As a cannabis operator, you may have already heard about 280e and have tried to figure out how to get the most deductions for your business. Though many states are close to fully legalizing cannabis, federal regulations like the 280e prevent current legal cannabis businesses from taking full advantage of small business tax deductions. The 280e is a section of the  United States Tax Code enacted during the Reagan era that prohibits businesses that deal with Schedule I and II controlled substances from taking tax deductions and credits. At the time that it was enacted, Congress decided to include an exception that allows for the deductions of the cost of goods sold (COGS), even if they are federally illegal substances. it means your cannabis business can still claim deductions.

Although it is tricky to work around the restrictions of  280e, there are some straightforward tips to help you get the most deductions for your cannabis business.

Understand the concept of “Cost of Goods Sold.”
The Cost of Goods Sold is the direct costs associated with producing the goods you sell. Since your cannabis business is not treated like other legal businesses, the COGS for other types of businesses that include marketing and advertising cannot be included in the cost of goods sold for cannabis and cannabis products. You may not deduct anything related to marketing and advertising, like your dispensary display equipment, marketing material, ads, and signage. What can you deduct? Only parts related to production, such as the salary of employees who actually harvest and cure cannabis, materials that go into cultivating and manufacturing the cannabis, etc..

Create comprehensive and descriptive job descriptions for your employees
By having comprehensive and detailed job descriptions for each of your employees, it’s easier to determine whether or not an employee’s wages can be claimed as a deduction. Some employees’ roles that don’t involve any handling of the cannabis to create a finished product will not be deductible. On the other hand, having an in-depth look at each role could help your accountant claim some deductions for employees’ salaries you initially thought couldn’t be claimed.

Keep detailed records of your cannabis business and facility.
The exact square footage of your facility and knowing how each square foot is used could help you claim more deductions. Some facilities, specifically dispensaries, have a harder time claiming deductions for their business because most of the business is used to sell finished products. This shouldn’t stop you from providing facility information to your accountant. A good cannabis accounting firm can help you justify how you use the space appropriately for a COGS deduction. You may have a small back room where you receive, repackage, store, or handle cannabis and cannabis products prior to dispensing them. If that is the case, your accountant may be able to show that you can claim a deduction for the specific room.

Save all your receipts and give them all to your accountant.
Many accountants appreciate clients who take the time to put everything together to make filing taxes easier. In the case of cannabis businesses, your accountant should leave no stone unturned. Provide your accountant with every receipt for every expense. There may be expenses that your business can claim that you may have thought couldn’t be claimed before.

Familiarize yourself with the taxes associated to your industry. Know when and what to file
In the cannabis industry, there are three types of cannabis taxes:

• Cultivation tax
• Excise tax
• Sales and Use tax

Depending on what type of business you have, there are different tax deadlines that need to be met for each type. Being well informed and staying on top of being compliant is half the battle when it comes to getting the most deductions for your cannabis business.

If you need some assistance in understanding cannabis taxes, filing taxes or maintaining accurate records for tax filing, talk to a team member today.  Get the most deductions is possible with the help of an accountant or an accounting firm that works closely with the cannabis industry. The sooner your cannabis business becomes compliant, the sooner it can make a profit.

​2018 and the new tax code presents itself with a myriad of changes on both an individual and corporate level. One of the biggest changes, from a corporate level, was the elimination of the AMT (Alternative Minimum Tax). Today, we will talk about the definition of AMT, why it started and how it will impact the cannabis industry. 

What is AMT?
The corporate Alternative Minimum Tax (AMT) is a separate and distinct method of taxation that runs parallel to the “regular” corporate income tax.  Prior to 2018, every corporation had to calculate its tax burden under both the regular corporate income tax and the AMT, paying the higher of the two.  It’s important to note, today we will strictly be talking about AMT as it relates to corporations, not individuals (the AMT was not eliminated for individuals). 

The Alternative Minimum Tax began in 1969. The start of AMT can be traced to then Secretary of Treasury Joseph W. Barr.  He testified before Congress that 155 individual taxpayers, with incomes exceeding $200,000, had paid no federal income tax in 1966. Adjusted for inflation, those numbers would translate to $1.5 million dollars today. 

