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.