California City Taxes for Medical and Recreational Marijuana
In November 2016, California passed Proposition 64 which legalized recreational marijuana in the state of California. At the same time, voters voted on a number of city tax ordinances which were designed to apply local city taxes to the cultivation, manufacturing, distribution, and sales of medical and recreational marijuana.
With 482 municipalities in California in all, dozens of ballot measures were up for vote in November 2016. For several cities, we have provided summaries of each of the tax laws that have been passed below. While this is only a partial list of the measures that were passed it can help you to get a clearer picture of what taxes you will be required to pay based on where you locate your cannabis business.
The California medical sales tax rate is 7.60%. The majority of these ballot measures do not address the sale of recreational marijuana directly because they left it up to the passage of state laws and/or additional city ordinances to determine whether or not recreational cannabis would be considered legal in their municipalities.
With the passage of Proposition 64, in many cases, these city ordinances now also apply to recreational cannabis businesses. For more specific details, please check with each city to determine the exact ordinances that apply to your medical or recreational cannabis business.
As President Trump takes office, cannabis companies are likely to continue to face significant legal challenges given that federal policy regarding the sale, distribution, and use of marijuana
has not changed.
However, state laws are changing with California’s recent legalization of recreational marijuana during the November 2016 election. To ensure that cannabis companies continue to operate their businesses legally, they’ll need to take some extra steps to ensure compliance over the next president’s term.
Here are the steps that cannabis companies can take to improve their compliance under the
1. Get Audited Financials Statements
Hiring an auditor to help your business produce cannabis audited financial statements can
provide significant benefits for your business. An audit requires requires understanding and
evaluating all significant aspects of an organization and performing detailed procedures, which
will uncover valuable insight. This will be discussed privately in the course of the audit.
First, it will allow you to identify potential risks and areas for improvement. Auditors may also
identify risks of fraud, abuse, or non-compliance with government regulations that were hidden
beneath the surface.
In addition, auditors serve a greater purpose than just the simple preparation and review of your
company’s financial statements. In fact, management and the owners of your company can
discuss, in confidence, their business issues and strategies with the auditors.
2. Periodically Check Federal, State, County, and City Requirements
In addition to the legalization of recreational marijuana at the state level, California cities have
also passed a number of local ordinances that are designed to tax marijuana cultivators,
manufacturers, distributors, and retailers. As a result, it is important the periodically check
federal, state, county, and city requirements to ensure that your business is always in
3. Reduce Violations, Penalties and Fines
As with any legal procedure, there is always an appeals process. If you feel that a violation,
penalty or fine was wrongly assessed, it may be in your best interest to contest it before the
statute of limitations for an appeal expires.
In some cases, you may even be able to reduce violations, penalties, and fines as a result of
making a good faith effort to remain in compliance. This highlights a major reason why you
should implementing compliance training in addition to eliminating sources of future violations
and fines for your cannabis business.
4. Train Employees on Compliance Requirements
Compliance training is the process of educating your employees on how to comply with the legal
and tax requirements of doing business. These concerns range from taxes and licensing to
inventory and financial data and records and labeling, packaging and product safety.
As the cannabis industry matures, it is likely to become one of the most heavily regulated
industries in the world. As a result, you need to put compliance programs in place to ensure that
every employee at your company is properly trained with regard to compliance concerns that
will impact their day-to- day job duties.
5. File Your Taxes
Many cannabis businesses are still failing to pay their taxes because of uncertainties about the
legality of their businesses under federal law. However, with the legalization of recreational
marijuana in the state of California, there is no longer any excuse not the file your taxes.
Whether or not you believe that you are responsible for paying your tax liabilities, the tax
agencies are likely to audit you and assess back tax amounts, in addition to penalties and
interest, which can be significant. Failing to file your taxes may also put your business at risk of
being in noncompliance with the licensing and permit provisions that you are required to follow
in order to keep your business in operation.
Instead of risking incurring thousands and thousands of dollars of tax liability, as well as your
operational licenses and permits, start filing your taxes today and get your business up to date.
It’s never too late to start filing your taxes and this guide can help you get back on track.
On November 8, 2016, California voters opted to legalize cannabis for recreational use through Proposition 64. Proposition 64, known as the Adult Use of Marijuana Act (AUMA) legalizes and regulates recreational cannabis in the state of California. Proposition 64 will also add state taxes for licensed dispensaries and cannabis cultivators.
15% Medical Marijuana Tax
In 2018, all retail sales of cannabis will be subject to a 15% marijuana excise tax. Although the purchaser of the cannabis or cannabis product technically owes the tax, the seller will actually be obligated to collect the tax, as well as, any other sales and use taxes that apply in the state of California. However, there is one exception that makes businesses and customers exempt from this excise tax. That is, if the individual purchasing the medical cannabis or medical cannabis product provides a state-issued Medical Marijuana Identification Card.
Until now, qualified patients and caregivers have not been required to register as medical marijuana patients with the state. However Proposition 64 will require that these individuals obtain the identification cards if they want to be exempted from the excise tax.
Cultivation Tax for Cultivators
In 2018, all licensed cannabis cultivators, excluding those patients and caregivers who cultivate cannabis for personal use, will be required to pay a cultivation tax on all marijuana that is harvested to be sold on the commercial market per the Compassionate Use Act. The tax will be assessed at the rates of $2.75 per ounce of leaves and $9.25 per ounce of flowers.
Local Taxes for Licensed Cannabis Businesses
The Medical Cannabis Regulation and Safety Act (MCRSA) and Proposition 64 will enable California cities and counties to impose local taxes on licensed marijuana businesses. Several municipalities opted to include their own local tax measures on the recreational marijuana ballot for November 8.
In certain Northern California counties, including Calaveras County, Humboldt County, Lake County, and Monterey County, the cultivator taxes will be based on the grow's total square footage. Mendocino County has opted to place two tax measures on the ballot. These measures are from the County's Board of Supervisors and local marijuana advocates. They both suggest a 2.5% tax based on the gross sales of medical marijuana and the latter having a higher 5% tax on recreational sales of cannabis.
In Southern California, a San Diego tax measure proposal looks to tax dispensaries at a rate of 5% that will rise over time to 8% in 2019. However, a Santa Barbara tax measure looks to tax cannabis businesses at a 20% tax rate. Several Southern California towns have already began taxing cannabis businesses. Coachella is set to vote on a tax measure that will add quarterly taxes of up to 6% for gross sales and 15% per square foot.
If you haven't been paying your cannabis taxes due to uncertainties about changing California laws regarding canna-businesses, you're not alone. There are many businesses that have not paid taxes on their sales of marijuana. However, California state, county, and local governments, as well as, the IRS still expect for these payments to be made.
If you are worried about the back taxes that your business owes, you should know that you still have time to get your business in order before the provisions of the California Medical Marijuana Regulation and Safety Act go into effect in 2018.
The Medical Cannabis Regulation Safety Act gives counties the authority to levy a tax on the cultivation, dispensing, production, processing, and distribution of medical cannabis. It also sets up the divisions that will be tasked with regulating licenses and permits for canna-businesses, as well as, establishes a fund for the state treasury to receive fees and penalties that are assessed under the act. There may also be a chance that you can get the penalties and interest on your tax liabilities reduced under certain circumstances.
Here are the steps that you need to follow to catch up on your cannabis taxes and some potential options for lowering the amount of penalties and interest that you may owe.
File Your Taxes
If you have not filed your income tax returns in addition to not paying the taxes that you owe, you should start by filing your tax returns as soon as possible. You'll need to file your taxes on the original forms for each tax year which you should be able to obtain by searching the IRS website and the California Franchise Tax Board website.
For California sales tax, if you haven't registered with the California Board of Equalization, you will need to do so before you can make any tax payments. For county and local taxes, you will need to contact the tax agencies in the jurisdictions in which your business operates.
Request Installment Agreements
You should also arrange installment agreements if you can't pay the full amounts upfront but you can pay it over time. Installment agreements do not reduce the amounts that you will owe. However, it can help to prevent further collection actions from being taken against you as long as you make your installment payments on time.
Ways to Mitigate Penalties and Interest
If you don't pay your taxes, the debt only continues to accumulate interest and penalties as it remains unpaid each month. However, under certain conditions the IRS may be willing to waive or reduce these additional charges if you have a good reason for not making the payments on time.
If the reason why you didn't pay your taxes is due to a circumstance that it is outside of your control, such as imprisonment, a natural disaster or fire that resulted in the destruction of your records, you may be entitled to abatement according to the IRS. You may also be able to get some relief if the employee responsible for making the tax payments quit. The Franchise Tax Board offers a similar tax abatement program that you can apply to here.
However, if the reason why you did not pay is because you simply did not have the funds, the IRS is not going to wave your penalties and interest because the responsibility to set aside the necessary amounts for the payment of taxes is on you.