The idea that the wealthiest citizens could pay zero income tax did not sit well with the government.  Therefore, the AMT was created.  This ensured that even those with higher incomes would pay a minimum amount of tax.  Otherwise, through tax deductions and credits, citizens could essentially pay zero taxes. With so many deductions available, lawmakers wanted to ensure everyone paid at least some base minimum of tax regardless of how many tax breaks they could use to their advantage.

Changes For 2018
Prior to the changes of 2018, the United States had one of the highest corporate tax rates in the world at 35%. The new 2018 regulations establish a flat 21% corporate rate for businesses and personal service corporations (PSCs). The corporate tax rate average for the developed world is 22%.  Theoretically, the reduction of the corporate tax rate by 14% should create a nice boom for U.S. based companies, allowing them to keep their operations and profits here in the U.S.
 
Prior to the changes for 2018, the corporate AMT tax rate was 20 percent. Additionally, C corporations with average gross receipts less than $7.5 million over the preceding three tax years were not subject to AMT.  As of January 1, 2018 – the corporate AMT was completely eliminated.  Individual AMT still applies, although a few things have changed.  Please consult California Cannabis CPA if you’d like some guidance on individual AMT regulations. 
 
How Do These Changes Affect The Cannabis Industry?
If your cannabis business is a corporation, you may benefit from the elimination of the AMT.  If you are still researching how to set up your business, read our 10 steps to start a cannabis business. California Cannabis CPA is happy to walk you through the process.

Theoretically, the removal of AMT should be a benefit. The AMT was a completely separate tax code that created a lot of additional record keeping. The elimination simplifies dozens of other tax code sections that were related to the corporate AMT.  And unlike before, if your business made over a certain amount of money, you had to pay the higher of the two taxes.  Not the case anymore. 
 
Second, functioning businesses are able to write off (or deduct) certain business expenses from their overall income.  Normally, these include expenses such as operating costs, employee expenses and equipment.  However, the cannabis business has certain limitations due to tax code 280E.
 
On the federal level, cannabis is still considered a Schedule 1 drug.  Therefore, licensed marijuana businesses have to file federal taxes under tax code 280E because of the Controlled Substances Act.  The downside to filing under 280E is that licensed cannabis businesses pay more in federal taxes than other businesses do. 280E bans any tax deductions besides the cost of goods sold.  If you try to deduct other expenses (similar to how other businesses operate) you will likely face an audit. 
 
However, there are situations where additional write-offs may be allowed.  This is usually the case if your business participates in marijuana for medicinal purposes. 280E is a very complicated tax code, so we recommend consulting with California Cannabis CPA to ensure every detail is covered.
 
In conclusion, it looks like the removal of the AMT will be beneficial, but cannabis companies will still run into challenges with the amount of expenses they are able to deduct.  California Cannabis CPA is happy to speak with you to discuss your individual circumstance, ensuring you remain compliant with the new tax codes. 
 
 

So, you want to start a business in California’s booming cannabis industry. Now seems like the perfect time to get in on the ground floor: the market estimates that cannabis will bring an additional $5 billion to California each year. It would be nice to get a slice of that pie, no?
Before you dive in, take some time to learn about the different ways to structure your business in a way that will give you the biggest slice of the pie -- not the leftover sliver that’s all crust (unless crust is your thing). The way you setup your company can mean the difference between growth and success and burning out after a year in business. Ask these five tax questions when setting out to structure your canna-business!

1. What kind of legal entity do you want to be?
Historically, before California decided to have a fully regulated state system for medical marijuana, cannabis companies were set up as non-profits. Now, there are other options for structuring your business. Figuring out which model is right for you depends on many factors, including your role in the cannabis industry (i.e. grower, distributor, or partner); county and local regulations; and your projected growth. Here are some options available:

Nonprofit (allowed pre-2018):

• The California Cooperative Corporation: in this scenario, cooperatives will be able to operate both as for-profit and non-profit entities.

For profit (allowed in 2018):

• The B-Corporation: B-Corporations are now authorized at the state level in California. A B corporation is a benefit corporation, a for-profit with a certain score for social and environmental performance.
• ​​C-Corporation: a C-Corporation refers to a for-profit corporation that is taxed separately from its owners. In this scenario, your business will be taxed on its income at a corporate level, and then as the owner, you will be taxed on your personal return for any income received from your canna-business. If this double-taxation seems unfair, you’re not wrong; however, having C-Corporation status creates a firewall against any personal tax liability, lowering your personal risk.
• S-Corporation: an S-Corporation is another for-profit model, like the C-Corporation. The difference here is that the business doesn’t pay income taxes. Your canna-business’s income or loss is divided among your shareholders. Then, each shareholder must report the income or loss on their individual tax return. This puts the liability on each individual -- and can have big repercussions depending on how well your business succeeds.
  
