped prepare over 1,200 annual tax returns for cannabis operators spread across all verticals dispensaries distribution cultivation manufacturing delivery and testing we have over 350 cannabis business clients spread across 12 states in over the past two years we’ve done 15 audit and valuation related projects so helping people do M&A deals and make sure that their companies are being valued at the proper valuation doing the due diligence for the people that are buying those companies as well we have a thorough and deep understanding of tax compliance and assurance related requirements for the cannabis industry so anything you need for your cannabis business we can help you out with that or we can put you in contact with the right skilled team that can help you out with that task so before we hop into today’s presentation I need to let you know that the information contained in this webinar presentation is meant for guidance purposes only and not as professional legal or tax advice and further it does not give any personalized legal tax investment or any business advice in general so with that out of the way let’s hop right into today’s agenda so first we’re going to cover the history of Rd tax credit and then talk about the conflicts that it has with 280e our favorite thing to talk about right and why use R&D tax credits then we’ll define what R&D actually means right research and development you know when you hear that you probably think lab coats and really high-tech bits and bytes and gadgets and all that but I’ll actually pull the cover back and show you what R&D actually stands for and the IRS is eyes and then will define what qualified research actually is give you some indicators and examples of qualified research and then we’ll talk about which expenses actually qualify or qre qualified research expenses and then we’ll talk about the Rd study methodology so let’s just quickly go over the history of R&D tax credits so it was initially introduced in 1981 in the basis of it was to incentivize companies to invest in u.s. innovation they want to reward companies for you know doing that research in that R&D stateside and it did expire but it keeps coming back year after year the IRS keeps renewing it and that’s a great thing for companies just like yours and one thing to understand is it’s not a Tier one issue which means it’s not subject to audit scrutiny so once you take this credit it doesn’t necessarily trigger an audit for your company which is good it gives you some kind of peace of mind and some air cover to know that you can take these credits without triggering an audit and creating more problems for yourself one of the biggest things that happened in 2004 was there was an update to it and what it said is that the R&D that you’re doing doesn’t have to be new to the world it just has to be new to you the tax payer another update from there is that it doesn’t have to be just for products they also opened it up to process improvements and this can be ongoing processing improvements in year after year you can take advantage of these credits then a third aspect of that expansion and update was it expanded who the qualifying employees are so it used to be just the people that were directly doing the R&D or doing the research and development but they realized that hey a lot of time is being taken up by support and supervisory roles and people that are actually making sure the research and development actually happens so the IRS expanded who you could claim under qualified research expenses the wages and the salaries of supervisory and support roles so that’s very very good for you and your company expands the scope of how you can take it of the Rd tax credits so as we all know to a te it’s the biggest tax code that has to do with anybody dealing with a Schedule one substance which cannabis is and so to a te it disallows any credits or deductions that are not cogs or cost of goods sold so to help take advantage of Rd tax credits what you can do is create a separate entity just for R&D which would become a third party which we’ll talk about later in this presentation and when you do create that third party Rd firm for your cannabis company right it’s a whole separate legal entity you create a contract manufacturing service relationship with that company and then you can start to take advantage of these Rd tax credits so as you can see on the map here a map from KB kg comm many many states nearly all the states offer some type of Rd tax credits in some capacity some offer them for longer terms some have higher deductions you can take from them but as you can see here if you have a cannabis company that is based in one of those maroon states and the Rd is taking place in one of those states then you can take advantage of the Rd tax credits for your cannabis company so you may be asking hey why should we even take the time to take advantage of Rd tax credits well right away it’s immediate cash you get 13 cents back for every dollar spent on qualified research in California at six and a half percent and at the federal it’s also six and a half percent what this can do is a dollar-for-dollar tax credit so it reduces your taxes at a federal and a state level so if you have a thousand dollar tax bill and you have $1,000 in tax credits you now have a zero tax bill which is great so that’s a main reason of taking advantage of R&D tax credits now what’s good is it’s available for open tax ears meaning that if you didn’t take advantage of it you know in prior years you’ll be able to go back and reclaim those credits so for the federal it’s three years back and then for California it’s four years back you can check with all the other states so you’re based in Oregon or you’re Basin you know Michigan or any other state you’ll have to check with that statute is but for California here is four years another thing that is great is it can be carried forward so if you’re a start-up and you’re not having revenue so you have no tax exposure on that end and you can carry these things forward so for federal taxes it’s 20 years you can carry it forward and for California it’s indefinitely you can carry it forward now understand that this is applicable to any vertical in the cannabis industry you’re pretty much eligible in any part of the industry and that you know 95 percent of the people that are eligible well even ninety eight percent don’t claim these credits because pretty much they don’t even know that these exist and a lot of people ask us hey is this even a real thing