Assembly Bill 567 Vetoed by Governor Brown
When it comes to California state, county, and local taxes, there are no specific programs available to help you avoid penalties and interest given that Assembly Bill 567 was vetoed by Governor Brown in September 2016.
This was a bill designed to create a tax amnesty program for some California collectives under the Medical Cannabis Tax Amnesty Act to allow businesses to temporarily avoid a 25-50% penalty on the unpaid tax liabilities incurred before January 1, 2015. Governor Brown vetoed the bill because he felt it was proposed prematurely given that the regulations that link enforcement to licenses for cannabis businesses do not go into effect until 2018.
Under Internal Revenue Code (IRC) Section 280E, no individual is permitted to take a deduction or credit on income taxes if the income resulted from carrying on any trade or business if the business consists of trafficking in controlled substances, such as marijuana, under the Controlled Substances Act (CSA). This section of the IRC was designed to prohibit individuals from taking individual tax deductions from marijuana sales. However, how does federal tax law apply to California corporations, s-corps, LLCs for the purposes of deducting expenses?
California Corporations and the Revenue and Taxation Code
The differences between federal law and California state laws have created an unique situation for California marijuana businesses due to the treatment of income and expenses for personal income tax (individuals and partnerships) versus corporation tax law (including statutory cooperatives).
For individuals and partnerships, Revenue and Taxation Code Section 17282 has prohibited taxpayers from taking deductions on any of his or her gross income as a result of income derived from illegal activities, including drug trafficking. However, the taxpayer must be found to have engaged in these activities first due to a criminal or other proceeding in which the state, county, city, or other subdivision was a party.
For corporations, including statutory cooperatives, California has enacted a stand-alone law. A statutory cooperative is a cooperative that has organized and registered as a corporation under the Corporations or Food and Agricultural Code (Id. at Section 12311(b)).
According to California tax law, an entity that is taxed as a corporation per Part 11 of the Revenue and Taxation Code and is also involved in medical marijuana activity is permitted to deduct its ordinary and necessary businesses expenses, along with the cost of goods sold, provided that the entity can substantiate any deductions that it claims with adequate records.
How California Classifies C Corporations, S Corporations, and LLCs
In California, a C corporation refers to an entity that is doing business in California, organized in California, or registered with the California Secretary of State. A C Corporation is business entity that is taxed as a separate entity from its shareholders. The C Corporation pays corporate taxes on its profits while the shareholders are not taxed on the C corporation's profits. The shareholders of a C corporation only report and pay taxes on the income that is paid to them by the corporation.
In addition, California also has specific definitions for corporations that are S corporations or LLCs:
The owners of LLCs that have not made the election for the LLC to be classified as a corporation for federal tax purposes are not required to pay a salary so they can take their earnings as distributions. Therefore, when they report the net income for the LLC, there may be no salary expenses to be disallowed under Section 280E. Additionally, if the owners are involved in the selling, marketing or delivery of marijuana and they do take a salary, this salary expense is disallowed under Section 280E.
However, if the LLC is taxed as a C corporation, the LLC owners are required to pay themselves reasonable salaries, and this salary expense may be disallowed under Section 280E.
California Tax Law Does Not Automatically Conform to Federal Tax Law
In California, individuals are bound by the provisions of Section 280-E. However, this tax law does not automatically conform for corporations. This is due to the fact that California law has not been designed to conform to changes in federal tax law, except under specific circumstances. Instead, California policy makers are required to affirmatively conform to changes in federal tax law.
However, legislative sessions in California do not systematically address nonconformity with federal law and they haven’t in sometime. In fact, the last time that California policy makers agreed to address nonconformities with federal tax laws on an annual basis occurred from the years 1982 through 1992. Beginning in 1992, the California Legislature stopped enacting annual conformity bills that were designed to require policymakers to act on federal tax law changes by a specified date each year.
As a result, several nonconformity issues, such as the nonconformity of California corporations with Section 280-E of the IRC, have gone unaddressed.
AB 2679: California Issues Guidance for California Cannabis Manufacturers
On September 29, 2016 Governor Jerry Brown, signed AB 2679 into law in order to provide guidance for cannabis manufacturers that are currently operating in the state of California. The bill's authors were the same legislators that designed the Medical Cannabis Regulation and Safety Act (MCRSA).
A cannabis manufacturer is any company that uses methods to prepare cannabis or its by-products for commercial retail and/or wholesale, including, but not limited, to the processes of drying, cleaning, curing, packaging, and extraction of the active ingredients of cannabis in order to create marijuana-related products and concentrates. Examples of companies that are considered as cannabis manufacturers are companies that produce marijuana extracts and concentrates.
Although all cannabis businesses are still illegal under federal law, California cannabis manufacturers are particularly at risk due to a state law which made the manufacturing of a controlled substances, such as cannabis, by chemical extraction illegal.
Prior to the passage of AB 2679, there was very little guidance available to cannabis manufacturers informing them of how to ensure that their business operations were compliant with California law. However, AB 2679 has now exempted collectives and cooperatives that engage in the manufacture of cannabis products from criminal penalties, if they meet certain requirements.
Under AB 2679, cannabis manufacturers are required to:
In the same way that the current laws govern California medical cannabis cooperatives and collectives, these new provisions for cannabis manufacturers are designed to be repealed during the year following the announcement that state marijuana licenses are being issued from the Bureau of Medical Cannabis.
Once this occurs, the California Department of Public Health (CDPH) will take on the job of issuing licenses to these cannabis manufacturing businesses per the MCRSA. The CDPH is also responsible for developing the standards that apply to the manufacturing and labeling of manufactured medical marijuana products.
In addition, the CDPH has been tasked with identifying and creating reports of any medical marijuana products that have been misbranded or adulterated. The CDPH is currently holding meetings in order to address concerns regarding cannabis manufacturer licensing.
However, until 2018, which is when the CDPH officially takes over as the regulatory body for cannabis manufacturing, state legislators are hoping that AB 2679 can provide cannabis manufacturers with adequate protection from unnecessary raids from local law enforcement agencies, enabling them to continue with their normal operations.
For those cannabis manufacturers who were waiting for this guidance, the passage of AB 2679 should provide relief and the information that they need to bring their businesses into compliance with California law in preparation for the issuing of cannabis manufacturing licenses in 2018.
How Mutual Benefit Corporations Are Taxed in California
If you are planning to open a cannabis business in California, you may have considered a mutual benefit corporation for your business. Mutual benefit corporations are quite popular among California cannabis businesses and may be the best option for a business entity for your business if your plan includes the sale of cannabis.
However, you should also understand the taxation rules that apply to mutual benefit corporations and how they differ from non-profit organizations. Here is how mutual benefits corporations are taxed in California so that you can familiarize yourself with the tax rules that apply to mutual benefit corporations at the state level.
What Is a Mutual Benefit Corporation?
A non-profit mutual benefit corporation in California is is a type of corporation that is a non-profit per California Corporations Code Section 7110. The purpose of a non-profit mutual benefit corporation is to provide only for the benefit of its members, and not to make a profit.
Non-profit mutual benefit corporations are commonly established for cannabis businesses in order to circumvent the provisions of S.B. 420, which specifically disallows “any individual or group to cultivate or distribute marijuana for profit.”
However, they are still required to file and pay income tax like regular C corporations because they are not formed to benefit the general public, unlike non-profit organizations. In addition, they can also be established for any lawful purpose, not limited to charity, unlike non-profit organizations.
How Do They Differ From Non-profit Organizations?
There are some significant differences between non-profit organizations and mutual benefit corporations. First, mutual benefit corporations are not eligible to be formed exclusively for charitable purposes under California law. If the corporation does have some charitable assets, it must register and report the charitable assets to the Attorney General of the State of California. As a result, it can receive tax exempt status for some of its assets but not all.
Second, mutual benefit corporations are not permitted to apply under Section 501(c)(3) of the Internal Revenue Code to receive tax-deductible donations. However, the IRS does allow tax exemptions for certain types of non-profit mutual benefit corporations under IRS 501(c)(6).
Finally, the management and shareholders of a California non-profit mutual benefit corporation are not permitted to take distributions of the assets of the corporation until the corporation is dissolved. As a result, they are required to take payments from the corporation either as a repayment of debt or as a salary. This is important because this rule affects gross income that is be reported on income tax filing for the corporation.
Which Tax Forms Do Mutual Benefit Corporations File?
Mutual benefit corporations are generally required to file the filing forms in California for federal and state taxes:
These forms may vary depending on whether or not your mutual benefit corporation has tax-exempt status. However, mutual benefit corporations generally follow the same rules as C corporations when it comes to taxation.