  
  

There’s no one model fits all for your cannabusiness. Consult with a tax professional to learn about these options -- and others -- before incorporating.

2. What are your growth goals?
Do you plan to have multiple locations and holdings? Depending on how your business operates, you can structure to account for different levels of liability. If you have multiple corporate entities, for example, you can limit your liability within each one. Then if one of your locations is sued or forced to shut down, your other locations can continue to operate independently. Conversely, managing multiple corporate entities can be a logistical nightmare -- especially if you intend to grow big or go home. It is much more efficient to run all your branches under one corporate entity if you’re smart about handling your risk.

3. What are your investors looking for?
Investors will be interested in your company’s assets, inventory, cash receivables, and profit potential. They will want to see your business model in all its parts: trademarks, intellectual property, physical locations, and more. When you want to raise some serious capital -- going beyond your personal investment and a Kickstarter campaign -- the way you structure your company can impact an investor’s interest. For example, in a multi-entity structure with different locations and sub-companies, an investor can pick and choose which parts of your business they want to fund. Having a multi-entity structure can be very attractive if you’re shopping your canna-business around to people with low risk tolerance (and it widens your potential pool of funders). However, different ownership stakes can start to lead to conflicting interests for you as a manager. Having a seat at many tables with multiple influential voices can cause some real cross-company conflicts for you as a leader.

4. How should you structure compensation and benefits?
Cannabis tax regulations have two special rules. First: cannabis companies can deduct the cost of goods sold on their tax return. Second: cannabis companies cannot deduct any sales and marketing expenses. Ouch.
​
What this means is that many traditional expenses can’t be claimed as decreed by tax law section 280E. Know the ins and outs of payroll tax, executive compensation, and healthcare benefits you’ll be accountable for as a business owner in the California cannabis industry. The best way to do that is to consult with a tax professional in your community.

5. What do you need to do to be compliant?
This is a big question -- and pretty broad at that. If you’ve made it this far, this step is the most crucial. Knowing what forms you need to fill out, what licenses you need, and how to best account for your expenses is what will make or break your business in the long run. California Cannabis CPA will be releasing more guides and checklists in the coming weeks to help you keep track of everything, but know that compliancy varies by district, county, and between the federal and state levels. If you’re going to have locations in different parts of California, do the research for each area you’re operating in. When in doubt -- pay your taxes! 

Beginning January 1, 2018, the state of California’s marijuana tax laws will change for distributors, cultivators, manufacturers and retailers of marijuana and cannabis products.   

The information outlines the process for collecting, paying and filing taxes under the new laws:

Step 1: Secure Permits and Licenses

Step 2: Register with California Department of Tax and Fee Administration (CDTFA)

Step 3: Collect and/or Pay Taxes

Step 4:  File Taxes

Background:

On November 8, 2016 voters in California approved Proposition 64 (Prop 64), the “Control, Regulate and Tax Adult Use of Marijuana Act”.  This proposition was designed to reshape the use and taxation of marijuana in the state in a number of ways including designating specific agencies to regulate and licenses of the marijuana industry in California.  Prop 64 also impacts the collection and payment of taxes for the following marijuana business groups defined below:

• Distributors: produces, sells and/or transports marijuana between licensed marijuana businesses such as cultivators, manufacturers or retailers
• Cultivators:  engages in the business of planting, growing, harvesting, drying, curing, grading or trimming marijuana
• Manufacturers:  produces or prepares cannabis products at a fixed location that packages or repackages marijuana or cannabis products or labels or relabels its container
• Retailer (Dispensary):  sells marijuana or cannabis products directly to consumers

Step 1: Secure Permits and Licenses

• Local permits and/or licenses: All marijuana distributors, cultivators, manufacturers and retailers must contact the local jurisdiction in which they plan to operate their business and apply for the appropriate permits and/or licenses.  Each city and/or jurisdiction has their own process.  It is important for distributors to secure the local permit by following their process and paying any applicable fees.
• State Licenses:  All marijuana distributors, cultivators, manufacturers and retailers must contact the appropriate state agency (listed below) to secure the appropriate license/permit for their business.  