yes these are real credits just because you haven’t heard of it or you think that your business doesn’t do technology or some kind of research and development that you can’t take advantage of this yes you can and it’s in your best interest to at least do an initial study to see if a claim or a credit is available for your company so let’s define what R and D actually is you know I want you to understand that it’s not what you think in your mind but it’s what the IRS defines R and D right it’s not just lab coats or world changing technology 5g LTE small little boards and whatever these kind of things that you think in your head are Rd it’s not limited to just that so the IRS says it has to be a new or improved business component to the taxpayer and not to the world so a product a process a technique of formula and invention or a software item so I’m sure as you start to hear them you’re like hey we have products hey we have processes we have new formulas we’re inventing things we build software yes that is R&D and it doesn’t have to be big or world-changing and it doesn’t have to be successful either sometimes and you’re developing new processes or new products they don’t ever see the light of day they never get to market but you did have expenditures of doing R&D and trying to figure out a problem in relieve uncertainty in your business and you can still claim tax credits even if your project wasn’t successful what’s great about the R&D is that it’s not just in one phase it covers from start to finish what we’ll talk about here is a four-part test and one of those parts of that test deals with uncertainty so all the expenses that you put out while dealing with uncertainty it covers from the start of that uncertainty to the end of that uncertainty which is great for you because again goes over time and it can be staggered year over year over a year and takes a four-part test to qualify and define what Rd is and we’ll hop into understanding that process right now so qualified research it’s a four-part test all right I think I said that three times now but it’s a four-part test and so the four components of it basically are this okay so you have it needs to be a permitted purpose so again it’s got to be for a product a process a technique a formula invention or a software item and this has to be new or improved so again it doesn’t have to be new to the world it can be just new to your company or if you’re doing process improvement that works as well or technique improvement or improving a formula that works as well that would qualify under the first part and I didn’t say this yet but you have to hit all four pieces of this test it’s not just one or two or three you have to hit all four pieces of this test so as long as you’re starting out with a permanent purpose great you’ve got one check box done there now the second part it has to be technological in nature which means it has to rely on hard sciences like engineering chemistry the physical sciences mathematics physics biology computer science things like that right not things like social sciences like arts or humanities so if you’re developing a new business component its technological in nature boom we got two boxes checked off here now the third part is that you have to eliminate uncertainty so when you’re doing something an activity must be undertaken to discover information related to uncertainties regarding the capability or method for developing or improving a product or process uncertainty may exist as to the capability of the methodology or design you may be asking questions like hey is it possible to develop the business component at all what is the optimal design of the product of the process and what is the best way to achieve our desired results right there’s gonna be a risk of failure there if there is an understanding there’s that risk and you qualify for that third part of elimination of uncertainty right when you have multiple options or multiple ways to accomplish something and you are doing business activities to relieve that uncertainty you qualify under that third part there now the fourth part of this test is actually the process of experimentation so you must test one or more ideas or concepts to overcome that uncertainty you can’t just think about it you actually have to do it so something like setting goals and then brainstorming with your team on what you want to do and then creating a detailed development process or plans and then go into prototyping out those plans and be creating processes or products and then you actually test those out and you look at the data and analyze the data and make conclusions and you modify whatever that process is and then you repeat that testing and you continually iterate over this product or this process until you finally relieve that uncertainty so if you hit all four those permitted purpose technological nature elimination of uncertainty and process of experimentation then that is qualified research so now that you understand the four-part test let’s give you a few more things to think about right some indicators a qualified research that your company may be doing so do you have an R&D department people that are actually doing research and development you almost surely have some ability to take R&D tax credits do you employ scientists or chemists or product engineers how about process engineers what about doing product development I’m sure most people that are in the cannabis space since it’s been you know sitting on the fringes of society not many people have been out there doing new and great product development there’s been a lot of great product development I don’t want to you know make light of any of that but you’re seeing more and more and more product development process development software development coming out there because people are now seeing this is not a gray industry it’s becoming more black and white it’s becoming more accepted as a place to work at do you have technology that you’ve been developing and getting patents on these points here are indicators that your company is doing qualified research and development for tax credits so let’s make it a little more concrete I want to give you some examples of qualified research even talking about some products or things and you may be doing in your cannabis company already so there’s a lot of manufacturing going out there creating new products so think about maybe you as a canvas manufacturer have done pilot runs you’ve done hey we’re going to create 1,000 units of something