When it comes to taxes, many hemp businesses are unsure about Internal Revenue Code Section 280-E and whether or not it applies to their businesses. Section 280-E was passed in order to prevent drug dealers from taking business deductions on income from trafficking in controlled substances, like cocaine and marijuana. Here is what you should know about growing hemp versus marijuana and its application to 280-E.
The cultivation of hemp has been considered by the federal government to be a violation of the Controlled Substances Act because hemp is botanically related to marijuana. In addition, hemp also contains low levels of THC, which is the same psychoactive substance found in marijuana. These properties are why the government sought to include hemp by default in the Controlled Substances Act.
The government did make some distinction between hemp and marijuana with the passage of the Agricultural Act of 2014, which removed the federal restrictions on growing industrial hemp and permitted any states that have legalized the manufacturing of hemp to set up research programs in order to study the benefits of cultivating hemp.
Since the federal government has failed to create an exception for hemp in the list of Schedule I substances of the Controlled Substances Act, Section 280-E still applies to hemp growers and hemp distribution businesses.
As a result, hemp growers still face the same restrictions on permitted deductions as marijuana growers when it comes to taxation. The full list of deductions that are available to hemp growers can be found here.
In the same way that hemp growers are treated like marijuana growers for taxation purposes, hemp distributors must also follow the same rules as marijuana distributors. The full list of deductions that are available to hemp distributors can be found here.
If you sell medical marijuana or marijuana-related items in California, the law requires that you register with the Board of Equalization (BOE) for a Seller’s Permit. Both cannabis growers and dispensaries are required to register, even if your business has not made any sales yet. There is no cost to obtain a Seller’s Permit.
Here are the steps to help you apply for your Seller’s Permit along with a brief overview of what you need to do after you’ve been approved by the BOE.
Applying for a Seller’s Permit
In order to start the registration application process, you will need to gather a number of documents about your business and the management team for your business. The full list of required documents can be found here.
Create an Online Account
The BOE registration process will guide you through the steps that are required to obtain your Seller’s Permit. Once you have successfully registered, you will be provided with a User ID for your business so that you can access the BOE online system and file your sales and use tax returns.
When to Register for a Seller’s Permit
The BOE wants every business to register for a Seller’s Permit before it makes its first sale. Although the requirement to register for a Seller’s Permit for businesses who sell medical cannabis didn’t go into effect until 2005, business who opened before the effective date are still required to register and pay any taxes that they may owe. Additionally, businesses who opened after this date and failed to register for a Seller’s Permit are required to register and may also be required to make back tax payments.
How Many Seller’s Permits Do I Need?
If you have multiple locations, you are required to register each location (located on different premises) of your business. Each location may be required to maintain a separate Seller’s Permit. In some cases, the BOE does allow you to obtain a consolidated permit for multiple business outlets. Even if you run a mobile dispensary, you still have to register.
The sales and use tax rate is made up of:
Cities and counties with applicable district taxes add to the base rate, which cause rates to be different throughout the state. As a result, you will also need to register with your city and county. A comprehensive list of the different California city and county sales and use tax rates can be found here.
What to Do After You Register
After you have applied and have been approved for a seller’s permit, you must make sure that you file sales and use tax returns, along with paying any tax that is due. If you file to file your returns on time, you may be subject to additional penalties and interest. The state of California offers an online sales tax filing service, which you should use to file your returns. When you have to file will be determined by the BOE based on your reported sales tax or your anticipated taxable sales at the time of your registration.
Sales and Use Tax Return Due Dates
The sales and use tax return due dates may vary depending on whether you are a monthly, quarterly or annual filer. However, they are generally due on April 30th, July 31st, October 31st, and January 31st for quarterly filers. For monthly filers, the due date is the last day of the following month. For annual filers, the due date is January 31st of the following year. If any of these due dates fall on a weekend or state holiday, the returns are due on the next business day. Even if you made no sales, you still need to file a return showing zero sales.
The BOE generally does not accept cash payments for tax due. However, with many cannabis businesses operating in cash only, some provisions have been made to accommodate these businesses. If you plan to make your payments of sales and use tax in cash, you will need to make an arrangement with one of the BOE’s field offices for cash the transactions by completing a ‘No Cash Exemption Request’ form.
Record Keeping for Your Business
In addition to filing timely sales and use tax returns, you are also required to maintain records about your business including:
These records must be maintained for at least 4 years unless you have been given explicit permission by the BOE to discard these records.
Which Sales Are Subject to Sales and Use Tax in California?
Sales that are subject to tax include all retail sales of medical cannabis. All sales are presumed to be retail sales unless your customer provides you with a valid resale certificate. Additionally, a portion of the equipment purchases that you make for your business may be exempt from sales and use tax. This equipment includes certain farm machinery and equipment that is used for the production and harvesting of agricultural products.
Who Is Exempt From Registering for a Seller’s Permit?
If your business is a health collective that dispenses medical cannabis, you may be exempt from applying for a Seller's permit under Regulation 1591. In order to qualify for this exemption, your health collective must be qualified as a "health facility" under state law to provide 24-hour inpatient care or as a state-licensed clinic.
The IRS is getting tough on cannabis business in Colorado and is going after cannabis entrepreneurs who failed to fill out Form 8300. If you want to avoid being audited by the IRS, it is important for you to stay on top of these filings. Here is what Form 8300 is and why it is important.
What Is Form 8300?
Form 8300, Report of Cash Payments Over $10,000 Received in a Trade or Business, is a form used by the federal government to keep track of cash payments of more than $10,000. These filings are designed to assist law enforcement in investigating and preventing money laundering, tax evasion, drug dealing, financing of terrorism activities, and other criminal acts.
For purposes of Form 8300, cash doesn't only include U.S. dollar coins and bills and foreign currency notes; it may also include cashier's checks, bank drafts, traveler's checks, and money orders if the face value is $10,000 or less.
These filings are designed to assist law enforcement in investigating and preventing money laundering, tax evasion, drug dealing, financing of terrorism activities, and other criminal acts.
Who Must File Form 8300?
Every person who engages in a trade or business and also receives more than $10,000 in cash in a single transaction or in two or more related transactions is required to file Form 8300. Transactions that are considered related transactions are those that are conducted between a payer (or its agent) in a 24-hour period. The transactions may also be considered related if the recipient of the payment knows that each transaction is a part of a series of transactions.
The IRS has also issued IRS Form 8300 Reference Guide to help you determine which transactions qualify as reportable transactions. Cash doesn't only include U.S. dollar coins and bills and foreign currency notes. It may also include cashier's checks, bank drafts, traveler's checks, and money orders if the face value is $10,000 or less.
Form 8300 Filing Examples
Here are two examples to help you understand when you need to file Form 8300:
Example 1. Jack asks an employee to purchase cannabis for his dispensary. The employee orders the product in two shipments and he pays with two cash payments, each for $6,000. The cannabis grow business who received more than $10,000 in the designated reporting transaction must file Form 8300.
Example 2. A cannabis supply shop sells growing equipment for $9,000 in cash to Adam at 10 a.m. During the afternoon on the same day, Adam returns to buy more equipment and pays an additional $9,000 in cash. Since, both transactions occurred within a 24-hour period, they are related transactions and the grow equipment supplier must file Form 8300.
When Do I File Form 8300?
Each time you receive a payment that meets the criteria for filing Form 8300, you must file the form for the transaction within 15 days of receiving the payment. You can file online using the Bank Secrecy Act (BSA) Electronic Filing (E-Filing) System at the FinCEN website.
What Are the Penalties for Failing to File Form 8300?
If you simply fail to file Form 8300 on time, a penalty of $250 per occurrence will be assessed. This penalty is capped at $1,000,000 per year for businesses with gross receipts not exceeding $5 million. If you fix the error and make sure that the forms are filed within 30 days of the deadline, then this penalty limited is reduced to $175,000 per year for businesses with gross receipts not exceeding $5 million. However, if your business grosses more than $5 million, then the penalty cap increases to $3 million.
However, if you intentionally fail to file Form 8300, the penalty increases to $25,000 of the total amount of the transaction, up to a maximum of $100,000 for each time that you failed to file. In addition, felony charges may be brought against you in more severe cases. Criminal penalties will be applied by default if you structure or appear to structure payments in order to avoid filing Form 8300 for the transactions.
Cannabidiol (“CBD”) products have emerged on the market in several states with various claims, including the treatment of specific illnesses, reportedly backed by scientific research. CBD is a non-psychoactive component of both marijuana and hemp. While products containing this substance have been permitted in certain states, marketing CBD oils and related products as treatments for specific conditions has been disallowed by the FDA.
For companies that market CBD related products, having an understanding of the federal and state regulations that are applicable to their businesses is crucial. Here is a brief guide on the current regulations regarding the marketing of CBD related products.