Under the new state law, marijuana businesses will be required to obtain licenses from the state agency listed above.  The Bureau of Cannabis Control (BCC) is the agency developing regulations for medicinal marijuana use and those regulations should be available November 2017.  Marijuana businesses are highly encouraged to apply for a temporary license from the BCC as soon as the regulations are available.  The BCC will also issue temporary licenses which be effective January 1, 2018.  In order to secure a temporary license through the BCC, a business must have authorization from a local government (city and/or county) to run a marijuana business in their local community.  Temporary licenses will be good for 120 days from the date of issuance.

This proposition imposes specific marijuana excise and cultivation taxes.  Prop 64 was later amended by Senate Bill 94 (SB 94) which repealed the Medical Cannabis Regulation and Marijuana Safety Act (MCRSA) while defining the payment and collection of taxes.  Below is the breakdown of tax collection and payment between distributors, cultivators, manufacturers and retailers:

Step 2: Register with California Department of Tax and Fee Administration (CDTFA):  All marijuana distributors, cultivators, manufacturers and retailers are required to register with the CDTFA for seller’s and tax permits.  Seller’s and tax permits are different and require that businesses apply for separate permits.  Below is information that will be required for businesses to provide when registering with the CDTFA:

• Business Information (name, contact information)
• Federal and state tax identification numbers
• North American Industry Classification Number (NAICS)

The NAICS number for most medicinal marijuana businesses is classified the same as pharmacies and drug stores therefore the code is 44610.  Manufacturers may fall under a different NAICS code, depending on their business activities.  The manufacturer section offers additional business code information on their NAICS classification.  

Distributor: Marijuana distributors must collect the following taxes: cultivation, excise and sales from the cultivators, manufacturers and retailers. 

• Cultivation Tax Collection:  Distributors must collect cultivation taxes from retailer, manufacturers and/or cultivators from which they receive any marijuana and/or cannabis products.  The process for the cultivation tax is different for the cultivator and manufacturer. They are applied the following ways:
  • Cultivator: The cultivation tax is collected when the product is “harvested” and “entering the commercial market” after it has met all quality assurance and testing standards
  • Manufacturer:  The cultivation tax is collected when the product is first “sold or transferred” to the distributor for quality assurance, inspection and testing
  • There are two cultivation tax rates: 
    • $9.25 per dry-weight once of cannabis flowers
    • $2.75 per dry-weight ounce of cannabis leaves  
  • Please note that cultivation tax rate may change. Beginning January 1, 2020, the CDTFA will be required to annually adjust the cultivation tax rate based on inflation.
• Documentation like a receipt or invoice with the following information must be provided for these transactions.  The information below should be included:
  • Licensee receiving the product
  • Cultivator where the product originates with the product identifier number
  • Amount of cultivation tax

 

• Excise Tax Collection:  Distributors are required collect excise taxes from retailers that they supply (sell and/or transport) with marijuana or cannabis products.
  • The excise tax must be collected within 90 days of the sale or transfer of marijuana or cannabis products in an arm’s length transaction.  The state of California defines an arm’s length transaction as a sale “that reflects the fair market price in the open market between two informed and willing parties”.  If the sale is “no arm’s length” the taxes must be collected from the retailer on or before 90 days after the sale or transfer of marijuana or cannabis product to the retailer or at the time of the retail sale by the cannabis retailer, which ever is earlier.   from the retailer on or before 90 days after the sale or transfer of cannabis or cannabis product to the retailer, or at the time of the retail sale by the cannabis retailer, whichever is earlier.from the retailer on or before 90 days after the sale or transfer of cannabis or cannabis product to the retailer, or at the time of the retail sale by the cannabis retailer, whichever is earlier.from the retailer on or before 90 days after the sale or transfer of cannabis or cannabis product to the retailer, or at the time of the retail sale by the cannabis retailer, whichever is earlier.the retailer on or before 90 days after the sale or transfer of cannabis or cannabis product to the retailer, or at the time of the retail sale by the cannabis retailer, whichever is earlier.from the retailer on or before 90 days after the sale or transfer of cannabis or cannabis product to the retailer, or at the time of the retail sale by the cannabis retailer, whichever is earlier.
  • Like with the cultivation tax, distributors must provide documentation like a receipt or invoice with the following information must be provided:
    • Licensee receiving the product
    • Cultivator where the product originates with the product identifier number
    • Amount of cultivation tax

