The Ultimate Cannabis Business Tax Guide: How to Limit Tax Exposure

There are a few ways to limit tax exposure for your cannabis business. This article by a cannabis tax attorney will cover many of them in detail. 

It’s a fact that when you own a cannabis business, you’re going to be audited by the Internal Revenue Service (IRS) sooner or later. 

However, the first way to limit the risk of tax exposure is to consult with a cannabis attorney to properly structure your cannabis business.

Watch the full episode on YouTube. Listen to full episode on Spotify.

Want to know how to limit tax exposure for your cannabis business? Request a consultation now.

The IRS vs. the Cannabis Industry

When you’re in the cannabis industry, you’re still conducting “federally illegal” activities according to the Controlled Substances Act (CSA). 

This is why the IRS treats the cannabis industry much differently than any other business. 

And the difference, unfortunately, is not in our favor.

Hopefully that will change. 

However, in the meantime, you should plan properly so that you can earn as much money as possible, and not pay any more taxes than you have to.

The IRS actively audits cannabis companies. 

They actually have a comprehensive list of every single license ever issued that they work off of. 

Additionally, it’s up-to-date in every state.

Furthermore, it doesn’t matter how small of a business you are; you’re on that list and they will audit you eventually. 

The reason they do this?

Cannabis business audits are their most profitable. 

They, without question, are able to gain income tax from those more than any other business. 

One of the big reasons why cannabis businesses are so profitable to them is because of poor record-keeping. 

Solid record-keeping is vital when it comes to justifying your calculations for cost of goods sold, and even beyond that.

Want to know how to limit tax exposure for your cannabis business? Need assistance with record keeping? Request a consultation now.

How Should I Structure My Business For Tax Purposes?

For legal purposes, most cannabis businesses organize as a Limited Liability Company (LLC).

While that’s perfectly fine, you want to consider how you should structure your business for federal income tax purposes. 

For example; if you elect an S corp or a partnership (which is like an LLC), you then elect to be treated as pass-through entity.

The difficulty there is that, in comparison to a C corp, you’re not personally protected for any tax liability assessed against the company due to underpayment of taxes.

It could be because of an audit. 

It could be just because of your operations, you were profitable, which is always good. 

However, there are often situations where the company itself doesn’t have the cash to pay the tax liability.

It goes to the people who own the company.

Therefore, it’s something for which you’re personally liable. 

And that personal liability attaches to you whether or not you’re part of the management.

As long as you’re an owner, this will follow you even if you leave. 

Things to Consider

Selecting the right way that your company will be treated for income tax purposes will differ from business to business. 

Typically, the decision is based upon:

• Your size
• Business’ organization
• Your business’ age 
• How many state(s) you operate in

How to Implement Good Record-Keeping

Since the IRS will inevitably audit your cannabis business, you need to implement good record-keeping from the get-go.

Whether you’re starting a business, or if you’ve already started, you need a skilled cannabis attorney and CPA.

This means that it can’t be an attorney and/or CPA who’s “dabbling” or doesn’t understand the cannabis business.

Why?

Because cannabis tax law is far too complicated.

Therefore, it leads to extreme risk to assess material tax liabilities, in which you’re personally liable.

You also need to ensure your accounting records are being taken care of.

Are you keeping the kind of detail in your accounting department, such that when the state comes in or when the federal government comes in, they’re going to know exactly how you calculate your cost of goods (COGS) sold? 

If there isn’t an easy trail for them to follow, they’re going to stop you right in your tracks. 

How to Deduct Business Expenses

Under IRS code Section 280E, any expenses related to “illegal activity” can’t be deducted. 

Since cannabis is federally illegal, this pertains to cannabis businesses.

So, what do you do?

Obviously, you don’t want to send all your revenue in and pay taxes on it. 

Luckily, there’s a section that constitutionally protects your business

IRS code Section 471 allows you to deduct only your COGS.

However, this helps grow operations more than retailers. 

As a retailer, your rent, lighting, heat, the salaries you pay, etc. are all considered indirect expenses and therefore, not a part of “cost of goods sold”.

On the other hand, grow operations can incorporate many of those expenses into the manufacture of their product.

Therefore, it becomes part of the COGS. 

This is why your business should fold as much as you can into your COGS.

This is so that you can deduct more, and then report less net income that’s subject to federal income tax. 

Want to know how to limit tax exposure for your cannabis business? Need assistance with record keeping? Request a consult now.

Limit Tax Exposure by Consulting with a Cannabis Attorney

The CSA still classifies cannabis as a schedule I controlled substance, right next to heroin, while fentanyl is a schedule II drug. 

Does this make sense? No.

However, the reality is that since it’s still a Schedule I classification, 280E applies because of it. 

Because of these unique tax issues, this is why you need to consult with an experienced and proven cannabis attorney and CPA to limit tax exposure for your cannabis business. 

They can weave through the thorny issues that the cannabis industry presents itself, specifically related to tax consequences.

Again, cannabis business IRS audits are so profitable because:

1. cannabis’ federal classification, and
2. poor record-keeping. 

This is the regulatory administrative side that generally isn’t very fun, but is necessary in order for you to continue to have fun.

Watch the full episode on YouTube. Listento full episode on Spotify.

Want to know how to limit tax exposure for your cannabis business? Need assistance with record keeping? Request a consultation now.