In a previous article, we discussed some of the tax implications of offering free cannabis samples to your customers. As a cannabis dispensary operator, it’s tempting to stand out from the competition by letting your product speak for itself. Some dispensaries give out free cannabis by letting their customer “spin the wheel” to see what their prize is – in many cases a free joint or an edible.
Giving away free cannabis as a buy-one get-one promotion or a fun marketing tactic works for diversifying your customer base and driving repeat business. But what are your tax responsibilities when you offer free samples of cannabis products? This post will take a deeper dive into your financial and compliance obligations from giving away free cannabis.
COGS and Free Cannabis
There are two scenarios that have different tax implications for cannabis dispensary owners.
Scenario 1: Samples
In the first, let’s work with the example of a dispensary offering a free joint that a customer can win by spinning a wheel. Ultimately, the value of the cannabis you offer as a free sample will be calculated into your cost of goods sold (COGS).
When calculating COGS, you will use this formula: Beginning Inventory + Purchases - Ending Inventory = COGS.
In this scenario, let’s say you started out the period with $10k in product (beginning inventory). Then, you add in the purchases of products you made, including those free joints you gave away as samples. That results in $100k in purchases.
At the end of the period, you calculate your ending inventory is $20k.
According to the math: $10,000 + $100,000 - $20,000 = $90,000 COGS. In this instance, you have no additional tax obligations, since the samples are rolled into your COGS.
Scenario 2: BOGO Deals
Alternately, in a second scenario, the cannabis dispensary owner offers a buy-one get-one deal for pre-roll joint packs. Instead of 2 joints for $20, the dispensary offers 4 for $20. This is considered a discount, in this case, a 50% discount.
How does that impact your taxes? In this scenario, the promotion differs from the first example in that the dispensary is not offering a FREE joint, but a DISCOUNT. The full transaction amount goes into sales: meaning you will pay taxes on the full $40 value, even though the customer did not pay you $40 in cash.
The issue with this second scenario is that if your deal becomes incredibly popular, you will be exposed to a much larger tax liability – with not enough income to offset your taxes.
Cannabis Tax Implications
Here’s an extreme example of the BOGO deal and what can go wrong with your California state taxes. Imagine you are an LLC. In CA, you have a minimum tax payment of $800 even if you have no sales. Further, in California you may be liable for more franchise taxes if you have additional gross sales above $250k. As a dispensary, it’s highly likely you will meet this threshold.
For this example, let’s say you had gross sales of $300k, $60k in BOGO discounts, and after all other expenses you ended the year with HUGE loss of $50k. For the sake of this exercise, we’ll disregard some of the complicated 280E calculations and consider this as pure gross profit and loss.
With a loss of $50,000, the good news is that there will be no federal tax due. Neither will there be taxes due to the state of California.
The bad news, however, is that you still need to file a form 568. This is the franchise tax return, and that’s where the $300k in gross sales will come back into play – and where those BOGO deals can negatively impact you. Check this table to see what your additional taxes would be.
To calculate your Franchise Tax Return, you will have:
That’s a pretty big tax burden for a cannabis company that operated at a loss this year!
Considerations for Free Cannabis
Samples are used to get business and are not a part of taxable gross revenue. However, buy-one get-one deals do have tax calculated, since they are considered discounted and included in gross revenue.
So, if you were to have “given” $60,000 as free samples rather than discounts, you would not be liable for the additional $900 in taxes.
Consider speaking with your operations manager to tweak your offerings and deals so that you can decrease your potential tax liability.
And, if you have additional questions, reach out to GreenGrowth CPAs so that they can help you plan out the most effective tax strategy while improving the customer experience at your dispensary.
Click the "Get Started" button below to request a cannabis tax consultation.