 

• Sales Tax Collection: Distributors are responsible for transporting marijuana and cannabis products between cannabis businesses and are responsible for filing returns and reports with the CDTFA. 
  • The customer (ex: retailer) must provide the marijuana distributor with a valid and “timely” resale certificate whether sales are subject to tax or not.  The resale document supports the sales for the resale.  If the resale document is not provided all sales are assumed to be taxable and will be taxed.  The California State Board of Equalization (BOE) offers additional information on “sales for resale” in Publication 103.
  • Distributors are not subject to sales tax when transporting marijuana or cannabis products from cultivators or manufacturers that the retailers contract with directly.
  • It is important that all marijuana or cannabis products sales or transportation by the distributor is recorded through invoice or receipt.  This will assist the distributor in filing their returns. 

 

• Additional Tax Collection Information: 
  • Any purchases of product that distributors make that will be resold are not subject to sales or use tax as long as they provide the seller with a “valid” and “timely” resale certificate.  Distributors essentially take on the role of retailers in this transaction. 

​
All business equipment and supplies (computers, signage, etc.) are generally subject to sales tax.  Most retailers will collect the tax at the time of purchase.  If the distributor is not taxed but the seller of the equipment, they should include the purchase on the “Purchases Subject to Use” tax on the “sales and use tax return”.  Supplies like wrapping for marijuana and cannabis products (ex: bags) may fall under resale.  The Tax and Fees section of the BOE offers additional information on use tax.

Cultivator: The cultivator must pay the manufacturer and distributor a cultivation tax.    

• Sales:  Cannabis Cultivators are subject to the cannabis cultivation tax when they sell to a distributor, manufacturer or retailer.  There are two cultivation tax rates: 
  • $9.25 per dry-weight once of cannabis flowers
  • $2.75 per dry-weight ounce of cannabis leaves 

Please note that cultivation tax rate may change. Beginning January 1, 2020, the CDTFA will be required to annually adjust the cultivation tax rate based on inflation.

The cannabis distributor, manufacturer and retailer must provide the cannabis cultivator with a “timely” and “valid” resale certificate.  If a resale certificate is not provided a sales tax will be applied to the sale and the cannabis cultivator must report and pay tax to CDTFA.  The California State Board of Equalization (BOE) offers additional information on sale for resale in Publication 103. 

• Purchases:  Most purchases made by cannabis cultivators will be subject to a sale or use tax.  There some cases when some supplies and products may not be taxable or may qualify for a partial tax exemption.
  • Use or Sales Tax Items: General cannabis cultivation business items (ex: computers, gloves, pesticides) will be subject to a sale or use tax at the time of purchase.  Vendors are responsible for collecting the taxes on these items. Out-of-state vendors may not apply the California state tax. In this situation the cannabis cultivator is responsible for reporting and paying the sales or use tax when they file their return with the CDTFA. 
  • Partially Exempt Use or Sales Tax Items:
    • Farming Equipment and Machinery:  Cannabis cultivators may qualify for a partial exemption rate available through the state general fund.  The current rate is 5% meaning that if the tax is 7% the partial rate is subtracted from the tax so the taxes paid by the cultivator will be 2%.  To qualify for this partial exemption, the following requirements must be met: Sold to a qualified person.
      • Sold to a qualified person
      • Used exclusively or primarily (50 percent or more of the time) for producing or harvesting agricultural products
      • Defined as farm equipment or machinery including but not limited to appliance, device or apparatus used in agricultural operations

The following are examples of items considered cannabis cultivator farm equipment and machinery:
​

• Plant equipment
• Trimming tools
• Drying racks and trays
• Hydroponic equipment

Cannabis cultivators who qualify for partial farm equipment exemptions may also qualify for partial exemption on solar power equipment.  The state issued a special notice on solar power farm equipment offering additional details. 

