The Limited Liability Company (LLC) is a flexible business structure that offers limited liability protection to its owners. For many business owners, it is a preferred type of business entity because it is generally cheaper and easier to set up a LLC, you can structure it to be member-managed or manager-managed, and it avoids the “double taxation” that C Corporations are subjected to.
How is a single-member LLC taxed?
Traditionally, a single-member LLC is taxed as sole-proprietorship, meaning the business owner files a Schedule C on their personal income tax return that reflects the income they made from the business. Multi-member LLCs are taxed as partnerships, and Schedule K-1s are filed for each member to reflect their share of business income. Both of these allow for the business income to flow through the company to the owners, and only have the income taxed once at the owner level.
However, the cannabis industry is notorious for being the exception to the general rule. Additionally, there are scenarios in which the flow-through LLC taxation model may not be in the best interest of a cannabis company or its owners. In such cases, a cannabusiness may find it preferable to elect C Corporation taxation by filing IRS Form 8832.
Why we recommend C Corporations
The main reason why we advocate for a C Corporation tax election is to reduce the amount of information that is subject to an audit by the Internal Revenue Service (IRS). The IRS has taken the position that cannabusinesses, even in states where marijuana is legal, are considered “special interest” groups. This means that they can be audited at a higher frequency than other industries. For that reason, the IRS started auditing cannabis companies regularly.
It is no surprise that audits can lead to additional tax penalties or assessments, especially with cannabis companies being subject to Internal Revenue Code Section 280(E). Simply, this means that marijuana businesses cannot claim any business deductions on their taxes other than for the cost of goods sold. This provision creates a much higher tax burden on cannabis companies, and can lead to increased tax liability if not computed correctly.
When the IRS audits an LLC with standard flow-through taxation, the audit starts at the entity level and can flow through to the owner’s personal finances. However, if the LLC elects to be taxed as a C Corporation, the audit generally stops at the entity level and the auditors cannot continue the audit into your personal finances. While your cannabusiness LLC is now subjected to tax at both the entity level and the owner level, this tax election does allow for some protection and peace of mind against an audit.
Filing taxes as a cannabusiness LLC
Your tax filings are serious business and should be advised upon by a trusted professional. Before making elections, it is advisable to seek counsel from your Certified Public Accountant (CPA) or cannabis business attorney.