The Federal Food, Drug and Cosmetic Act, also known as the FD&C Act, requires scientific information to demonstrate that a drug is safe. The FDA has made it clear that CBD products cannot be sold as dietary supplements because CBD is “authorized for investigation as a new drug,” a classification that disallows products from being sold as dietary supplements while under clinical investigation.
With clinical trials generally lasting several years followed by the FDA’s 10 month goal for standard new drug approvals, it could be several years until the status of CBD is changed from its current classification as a “new drug.” As a result, the FDA has also prohibited the use of CBD in food.
The FD&C Act defines a dietary ingredient as a vitamin; mineral; herb or other botanical; amino acid; dietary substance for use by man to supplement the diet by increasing the total dietary intake; or a concentrate, metabolite, constituent, extract, or combination of the preceding substances. Unlike drugs, dietary supplements are not intended to treat, diagnose, prevent, or cure diseases.
The FDA also requires all companies that plan to market a dietary supplement that contains a new dietary ingredient, and the new dietary ingredient has not been present in the food supply as an article used for food in a form in which the food has not been chemically altered, to submit to FDA, at least 75 days before the dietary ingredient is introduced or delivered for introduction into interstate commerce, information that is the basis on which the company has concluded that a dietary supplement containing the new dietary ingredient will reasonably be expected to be safe.
In addition, the FDA has some stringent requirements for the labeling of products including:    
●The FD&C Act prohibits the listing of a drug as safe and effective for specific uses on product labeling unless it has been recognized by the FDA as such. Until then such drugs are considered as “new drugs.”
●Products may not be labeled for use or with directions for use for conditions that can not be self-diagnosed and treated by individuals who are not medical practitioners 21 CFR § 201.100(c)(2).
●CBD Companies should not try to circumvent these rules by using scientific publications to prove the validity of a product’s use for the treatment of specific medical ailments as this is also disallowed under 21 CFR 101.93(g)(2)(iv)(C).
●Products should include adequate directions for use under which a layperson can follow to use the product as intended   [21 CFR § 201.5]. However, this regulation is being arbitrarily applied to CBD products given the fact the the manufacturers of the products are not permitted to make claims about CBD as treatments for specific illness.
Labeling for CBD Related Products
In the states where cannabis-derived CBD products have been permitted, including Washington, California, Illinois, Connecticut, and New York, the packaging for all CBD products must list CBD as an active ingredient with the amount of CBD that the product contains.
Given the FDA’s stance on CBD as a new drug, it is a good idea to avoid using the labeling of the packaging to make medical claims about the benefits or denoting specific uses of the product. The FDA has already issued warnings to several CBD companies about the mislabeling for violation of FDA regulations.
In addition, many CBD companies are violating FDA regulations by marketing CBD products as dietary supplements when they have not been awarded that classification by the FDA. As a result, while the sale of CBD products have been permitted in certain states, the regulations set forth by the federal government, namely the FDA still take precedence over state laws. This means that the federal government can go after CBD companies even if the state in which the company is located has decided not to.
Things to Consider When Marketing CBD Products
Given the myriad of federal and state regulations that CBD product manufacturers must comply with, CBD companies should take extreme care when marketing CBD products. Most importantly, the product should make mention of the fact that it has not been approved by the FDA.
Secondly, the products should never be labeled for use in conjunction with specific medical conditions, given CBD’s status as a new drug. CBD companies should also review applicable state laws carefully to determine whether or not the labeling for their products are in compliance.
The FDA has also made it the responsibility of the companies to comply with all of the requirements of federal law and FDA regulations. While the FDA may take steps to notify a company that it is violation of the law, it is the company’s responsibility to review the law in order to determine if its products are in compliance and resolve any violations.
For Online Sellers of CBD Products
Online sellers of CBD products need to take special precautions when selling CBD products online. These sellers need to be aware that:
●Cannabis is still illegal under federal law.
●Even in states where cannabis products are legal, it is not legal to ship the cannabis products from state to state, or to leave the state with such a product.
●For CBD products that are the result of CBD extracted from hemp, the sellers should make it very clear to customers that its products come from imported hemp and not marijuana.
●In all cases, online sellers should avoid making claims about the medical benefits of using CBD products.
While this is not an exhaustive list of the regulations that CBD companies face, these findings highlight the fact that many CBD companies are operating in a legal grey area when it comes to the sale of CBD products online.
Nearly 20 years after California become the first state in the country to legalize the medical use of cannabis, Governor Jerry Brown signed a package of bills, which went into effect January 1, 2016, that is designed to regulate the medicinal-cannabis industry. Known as the California Medical Marijuana Regulation and Safety Act (MMRSA), this legislation sets forth comprehensive regulations and standards that govern almost every aspect of the industry in California from taxation and licensing, to quality control, packaging, shipping and standards for cultivation.
MMRSA is made up of three laws, Assembly Bill 266, Assembly Bill 243, and Senate Bill 643. Here is a summary of the provisions of these three laws.
AB 266 establishes the Bureau of Medical Cannabis Regulation under the California Department of Consumer Affairs. The Bureau will be responsible for keeping track of licensees and reporting the movement of cannabis and cannabis-related products. AB 266 also establishes 17 different license types for marijuana producers, testing facilities, dispensaries, distributors, and transporters:
1.Type 1 = Cultivation; Specialty outdoor. Up to 5,000 square ft of canopy, or up to 50 noncontiguous plants
2.Type 1A = Cultivation; Specialty indoor. Up to 5000 sq ft
3.Type 1B = Cultivation; Specialty mixed-light. Using exclusively artificial lighting.
4.Type 2 = Cultivation; Outdoor. Up to 5000 sq ft, using a combination of artificial and natural lighting
5.Type 2A = Cultivation; Indoor. 5001 -10,000 sq ft.
6.Type 2B = Cultivation; Mixed-light. 5001 -10,000 sq ft
7.Type 3 = Cultivation; Outdoor. 10,001 sq ft - 1 Acre
8.Type 3A = Cultivation; Indoor.. 10,001 - 22,000 sq ft
9.Type 3B = Cultivation; Mixed-light. 10,001 - 22,000 sq ft
10.Type 4 = Cultivation; Nursery.
11.Type 6 = Manufacturer 1 for products not using volatile solvents.
12.Type 7 = Manufacturer 2 for products using volatile solvents.
13.Type 8 = Testing
14.Type 10 = Dispensary; General
15.Type 10A = Dispensary; No more than three retail sites
16.Type 11 = Distribution
17.Type 12 = Transporter
For marijuana cultivators, the licenses also set a maximum allowable size for cultivation operations depending on the type of license issued. The law is also designed to prevent vertical integration of licensees businesses by only permitting licenses to be held in up to two separate categories. It also places quality control restrictions, which are in the process of being developed, on distributors regarding the content of cannabinoids, contaminants, microbiological impurities, and other compounds. These standards have not been developed yet by the California Department of Public Health. There is also a provision for a new fee for testing to be charged by the distributor in order to cover any new taxes that may be imposed at a later date.
AB 266 establishes with written laws that the actions performed by licensees that are permitted by a state license and local government, meaning that their actions are legal under state law in order to protect the licensee from legal repercussions. It also makes provisions for the grandfathering in of facilities that were in compliance with the law on or before January 1, 2018 so that these facilities can continue to operate until their license is approved or denied.
AB 266 also regulates cannabis deliveries requiring documentation of every delivery. The licensee is required to maintain a physical copy of the delivery request during the delivery to be made available upon request to law enforcement officers as required by the licensing authority. In addition, all employees of a dispensary offering delivery of medical cannabis or medical cannabis products are required to carry a copy of the dispensary's license along with government-issued identification.
Deliveries may only be made by licensed transporters to qualified patients and only by dispensaries in cities and counties where deliveries are not prohibited by local ordinance. The deliveries may also be taxed by the local county. The law also protects the privacy of patients and caregivers by protecting the confidentiality of their names and medical conditions.
AB 243 & SB 643
AB 243 & SB 643 assign the responsibility of regulating marijuana cultivation to the California Department of Food and Agriculture (DFA). The California Department of Public Health is responsible for developing the standards for the manufacturing, testing, production, and labeling of edibles.
The California Department of Pesticide Regulation is responsible for developing standards for pesticide use in marijuana cultivation. The California Department of Fish and Wildlife and the California State Water Resources Control Board have been given the responsibility of developing measures to protect water quality.
The DFA will establish a track and trace program for all marijuana plants at a cultivation site and also enacts civil penalties for cultivation operations that are in violation of these provisions. However, qualified patients can be exempted from the track and trace program if the cultivation area is less than 100 square feet for personal medical use. If the individual is a primary caregiver with five or less patients, then up to 500 square feet is permitted.
SB 643 sets for the qualifications for licensing including proof of local approval. The applicants are also required to undergo a DOJ background check at a Public Live Scan Site. Under these qualifications for-profit entities are also implicitly allowed.