or 300 units of something to see does it actually work from going from 3d printing to some kind of you know manufacturing process alright great so that qualifies potentially as our need credits but then you say all right we did a thousand units we want to go to 10,000 units that’s called a scale-up for production what that does is it introduces new external factors that create even more uncertainty so you may be able to get qualified R&D credits our research under that scale-up process because of that uncertainty right you have to create new process improvements you have to create new manufacturing equipment potential you have to do Quality Assurance processes for your product and make sure that it’s you know actually performing the way you thought it would perform from that you know prototype from this to the small test another scale-up so a lot of you manufacturers out there you may be able to claim R&D tax credits now there’s a lot of people here engineering new consumer products so you’re designing something totally new or maybe it’s an improvement on a current product out there in the market and you’re going out there to get patents for it this could be an example of qualified research for your cannabis company now think about agriculture and cultivation you know what if you’re doing improved irrigation techniques you’re finding a drip system that works for your company and for your grow operation maybe you’re having to dig new wells and improve on that irrigation or water saving techniques now what about thinking about totally new growing and harvesting techniques are you guys figuring out new ways to grow the plant to increase the yield per plant or for the space or for the height or whatever you’re thinking about doing or do you have these new harvesting techniques that could be qualified research potentially now if you’re in California you’re very well aware of track and trace and under this qualified research track and trace methodology especially if you have to do a full custom process especially for these vertically integrated partners out there and businesses out there it has to go from raw materials to distribution all the way out to that and consumer you may be able to qualify for these tax credits because you’re developing that full custom process how you actually integrate metric which is the track and trade system out in California into your business you may you know have to develop something very very custom in detailed in nature there’s processes that come along with that and lastly software now this is kind of a gray area due to the you know how are you actually using this software is it for internal processes or for external use as the temir so if you’re developing software you have to think about well there’s a lot of stuff that goes along with that QA and dev and testing and planning out what is a best implementation for the codebase and creating the source code in this way or testing out few libraries for it so these are examples of qualified research and hopefully you start to get your wheels turning like hey we do some of these things hey our cannabis company actually participates in these activities all right so now you understand the activities what expenses are actually qualified research expenses well it hits into three different prongs so we’ll start first with salaries and wages and this is the bulk of the credit okay so what this breaks out to is if someone who is a qualified employee that’s working on a project for you and 50% of their time is spent on that project then 50% of their taxable wages is going to be qualified research expenses now there is this thing out there called the substantially all rule and what it says is that there’s a break at 80% if someone’s spending 80 percent of their time working on a project and you could reasonably claim a hundred percent of their wages are qualified research the second part of qualified research expenses is supplies and this is non capitalized expenditures so things that are consumables and raw materials and it qualifies if when they were used uncertainty was involved in the process right so it’s not the ongoing of you actually now you’ve scaled up your manufacturing all the kinks are worked out and you want to start qualifying ongoing expenses that are not part of uncertainty it’s not going to work out so now I’m capitalized expenditures that had uncertainty involved in the process of using them that qualifies and then lastly third parties we talked about this earlier a 280e is gonna kind of throw a wrench in this because you can’t take credits as a person who’s conducting business with a schedule 1 controlled substance well this is where that third parties come in so number one if you are engaging another third party that you do not own that’s fine too so third parties are someone who does the Rd on your behalf and that work needs to be done in the US and the state of the tax return that you’re going to be filing that credit for and I believe that is going to be 65% of the payments to that third party so it’s in your best interests you start thinking about this because if you start thinking hey we spent you know two hundred thousand eight hundred thousand three million dollars on potential R&D Wow that is some good money dollar for dollar tax credit saying you can get back and save a ton of money for your cannabis company that you can actually reinvest into your company pay back to your employees as bonuses or whatever you’d like to do with that money so how does the IRS know that you’re not just making this all up there’s got to be some way that you document this right what are the methodologies behind all of this so the IRS knows that you weren’t planning to do R&D to get a tax credit right so they have created a set of acceptable methodologies in reasonable ways to document your R&D to make sure that you can qualify for these tax credits it depends on the materiality of the credit right so someone is taking a thousand dollars in R&D tax credits versus someone who’s taken ten million dollars in R&D tax credits actual documentation and methodology will have to be a little more robust there so what you need to do is capture the supporting information around your R&D projects so if you’re starting off your new I would highly suggest you get a project accounting system it’s the most ideal way to do this what that is is that R&D activities and pretty much any activity is tracked by employee and by projects so costs for the supplies cost of person’s time third party expenses