• Buildings:  Facilities, like greenhouses, specifically designed for and exclusively use for commercially raising plants may qualify for a partial exemption. Vendors should provide the cannabis cultivator with a partial exemption certificate.
• Diesel Fuel:  Diesel fuel used to prepare land for planting, protecting, harvesting and/or growing crops may also qualify for a partial exemption.  According to the state of California, to qualify for this exemption the fuel must be used “in carrying on a trade or business of farming; on a farm in California; and for farming purposes, by the owner, tenant, or operator of the farm.”
• Exempt Items:  The following items are exempt from use and sales taxes:
  • Seeds, plants and clones:  Seeds, plants and clones grown to be resold as part of the cannabis business do not have an applicable sales and use tax
  • Fertilizers: Fertilizers used to produce cannabis products.
  • Liquid Petroleum Gas (LPG): LPG used for commercial cannabis crop production or harvest.  The seller should provide the cannabis cultivator with an LPG exemption certificate.  

Manufacturer: The manufacturer must collect taxes from the cultivator and must pay the distributor a cultivation tax. 

• Cultivation Tax Collection and Payment:   Cannabis manufacturers are required to collect the cannabis cultivation tax from cultivators when the “unprocessed cannabis is first sold or transferred” to the manufacturer.  Manufacturers are then required to pay the cultivation tax collected from the cultivator to the distributor when products are transported for distribution.  There are two cultivation tax rates: 
  • $9.25 per dry-weight once of cannabis flowers
  • $2.75 per dry-weight ounce of cannabis leaves 

Please note that cultivation tax rate may change. Beginning January 1, 2020, the CDTFA will be required to annually adjust the cultivation tax rate based on inflation.
Documentation like a receipt or invoice with the following information must be provided for these transactions.  The information below should be included:

• Licensee receiving the product
• Cultivator where the product originates with the product identifier number
• Amount of cultivation tax

 

• Purchases:
  • When manufacturers purchase a product that will be resold they can purchase it without paying sales and use tax by providing seller with a valid resale certificate.  Sales tax apply if the product is sold at retail. Products consumed or used by the manufacturer will be taxed based upon the amount of the purchase price.  According to the CDTFA, “use tax rate is the same as the sales tax rate in effect at the location of use”.  They can be reported as a “purchase subject to use” when the tax return is filed.
  • Products (signs, display cards, scales, computers) for your business are subject to sales tax at time of purchase.  Out of state purchases, not taxed must be included on “Purchases Subject to Use Tax” and are subject to tax.  Wrapping and packing supplies may be purchased for resale and therefore may not be subject use tax.
  • Manufacturing and Research and Development Partial Exemption:  Manufacturers may qualify for partial exemption of sales and use tax on certain manufacturing and research development equipment purchases and leases.  The state outlined the following requirements:
    • Be engaged in certain types of businesses, “qualified person”.  A qualified person is primarily engaged (50% or more of their time) in business activities that fall under NAICS codes “3111 to 3399, inclusive 54711, or 541712”.
    • Purchase “qualified tangible personal property” as outlined below:
      • Machinery and equipment, including component parts and contrivances such as belts, shafts, moving parts, and operating structures
      • Equipment or devices used or required to operate, control, regulate, or maintain the machinery, including, but not limited to, computers, data-processing equipment, and computer software, together with all repair and replacement parts with a useful life of one or more years, whether purchased separately or in conjunction with a complete machine and regardless of whether the machine or component parts are assembled by the qualified person or another party.
      • Tangible personal property used in pollution control that meets standards established by this state or any local or regional governmental agency within this state.
      • Special purpose buildings and foundations used as an integral part of the manufacturing, processing, refining, fabricating, or recycling process, or that constitute a research or storage facility used during those processes. Buildings used solely for warehousing purposes after completion of those processes are not included.
    • Use the property in a qualified manner which includes the following 50% or more of the time:
      • Any stage of the manufacturing, processing, refining, fabricating, or recycling process
      • Research and development
      • To maintain, repair, measure, or test any qualified tangible personal property described by the above, or
      • For use by a contractor purchasing that property for use in the performance of a construction contract for a qualified person, provided that the qualified person will use the resulting improvement to real property as an integral part of the manufacturing, processing, refining, fabricating, or recycling process or as a research or storage facility for use in connection with those processes.

Retailer: The retailer charges and collects sales tax on “taxable retail sales” marijuana and cannabis products as well as other products.  They are also required to collect cannabis excise tax from customers and pay this tax to the distributor.