New cultivation and dispensary facilities are not allowed to be located in school zones and must be located at least 600 ft from a school.
There are several provisions regarding physicians recommendations included in SB 643. However, they are not designed to significantly affect or impair a patient's current access to medicinal marijuana. The Medical Board has been ordered to consult with the California Center for Medicinal Cannabis Research in order to develop the medical guidelines for medicinal marijuana recommendations.
Physicians may not make medical recommendations to patients if the physician or a family member has financial interest in a licensed facility. Physicians are also required to include a warning notice that medicinal marijuana is still a Schedule I substance under federal law.
California dispensaries are required to meet a variety of tax and licensing requirements in order to operate legally in the state of California. Obtaining proper medical marijuana licenses is key to compliance. Below is a list of several applicable taxes and licensing requirements for dispensaries in California.
California Medical Marijuana Regulation and Safety Act (MMRSA)
In California, all dispensaries are regulated by the California Medical Marijuana Regulation and Safety Act (MMRSA), which is made up of three laws, Assembly Bill 266, Assembly Bill 243, and Senate Bill 643. AB 266 allows for businesses to obtain operational medical marijuana licenses from the state of California. It also legalizes all commercial cannabis activities by licensed California dispensaries. It gives local jurisdictions the power to tax and assess fees against California dispensaries. AB 243 regulates cannabis growers and SB 642 sets licensing standards for physicians who recommend medical marijuana to patients.
The state of California disallows the deduction of all business expenses for medical marijuana dispensaries that are not being taxed as a corporation under the State Revenue and Taxation Code. However, if the dispensary is structured in order to be taxed as a corporation, the deduction of all necessary and ordinary businesses expenses is permitted, as long as the dispensary maintains the proper records to support such deductions.
The state of California requires all dispensaries, including mobile dispensaries, to apply for a seller's permit with the Board of Equalization (BOE). There is no fee to apply for a seller's permit and it can be done via the BOE's Online Registration.
All retail sales of medical cannabis products and accessories are subject to California sales tax. California dispensaries are required to pay sales tax on a quarterly prepay, quarterly, monthly, fiscal yearly, or yearly basis based on the dispensary's reported sales or anticipated taxable sales at the time of registration for a Seller's Permit with the BOE. The statewide sales tax rate is 7.5%.
However, California dispensaries should also pay close attention to the laws regarding the taxation of medical marijuana as changes are expected soon. The California Senate is currently considering SB 987, a new bill introduced in February 2016, which would impose a 15% tax on the sale of medical marijuana to patients.
To mitigate having to pay taxes on purchases of medical marijuana and marijuana-related products, dispensaries must obtain a resale certificate to present to the supplier at the time of purchase. These resale certificates are available at California office supply and stationery stores and should include the necessary information to ensure that the form is a Board-approved retail certificate. One resale certificate should be kept on-file per vendor and the same resale certificate can be used each time a purchase is made from that specific vendor.
If your dispensary has employees, you will also be required to report wages and pay Income tax, Social security and Medicare taxes to the Employment Development Department (EDD) on a quarterly basis. The full requirements for reporting and depositing payroll taxes in California can be found here.
California dispensaries are required by law to maintain specific records so that the Board of Equalization can verify the accuracy of filed sales and use tax returns. These records must be maintained for at least 4 years. These records include sales and purchase records, bank statements, resale certificates, shipping documents, and tax returns. A comprehensive list of the books and records that are required to be maintained can be found here.
Depending on the other products and services that your business provides, there may also be other state taxes that apply to your business, including property tax and special taxes. Contact the appropriate offices to learn more.
Cannabidiol (CBD) is one of more than 400 substances that are found in marijuana and it is not psychoactive, meaning that it does not cause changes brain function or result in alterations in perception, mood, or consciousness. Many states have already passed laws that have permitted the use of CBD extract, typically in oil form, often with traces of tetrahydrocannabinol (THC), for the treatment of epileptic seizures in children. CBD has only be legalized in the United States since 2014 and only when it is sourced from the hemp plant and not the cannabis plant. A thorough understanding of the related tax and accounting issues is necessary to running your canna-business.
CBD is also found in hemp, which is a plant that is related to the marijuana plant. Hemp that contains little to no THC (0.3% THC is less) and its products are legal to import and sell in the US, but only in the states that have commercial industrial hemp programs. According to The Agricultural Act of 2014, also known as the 2014 Farm bill, US farmers are not permitted to grow hemp. It is only legal for farmers to cultivate or grow industrial hemp for the purposes of research under a state agricultural pilot program or academic research program. Hemp is also not permitted to be be shipped between states, even in instances where the plant is legal is both states.
In addition, legal CBD can only be obtained from the stalk of the plant, not from the leaves and flowers. Hemp also contains far less CBD than cannabis plants, which means that a large amount of hemp stalks are required to produce only a small amount of CBD.
Despite the fact, that CBD lacks the psychoactive properties of THC, as an ingredient of marijuana, it is still considered illegal under federal law if it is extracted from the cannabis plant. Marijuana is currently regulated as a Schedule I drug per the United States Controlled Substances Act. Even though, CBD does not meet the criteria for Schedule I classification under the law, it is still classified as such because it is a component of marijuana.
Furthermore, Congress created section 280E of the Internal Revenue Code during the height of the War on Drugs in order to prevent drug dealers from claiming deductions for business-related expenses. The current result of this legislation is that state-legal cannabis businesses are now being prevented from claiming most business expenses and are instead limited to cost of goods sold (COGS) deductions to offset their tax liabilities.
The short answer for businesses that provide CBD related products and services is that section 280E still applies. The only case where businesses might be able to claim deductions is if they can prove that the CBD came from an industrial hemp source that is legal per state law. As a result, CBD companies should refer to state laws regarding taxation for CBD businesses given that hemp laws are different in every state.
As a cannabis reseller or producer, you may have the option to deduct COGS for certain expenses related to the operation of your business. These deductions can offer some substantial tax savings for your business, as the deduction options for cannabis businesses are limited to COGS due to § 280E of the Internal Revenue Code (IRC).
When the IRS Office of Chief Counsel issued Chief Counsel Advice (CCA) 201504011 in 2015, this memo was designed to clarify the COGS deductions that are available to cannabis businesses. The IRS determined that the specific IRC sections that govern the items that can be included as COGS for cannabis businesses are §1.471-3(b), in the case of a cannabis reseller, and §1.471-3(c) and 1.471-11, in the case of a cannabis producer.
While these regulations outline the general categories of deductions that are permitted for cannabis businesses, they do not detail what specific items cannabis businesses can deduct. To help you sort things out, here are some examples of the costs that you should include in your COGS basis for your canna-business so that you know exactly which items are deductible.
COGS for Cannabis Resellers
According to §1.471-3(b), the IRS has interpreted this section of the IRC to mean that cannabis businesses are permitted to deduct expenses related to inventory as COGS only. As result, cannabis resellers can claim deductions for:
●The invoice price for cannabis, less trade or other discounts
●Electric bills for designated inventory areas (electricity used in sales areas are not eligible to be deducted as COGS)
●Transportation (the cost of travel to purchase cannabis, transportation and shipping costs of the cannabis)
Cannabis resellers are permitted to take these deductions only as long as these charges are strictly related to the acquisition of cannabis for resale and the storage and handling of inventory. The best way to ensure that the IRS will not challenge these deductions is by creating an inventory space that is closed off from the sales area of your cannabis business.
COGS for Cannabis Producers
For cannabis producers, §1.471-3(c) and § 1.471-11 of the IRC define how these businesses should treat cannabis production costs and define which expenses they are permitted to deduct as COGS. The IRC advises the use of the "full absorption" method of computing COGS which takes into account both direct and indirect production costs.
Direct production costs are considered those costs which are necessary for the production of cannabis and the materials that are consumed as a part of the production process.
Per the IRC, the direct production costs that cannabis producers can deduct are the costs of:
●Raw materials and supplies (seeds, soil, clones, fertilizer)
●Expenditures for direct labor (hiring workers to clean, trim, cure, package and inventory the cannabis and the associated wages, payroll taxes, and insurance)
Examples of indirect production costs that can be deducted as COGS include:
●Repairs to production and storage facilities
●Maintenance costs for your production and storage facilities
●Utilities (water and electricity used to grow cannabis)
●Rent for your production facility
●Indirect materials and supplies (grow supplies and packaging)
●Indirect labor (supervisory wages)
●Costs of quality control and inspection
These indirect production costs are only deductible if they can be related to the production of cannabis. In addition, if the cannabis production business prepares financial statements that are in accordance with GAAP, some additional expenses can be deducted, which are outlined here.