that go out there right this is a very very detailed way to do it if you’re a start-up it’s more easy to implement this way because you’re you know you’re new when you don’t have a bunch of antiquated systems that are holding you back but time allocation studies are actually the most common way and what this is is pretty much a breakdown of testimony from employees we say hey we interview them and they say hey I spent 10 percent of my time working on this project I spent you know 18 percent of my time working on this project and whatever that’s going to be and then you get supporting documentation to create a connection between the qualifying employees the supplies in the contractor costs with specific projects that meet that four-part test we talked about earlier in this presentation right qualified documentation can be project plans test results design review meeting minutes emails calendars all those kinds of things that go along with attaching you know real results or participation and effort into qualified projects that can be considered document in drawing that connection between the employees the project the costs and all that stuff related to the project now you may be saying hey we’re a start-up we have no taxable income what’s the reason for doing these tax credits what does it matter we are not going to be reducing our tax burden good point but if you think about it from a tax perspective and something I talked about earlier the carry forward okay so keep documenting and capturing all of your expenses maybe make journals if you don’t want to create a project accounting system keep detailed journals make sure you don’t delete any emails keep all the project plans and the test results and your review meeting minutes because if you start to do that and capture that once you start to generate revenue we can carry forward these expenses again in the federal for 20 years and in California for indefinitely all right so make this part of your workflow ASAP right away especially if you’re doing this Rd as a manufacturing company as a product company it’s in your best interest to do this it’s not hurting you it’s pretty much a small little diary that could pay off huge dividends in the future so how do we actually perform an R&D study right so it’s not too intense it’s actually you can be as involved or as distant as you want as the cannabis business operator right we’re gonna help create a team that’s gonna come out to your business and help you do this okay what we’re gonna do is we’re gonna meet and interview key team members the technical people the financial people of your business and see what you actually do go through all the details and see if a credit is available and can even be utilized by your company all right so then if we see that hey there’s a potential for an RD tax credit for your company then we’ll step into the implementation phase this combines a lot more interviews so what we’re gonna do is meet with more people within your company more technical people more financial people to identify and qualify all the people and projects that could fall under qualified research then we’ll take the time to quantify the costs discuss and review the documentation involved in this Rd tax study and then we’ll perform the calculation for you I don’t want to get too detailed into the calculation part of it but we’ll do all those calculations for you and once that’s done we’ll produce a technical report for you that you can you as a roadmap for the IRS and for audit support it’ll include the methodology again audit support information and then we work with your CPA if we’re not your CPA already to help amend and file returns for those prior years and then create a schedule especially if you are start-up now going forward for that carry forward and then one of the most important parts is that will help to build and implement processes for going forward so that you have the ability to document at a more granular level and more accurate way of what qualifies under these R&D tax credits so that you can continue to take advantage of this year after year after year so the work we do at the beginning will help pay off for years and years ahead again you can be as involved or distance in this process that you want some people that we work with say hey just come in and do it and some businesses want to be real deep in their nitty gritty but I get it you’re busy you don’t have a lot of time to do and be involved in this Rd tax credit that’s why you pay us to come and save you this money what’s great about this is that it’s not a flat fee it’s just a percentage of what we can save you so we’re incentivized to find the most things because we get paid more when we help you save more so that’s what the best part about this is is that our incentives are aligned we’re trying to help you not just now but again for the future and help you build and save and save and reinvest into your company so let’s discuss some key takeaways about R&D tax credit so I really need you to understand this lots and lots of projects qualify for R&D tax credits again it doesn’t have to be groundbreaking world-changing technology it doesn’t have to be new to the world it just has to be new to you the tax payer okay and it has to come and fall under and qualify under this four-part test okay the four-part test is permitted purpose technological in nature has to have the elimination of uncertainty as its goal and a process of experimentation has to happen and what falls under qualified research expenses is salary and wages supplies that are not capitalized and third-party vendor costs and these can be recovered from three to four years back depending on federal or state level and which state you’re in as well as carry forward for 20 years or even indefinitely if you’re in the state California so it’s in your best interest to get this Rd tax study done for your business so if you’re interested in taking advantage of our D tax credits and getting an RD tax study for your cannabis company then please reach out to green growth CPAs by going to our website at green growth CPAs com or giving us a call at eight hundred 676

what could that do for your business how would that change your business so again thank you for taking the time to sit and listen and understand and try to learn about these tax credits hopefully this video in this presentation has brought you some value again give us a call at eight hundred 676 a and we’ll talk to you soon

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