Sales: 

• Beginning January 1, 2018 all marijuana and cannabis products (including medicinal) will be subject to an excise tax of 15 percent.  The excise tax is collected from customers and paid to distributors.  Retailer must collect the excise tax at the time of purchase.  Below is a list of products included in the excise tax:
  • Balms
  • Buds and flowers
  • Capsules
  • Edibles (cookies, butters, honey, chocolates, candies, soda, bars)
  • Extracts
  • Gum
  • Hash
  • Infused feminine hygiene products
  • Lotions
  • Oils
  • Plants and clones
  • Pre-rolls
  • Teas
  • Tinctures
  • Tonics
  • Topicals
  • Waxes
• Cannabis accessories are not subject to the excise tax
• The excise tax applies to the average market price which is determined by the type of transaction between the retailer and seller (cultivator, manufacturer or distributor).  Those transactions are:
  • Arm’s length, when the “average retail price is determined by the wholesale cost of the cannabis or cannabis product sold or transferred to the cannabis retailer, plus mark-up”.  Marijuana businesses will be notified when the mark-up rate is set.  The set rate will be posted on the BOE’s Special Taxes and Fees Rate Page. 
  • Non-arm’s length, the average market price means the “cannabis retailer’s gross receipts from retail sale of the cannabis or cannabis products.    
• Customers with valid Medical Marijuana Identification cards (MMI) and government issued identification (ID) are exempt from sales tax
• Retailers are not required to collect sales taxes from their customers but they must report and pay sales taxes to CDTFA.  If retailers choose to include sales tax in their product price, they must post visible signage explaining this to the customer. Otherwise, the sales tax will be on the sale’s price and added to the receipt.  

Exemptions: Effective November 9, 2016 certain sales of medicinal marijuana are exempt from sales and use tax as defined by the Business and Professions code. Some items included are: medical cannabis, medicinal cannabis concentrate, edible medicinal cannabis products or topical cannabis.

Customer must provide their MMI and ID at the time of purchase.  Retailers must keep an electronic or paper record of the following information for exempt transactions:

• A valid nine-digit MMI number with expiration date (visit the CDPH website to validate MMI numbers)
• Sales invoice or other original record of sale

Retailers should not collect sales tax on these purchases and should claim a deduction on sales and use tax return for exempt medicinal marijuana and cannabis products sales. 

Purchases:  Purchases made on products that will be resold can be made without paying sales or use tax.  Retailers must provide the seller a “valid” and “timely” resale certificate. Out-of-state vendors may not apply the California state tax. In this situation the cannabis retailer is responsible for reporting and paying the sales or use tax when they file their return with the CDTFA. 

Items for use in a retail business like signage, scales, and computers are subject to sales tax at the time of purchase. Packaging and other supplies may be purchased for resale without paying sales tax.  

Step 4:  File Taxes:  All marijuana business owners must register for a seller’s permit and file sales and use tax returns.  Distributors of marijuana and cannabis products must register for a cannabis tax permit and file tax returns regularly. 

• Registration:  Marijuana businesses can create an online profile to file and manage their taxes and update any business information.  Electronic payments can be made through the online system as well.  Businesses paying with cash can file for an exemption to the “No Cash” policy.  This exemption requires business owners to explain their financial situation and their lack of a bank account and access to other payment options.
• Documentation:  Record keeping is an extremely important component of the tax process.  All marijuana businesses are required by law to keep accurate business records which helps determine the amount taxes due.  Records should be kept on all purchases and sales transactions to assist in preparation of tax filing.  The state requires that distributors retain all records for at least four years.  The state suggests the following as options for record keeping:
  • Sales invoices
  • Cash register tapes
  • Sales journals
  • Resale certificates
  • Shipping documents
  • Purchase invoices
  • Bank records
  • Purchase orders
  • Purchase journals
  • Tax returns
• Sales invoices and receipts should include the following information:
  • Location of transportation
  • Cost to purchaser (include any discounts)
  • Kind, quantity, size and capacity of package of marijuana and/or cannabis products sold
  • Name and address of purchaser
  • Name and address of seller

As of November 9, 2016, certain retail transactions will be exempt from the sales and use tax.  The BOE lists examples and the process for recording tax exempt transactions in a “Special Notice”.

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.

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.

For Resellers 

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 Producers 

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,
     ● Maintenance,
     ● Utilities,
     ● Rent,
     ● 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.