Californians Helping to Alleviate Medical Problems (CHAMP)
In a 2007 case, Caregiving Californians Helping to Alleviate Med. Problems, Inc. v. C.I.R., 128 T.C. 173, the Tax Court determined that CHAMP could take business deductions for the patient care portions of the non-profit’s medical marijuana dispensary operations. CHAMP was a caregiving program that was designed to provide members with medical cannabis in according with the laws of the state of California. The organization also provided one-on-one counseling, medical supplies, yoga instruction, healthy meals, and Internet access.
As a not-for-profit entity per California law, the Tax Court agreed that CHAMP was actually two separate businesses. The ruling found that the CHAMP's primary business was actually caregiving services, which would permit the deduction of business expenses that were otherwise precluded by §280E.
The CHAMP case made it possible for cannabis businesses to operate multiple businesses under one roof. As a result, it is a good idea to add additional services onto your cannabis business so that you can take advantage of as many of these COGS deductions as possible.
Add patient services, such as counseling or advocacy, and make sure that all other businesses have real purposes and separate financial records to back up their operations. By expanding your business to include non-cannabis related services, you can improve your profits and increase the number of COGS deductions that your business can claim.
The Internal Revenue Service is after cannabis companies in Colorado, sparking uncertainty and unease among cannabis businesses. The newest audits are focusing on Form 8300, which is the form used to report cash transactions of $10,000 or more. The IRS is investigating large cash transactions which have been processed by these businesses for evidence of money laundering and under-reporting of business income. While some marijuana-related businesses in Colorado have already been able to settle their Form 8300 audits, other business owners are dealing with audits from the IRS regarding Section 280E. This article is intended to help marijuana related business mitigate their potential exposure to an IRS audit.
For cannabis companies, an IRS audit doesn't only come along with the risk of having to pay additional tax liabilities, the businesses may also be hit with fraud or other criminal charges because cannabis is still considered to be an illegal drug under federal statutes. Generally, businesses that earn $200,000 can expect to be audited at a higher rate than businesses that earn less than this amount. Underreporting your income is one of the top IRS red flags and with cannabis-related businesses dealing in cash, it is fairly easy for these businesses to come under the scrutiny of the IRS.
Until the law changes, every cannabis company is at a substantially higher risk of being audited by the IRS than other types of business. As a result, it is extremely important for your business to follow these best practices so that you can reduce your chances of being audited.
1. Maintain Careful Records and Copies. The more your business makes, the higher the chances are of an audit. This is because you are likely to be required to file Form 8300 for multiple transactions that were conducted. In addition, if your business takes large deductions for cost of goods sold (COGS), the IRS may wish to examine your deductions more closely. Make sure that you maintain copies of all filed tax forms and receipts for all of the items that you claimed as a part of your COGS deductions.
2. Make Sure to File on Time. While it may seem obvious that you should file your returns on time, it can be difficult to keep up with the forms and due dates for marijuana-related businesses since the rules seem to change each year. Having a qualified tax professional prepare your taxes can help you keep on top of the legal requirements for your business.
Here are the annual deadlines that companies should be aware of:
● Corporation income tax returns (Forms 1120 and 1120-S) are due by March 15th for S corporations and April 17, 2017 for C corporations.
● Partnership tax returns (Form 1065) are due by March 15, 2017.
3.Comply With All State Laws. Make sure that you have properly disclosed all of the activities of your business and any related party interest to your lawyer and CPA to ensure that your business is in compliance with state law. To find out more about the laws that apply to cannabis-related businesses in each state, go to:
● Alaska: Alcohol & Marijuana Control Office
● Washington: Washington State Liquor and Cannabis Board
● Oregon: Oregon Department of Revenue Marijuana Tax Program
● Colorado: Colorado Department of Revenue: Marijuana Taxes
● California: California Board of Equalization: Marijuana
Being in violation of state law puts your business at a much greater risk of audit because the federal government's current policy is to investigate cannabis-related businesses that violate both federal and state laws.
No matter how many precautions you take, there is absolutely no guarantee that your business won't be audited by the IRS. However, using the tips above can lessen your chances but you should still make sure to maintain, thorough, well-organized records just in case. If you have any additional questions, please feel free to contact us.
If you own or plan to own a cannabis business, it’s important to know that getting financial support from most banks will be difficult to do—but resources are available to help. We’ve put together a quick checklist for things to consider when trying to set up banking with your Marijuana business.
In 2014, the United States Department of the Treasury’s Financial Crimes Enforcement Network (FinCEN) issued guidance for financial institutions on this matter. Their goal was to clarify the expectations of the Bank Secrecy Act—which requires financial institutions to detect and prevent money laundering—in light of recent state initiatives to legalize marijuana.
By looking at FinCEN’s guidelines for financial institutions, marijuana-related business owners can get a good idea of what they need to do in order to give themselves the best chance of receiving financial support from these institutions.
Below are some things to keep in mind:
Have you submitted an application and supporting documents for a state license?
It is imperative that you obtain the proper state license to operate if you wish to receive any financial support. Financial institutions want to be sure that you are legally allowed to operate your business, otherwise they could face consequences for funding your business.
Are you duly licensed through the local authorities?
Occasionally, local jurisdictions require further licensing or have restrictions on marijuana-related businesses altogether. Be sure that in addition to your state license, you also are legally allowed to operate locally and licensed if needed.
Have you properly vetted other parties you do business with?
If you are doing business with other cannabis-related parties, you will want to vet them to make sure they are properly licensed and documented as well. Any affiliation with an unlicensed or improperly maintained third party could reflect poorly on you.
Have you properly vetted your employees?
In a similar vein to vetting any businesses you associate with, you also will want to ensure that your employees have no previous criminal records, especially those relating to money laundering or illegal drug trafficking.
Do you have a policy in place for the products you will sell and customers you will serve?
It is important to thoroughly document the type of business you do, as there are big differences depending on whether you sell or produce medical marijuana as opposed to recreational marijuana. Keep track of everything your business does in some way.
Do you have a good understanding of your business’ reputation?
Stay on top of current rulings and regulations so as not to fall out of compliance with authorities on a state or local level.
Do you fully understand the Cole Memorandum and your state’s laws?
Having an understanding of what is legally expected of you is imperative, because if you violate a state law or the Cole Memorandum in any way, financial institutions have every right to immediately pull their support and report your business.
Can you demonstrate a legitimate source of significant outside investments?
This is something that all businesses should do, regardless of whether they are marijuana-related or not. Financial institutions are more open to providing financial support if they can see that other institutions or investors have faith in your business.
Because of the Bank Secrecy Act, failing to follow any of these guidelines might result in worse than just losing financial support. Depending on the severity of the situations, it may be the financial institution’s responsibility to report you and your business, resulting in being shut down and, possibly, legal ramifications.
In the end, it is your responsibility to be diligent and transparent about your business’ operations if you wish to obtain or continue receiving financial support from an institution. If you have any questions with regards to this, please don’t hesitate to contact us.
Many cannabis-related businesses would like to take deductions for the costs related to their business activities. However, the tax code, Internal Revenue Code (“IRC”), has some very specific provisions regarding the businesses that are permitted to take cost of goods sold (COGS) deductions and which expenses may be included. COGS is at the core of all marijuana related businesses as its one of the key factors to reducing your taxable income.
Although figuring out which deductions are permitted can be tricky, it's in your best interest to claim all of the deductions that your business is allowed. COGS is a important deductions that marijuana-related businesses are allowed and can have a considerable effect on the effective tax rate for your business.
Consider the following examples:
Example 1. For a business with gross receipts totaling $776,772, a business with a high COGS could deduct $435,829, leaving a gross income of $340,953. Thanks to these allowed deductions, this business paid taxes on $340,953 instead of on $776,772. As a result, the business’s effective tax rate was 44% of its final earnings.
Example 2. For a business with gross receipts totaling $776,772 and a low COGS with only $50,000 in COGS deductions, the gross income of the business was $726,772. Therefore, this business would pay taxes on $726,772. For this business, the effective tax rate was 94% of its final earnings.
Simply taking COGS deductions rendered a 50% difference in the effective tax rate of each of these two businesses! As a result, claiming deductions for COGS could mean substantial tax savings for your business.
Here is a quick guide to help you understand what COGS deductions are permitted for your cannabis-related business.
Cannabis-related Businesses and Claiming COGS
Although, cannabis-related businesses are currently illegal under federal law, every business in this industry is still obligated to pay federal income tax on its taxable income because IRC § 61(a) does not differentiate between income that has been earned from legal sources and income that has been earned from illegal sources.
In 1982, Congress enacted § 280E, which prohibits deductions and credits for businesses trafficking in controlled substances. However, in a later case, Californians Helping to Alleviate Medical Problems, Inc., v. Commissioner, 128 T.C. 173 (2007) (“CHAMP”), the government acknowledged that § 280E does not prohibit a taxpayer from claiming COGS. In other cases involving non-medical marijuana or other Schedule I controlled substances, the Tax Court recognized that § 280E does not disallow adjustments to gross receipts for COGS.
Chief Counsel Advice (CCA) 201504011
As a result of these rulings, the IRS determined that marijuana-related businesses could claim certain COGS deductions. On Jan. 23, 2015, the IRS Office of Chief Counsel issued Chief Counsel Advice (CCA) 201504011 to clarify that although deductions may not be claimed for trafficking marijuana, the CCA allows a cost-of-sales deduction for indirect production-related business expenses.
The memo concluded that although marijuana-related businesses are permitted to determine COGS, they must do so using the § 280E as it was enacted in 1982 and § 471, which makes the provision for the use of inventories to determine business income. When §280E was enacted in 1982, an ‘inventoriable cost’ referred to any costs that could be capitalized to inventories under §471.
Capitalization simply means delaying the recognition of an expense by treating the item as a fixed asset rather than recognizing the cost in the period that it was incurred. Capitalization is generally only used by companies that operate on the accrual basis of accounting.
In addition, the IRS concluded that these businesses are not permitted to calculate COGS using the more recent IRS regulations which can be found in § 263A, which permitted the inclusion of additional expenses, namely purchasing, handling and storage expenses, and service costs.
In order to claim any of the permitted deductions, the items must be “ordinary and necessary” within the meaning of § 162.
IRC § 162 is one of the most important sections in the tax code because it defines what a deduction is. The IRC requires six different elements to claim an item as a business expense in order to claim a deduction.
These elements are that the cost is:
1. Ordinary and necessary;
2. In carrying on;
3. A trade or business activity;
4. That it is an expense; and
5. That it was paid or incurred during the taxable year for which the return will be filed.
The IRS findings explain what a deduction is and which expenses could be considered as COGS. Finally, it should be noted that the IRS concluded that the IRS has broad authority to require the marijuana-related business to change its method of accounting and to challenge the deductions claimed.
What Expenses Can Be Considered as COGS?
The IRS has made specific provisions for marijuana resellers versus producers.
CCA 201504011 clarified that, for resellers, the costs that they incur that are otherwise nondeductible under § 280E may not be deducted as COGS. These costs that are non-deductible are those that are directly related to the trafficking of marijuana.
For resellers, this means that only the invoice price of purchased cannabis, less any trade or other discounts, as well as, the transportation and other costs necessary to gain possession of the inventory can be considered as COGS.
For cannabis-production businesses, there are significantly more opportunities to claim items as COGS. Production-related wages, rents, and repair can be considered as COGS upon the sale of the inventory for accrual-basis taxpayers and immediately for cash-basis taxpayers that are cannabis-production businesses. However, marketing and general business expenses remain nondeductible.
Indirect production costs that may be considered as COGS include:
● Repair expenses,
● Indirect labor and production supervisory wages, including basic compensation, overtime pay, vacation and holiday pay, sick leave pay (other than payments pursuant to a wage continuation plan under section 105(d)), shift differential, payroll taxes and contributions to a supplemental unemployment benefit plan,
● Indirect materials and supplies,
● Tools and equipment not capitalized, and
● Costs of quality control and inspection,
only if these costs are incident to and necessary for the production of cannabis. If these expenses are not related to cannabis production then they are nondeductible.
The IRS has also permitted producers to claim some additional COGS deductions, as long as the company makes sure to produce financial statements that are in accordance with Generally Accepted Accounting Principles (GAAP).
These expenses include:
● Taxes deductible under § 164, other than state, local, and foreign income taxes;
● Depreciation and depletion;
● Deductible employee benefits, including pension and certain profit sharing contributions, workers' compensation expenses, stock bonus plans, premiums on life and health insurance, and miscellaneous employee benefits such as safety, medical treatment, cafeteria, recreational facilities, and membership dues;
● Costs pertaining to strikes, rework labor, scrap, and spoilage;
● Administrative expenses related to production;
● Officers' salaries related to production; and
● Insurance costs related to production.
While the provisions of the tax code do give some cannabis-related businesses the opportunity for some tax breaks, the IRS does not allow such businesses to take the same deductions as businesses in other industries. However, the repeal of § 280E of the IRC could make the burden lesser for cannabis-related businesses who have reported tax liabilities of up to 70% of their income.
In addition, these rules could change at any time. Until the law changes, it is important for all businesses in this industry to establish proper record keeping in order to meet IRS requirements. If you have any questions, please feel free to contact us.
The Financial Crimes Enforcement Network (“FinCEN”), a bureau of the U.S. Department of the Treasury that is responsible for receiving, maintaining, and analyzing the financial transactions data of businesses for law enforcement purposes, has issued guidance in order to clarify the Bank Secrecy Act (“BSA”) expectations for financial institutions which seek to provide banking services to marijuana-related businesses. The BSA requires U.S. financial institutions to assist U.S. government agencies to detect and prevent money laundering.
These updates have been made because there is has much confusion among the nation’s financial institutions on how to legally conduct business with marijuana-related businesses. As of 2016, certain marijuana-related activities have been legalized in 25 states and the District of Columbia.
The Cole Memo
At the same time, the U.S. Department of Justice Deputy Attorney General James M. Cole issued a memorandum (the "Cole Memo"), to provide guidance to federal prosecutors concerning marijuana enforcement under the Controlled Substances Act (“CSA”), which makes it illegal under federal law to manufacture, distribute, or dispense marijuana.
The memo reiterates Congress’s determination that marijuana is a dangerous drug and that the illegal distribution and sale of marijuana is a serious crime that provides a significant source of revenue to large-scale criminal enterprises, gangs, and cartels.
The U.S. Justice Department has offered assurances that it will not pursue criminal charges against marijuana-related businesses that are operating legally under state law. However, this non-enforcement stance has not guaranteed any protection for financial institutions.
Guidance for Financial Institutions
The FinCEN guidance clarifies how financial institutions can work with marijuana-related businesses while also making sure that their policies are inline with the marijuana enforcement activities of the U.S. Department of Justice under the CSA.
Financial institutions have been advised under the BSA to conduct due diligence for each customer to determine the risks of providing services to such business. The due diligence should include a thorough review of the business's registration and licensing with state authorities.
Financial institutions are also required to monitor these business on an ongoing basis and file suspicious activity reports ("SARs") where warranted. Three types of SARs may be filed, namely:
●“Marijuana Limited” SAR Filing. This report should be filed by the financial institution solely because the business is a marijuana-related entity and not because the business has violated state law or one of the Cole Memo priorities.
●“Marijuana Priority” SAR Filing. This report should be filed by the financial institution primarily in the case that the business violates state law or the priorities of the Cole Memo.
●“Marijuana Termination” SAR Filing. This report should be filed in the event that the financial institution wants to terminate the relationship with the business due to suspicion that illegal activity is taking place and to maintain the anti-money laundering compliance program of the financial institution.
Currency Transaction Reports ("CTRs") and Form 8300 are also required by FinCEN's regulations for financial institutions that offer services to any business that engages in marijuana-related activity.
Despite these updated guidelines, the fact that marijuana is still illegal under federal law but has been legalized in certain states has made almost all financial institutions outright reject doing business with marijuana-related businesses.
What Are the Banking Alternatives for Dispensary Owners?
At present, the majority of dispensaries are forced to pay their employees and vendors in cash while customers use an ATMs to obtain cash for purchases because of the conflicting laws for financial institutions. However, there is hope that the law may change in the near future.
The H.R.2029 - Consolidated Appropriations Act, 2016 bill, recently signed by President Obama, has a single sentence contained within the bill that says that the Department of Justice may not use money appropriated to it to prevent states from implementing laws regarding medical marijuana. However, banking reform was not specifically included within the bill.
In the meantime, alternative banking options are emerging for marijuana-related businesses that have been turned down by banks or do not meet the requirements of major financial institutions. Marijuana-related businesses can use online business directories and other industry resources to find payment solutions.
A number of payment processors have stepped up to provide transaction processing without the cash. Cashless ATMs for marijuana-related businesses are available from payment processors including Meta Payment Systems, Best Point of Banking, GreenStar Payment Solutions, Medical Cannabis Payment Solutions, and First American Merchant Funding.
Despite the fact that cryptocurrencies have been used in black market purchases of marijuana, they may also soon be used to help dispensary owners collect payments from customers. Cryptocurrencies, including Bitcoins, and PotCoins, are emerging as viable options for legal marijuana-related businesses.
Whether you are starting up a company for the first time or you are a serial entrepreneur, someone in your company will inevitably ask: “Should we write a business plan?” At this point, many might grumble and opt for the group to pick straws to determine who is going to write it. Simply put, a business plan is no easy undertaking. It requires a considerable amount of time spent researching your industry, scouting the competition, identifying your market, setting realistic milestones, establishing key value proposition, structuring company management, forming financial projections…the list could go on forever.
For better or worse, a business plan is absolutely essential. Not only does it improve your company’s internal operations by setting tangible goals for your team, it also validates your company from the perspective of investors, real estate companies, and the other business relationships key to your company’s success.
Do you think any of these parties enter into long-term business relationships with just
anyone? Not a chance. They want to know that you are not just acting on gut feelings and are going to simply wing it. Much like qualifying someone for a romantic relationship, they seek a company that takes itself seriously and has its ducks in a row. The easiest way for them to assess this professionalism is by asking for a business plan.
Even as cannabis inches closer each year to the end of prohibition, the “reefer madness” stigma and stoner stereotype still remain for many people -- and some of these people could be key to the success of your cannabusiness. This is why demonstrating your professionalism and overcoming stereotypes that work against you is more important than ever in this industry. And it all starts with a business plan.
At California Cannabis CPA, our team of professionals help entrepreneurs entering and thriving in the cannabis industry create business plans, optimize revenue, and navigate the ever-changing landscape of the marijuana industry. For that reason, we’ve created this simple outline to help you raise your first round of funding for your company.
The legalization of recreational marijuana in numerous states has created a market and a great investment opportunity. Once federal law is liberalized to allow wider use of cannabis, which is the direction current developments tend to lead to, this is going to be a sunrise industry with huge growth potentials. This section will describe the overview of your company, and what you’re trying to accomplish. For those investors who aren’t familiar with the cannabis industry, it might be important to include polls showing the growing demand for legalization of cannabis.
This business plan reflects a desire to mine the wider legalization of recreational marijuana for the launch and growth of a cannabis-based business. The goal is to participate in and profit from activities in the various sectors of the industry---biotechnology, cultivation and retail and consulting services.
The plan will be carried out in two phases. Phase I focuses on the particular states that have legalized marijuana for medical purposes. Under Phase II, the venture will be spread nationwide as legally applicable.
In the description, explain your mission (day-to-day objective) and vision (long term objective) for the company. Also describe how these objectives will be accomplished, such as “leveraging X platform,” “supported by X”, etc...This section could also include a potential list of strategic partners and affiliates that would help you achieve these objectives.
From an investor’s standpoint, seeing positive resumes of the proposed partners makes their investment decision easier to make. They want to know that the partners have good work ethic and are prepared to dedicate the long hours necessary in the early growth phase of a company. Partners should also have a healthy diversity of backgrounds to ensure that each partner brings specialized skills and experience to the table.
This section will also be used to showcase why your team is the team has the capacity to win in your respective business venture. Clearly articulate how your backgrounds will allow your company to thrive.
Market Size and Development
Including research about the general marijuana market size against your company’s proposed market sector gives readers an idea of your company’s potential growth. This research draws some lines in the sand for which market segments your company plans to invest most of its energy. These market segments would include marijuana retailers, growers, infused products, testing labs, ancillary goods, and ancillary services.
Additionally, it gives you an opportunity to clearly define the kinds of customers you will serve (including age, gender, median income, location, etc…) Unless you have a comprehensive team and plan already created, it is wise not to try to capture the entire market in the beginning phases of your company, as you will be spread too thin and lack any direction.
Here is a sample of recent macro trends and insights into the marijuana industry as a whole:
Investment firm Viridian Capital & Research recently published its outlook for the cannabis industry in 2015, including a look at some 75 companies that participate in the various sectors of the industry. Viridian noted that marijuana-related firms raised $80.4 million in capital during 2014, with the three largest segments being consulting services ($20.1 million), ancillary cultivation and retail ($18.9 million) and biotechnology ($12.3 million).
Viridian also maintains an equal-weighted total return cannabis index that posted a gain in 2014 of 38.4%, primarily on the basis of a 939% return in the first quarter of last year. That is when sales of marijuana first became legal in Colorado. Sales began in Washington in June. Consulting services posted the highest return, 170%, followed by biotech (nearly 85%), infused products (57%) and cultivation and retail (33%).
The same investment firm noted that the estimated $10-billion sale of marijuana in 2015 is far too low. In effect, the industry could yield more.
No matter how unique your company is, there will also be another business competing in your chosen market vertical. It really does not matter who does it first; what matters is who does it the best. If you cannot identify any competitors, then your search has simply not been thorough enough.
For your reference (and potential use in your business plan) are a few companies operating in the cannabis industry today:
GW Pharmaceuticals PLC (NASDAQ: GWPH) is a biopharmaceutical company that develops and commercializes therapeutics using a proprietary cannabinoid product platform. The company is included in the Nasdaq biotechnology index and has a market cap of $2.25 billion. Shares closed at $114.11 on Friday, and the stock’s 52-week range is $58.16 to $126.78.
Medbox Inc. is consulting services firm specializing in dispensary and licensing applications. The reported market cap for the company is $242.3 million. Medbox trades over the counter on the OTCQB under the ticker symbol MDBX.
Medical Marijuana Inc. is an investment and mergers and acquisition firm that trades over the counter on the OTCPink board. One of its portfolio companies, KannaLife Sciences, is developing a target drug candidate for treating concussions. The company’s reported market cap is $134 million.
PharmaCyte Biotech Inc. is a clinical stage biotech firm developing and commercializing cancer and diabetes treatments based on live-cell encapsulation technology, including a treatment using cannabinoids. The company’s reported market cap is $133.1 million and it trades over the counter under the symbol PMCB.
Cannabis Sativa Inc. has a reported market cap of $120.1 million and trades over the counter under the symbol CBDS. The company develops, manufactures, distributes and sells herbal-based skin products. Former two-term Libertarian governor of New Mexico, Gary Johnson, is the company’s president and CEO.
CannaVEST Corp. develops, produces and markets hemp-based cannabidiol products to the nutraceutical industry. The company’s reported market cap $88.2 million. The stock trades over the counter under the symbol CANV.
CannaGrow Holdings is a lessor, liaison and consultant to licensed marijuana growers in the state of Colorado. Because growing marijuana is strictly controlled and must meet strict site requirements, there are several companies that specialize in real estate issues. CannaGrow’s market cap is reported at $83.7 million, and it trades over the counter under the symbol CGRW.
Chuma Holdings Inc. is a consulting service that provides turnkey financing and support solutions to the medical cannabis industry in California. The company’s reported market cap is $60.1 million. Chuma trades over the counter on the OTCQB under the symbol CHUM.
Cannabis Science Inc. specializes in cannabis formulation-based drug development and related consulting. The company’s reported market cap is $58.6 million. The stock trades over the counter on the OTCQB under the symbol CBIS.
CannLabs Inc. has a reported market cap of $56.9 million. The company provides consulting services and cannabis testing technologies and methodologies. The company’s stock trades over the counter under the symbol CANL.
Brand Differentiation and Value Proposition
In terms of Value Proposition and Brand Differentiation (which may directly tie to your competition), below is a list of things to consider:
Easier to use
Safer to use
Designed by someone cool or endorsed by a celebrity
Approved by a respected organization
Company qualities (aka value propositions) like these are important to define as best you can early in your process. They will eventually inform how to brand your company to the public. Through the customer discovery process, you are sure to discover other needs and desires of your potential customers that you could not have anticipated. This is fine. As long as you treat your initial value propositions as hypotheses to be tested in the field, you will be able to respond to your customers’ true needs with agility.
Nevertheless, creating value propositions like these in the beginning will help guide your company and prove to anyone that you have some sense of direction early in your growth.
In terms of how your company interacts uniquely with its customers, explain how your cannabis products/services will endeavor to build relationships with customers and respond to complaints quickly and calmly. Delivery will be faster and hassle-free at all times. Offer online ordering where competitors don't. Consider leveraging a digital “platform” much like Uber or Airbnb to connect consumers with your company and with each other.
A strategy that will be followed, even in combination with other tactics, is to reemphasize and even improve on what makes a business successful. A solid marketing plan will clearly show how you plan to approach the marketplace and acquire customers. You may also want to consider what the competitors are doing and how their strategies are lacking or how they can be improved.
Building a sustainable and repeatable path to the customers is one of the hardest aspects of a company so please make sure to pay special attention to this section as it can make (or break) your overall business plan.
The financial plan is one of the most important parts of your overall business plan. If you are seeking outside investment, either from an angel investor, bank, or institutional venture capital firm, you will need to clearly show where their money is going. For example, if you are trying to raise $100,000 - where will that money go? Will it be marketing? Headcount? Research and Development?
This section may also tie in other aspects of your business plan. For example, in your marketing plan, you may have Google Adwords as a strategy and found that your CAC (customer acquisition cost) is around $2.50 per new customer. The more research and well-thought financial analysis you have, the more reputable and reliable you will come across. Make sure to thoroughly research every dollar that will be spent.