In the past decade, legal recreational cannabis has become a giant market for the U.S. Cannabis was initially legalized in individual states for medical purposes, but almost a fifth of the country now allows it for recreational purposes. With this burst of growth comes several new small business operating within the cannabis industry, and with that comes several tax and accounting implications! Check out the rest of this article for helpful information regarding accounting in the cannabis industry!
Landscape of Legal Cannabis Use
If we think back to 2012, the first two states fully legalized recreational marijuana use. These included the western states of Washington and Colorado. Following their example, Oregon, Alaska, and Washington D.C. legalized two years later.
Now that we’re in 2019, five more states have legalized (Nevada, California, Maine, Massachusetts, and Vermont) with a sixth waiting for next year (Michigan). Geographically, this definitely makes the west coast the cannabis headquarters of the U.S.
Interestingly, many of these states with legalized cannabis have interesting tax laws. For example, Washington doesn’t have a state income tax, while Oregon doesn’t have a state sales tax. Furthermore, each state has its own tax rate relating to the sale of cannabis.
Not only has a fifth of the United States legalized recreational cannabis, but several more allow it for medicinal use. That means that you can find marijuana, whether recreationally or medically, in more than two-thirds of the states in the country.
Market Potential is Huge
Two-thirds of the country is a huge statistic, but it also means that there is a giant market for the cannabis industry. In 2018, investors put more than $10 billion into the legal cannabis industry. By comparison, another industry the U.S. has recently decriminalized is sports betting. The market for legal sports betting is projected to reach between $3 and $5 billion in five years.
Yeah, you read that right. That means that the legal cannabis industry is already worth more than twice what the legal sports betting industry will be worth in five years. To put it simply, the market for legal cannabis in the U.S. is absolutely huge.
With such a large market potential, entrepreneurs and small business owners alike will flock to the legal cannabis industry. There are already hundreds of dispensaries and plantations in legal states. With such a newly-legalized industry, the laws surrounding taxation are sure to change as more research is conducted on live results.
Because marijuana is still federally illegal despite being locally legal within individual states, this makes it a tricky topic when it comes to accounting. There are many risks when it comes to operating a cannabis business, especially because of all the stipulations and fees that are associated with it.
If you don’t pay careful attention to all the implications of running a cannabis business, you can very easily run into a loss when it comes to tax season. Below are three of the most important things you’ll need to monitor for compliance within your cannabis business!
Without a doubt, U.S. Code 280E is the reason why cannabis accounting is so tricky. Code 280E relates to expenses incurred through the sale of illegal drugs. Even though you are legally operating a cannabis business within whatever state you are located, you are still technically breaking federal law.
This means that the sale of cannabis does in fact constitute the sale of illegal drugs. What this means for you is that you will not receive any deductions of credits for expenditures relating to the operation of your cannabis business. Business owners can only deduct cost of goods sold, which greatly increases their total tax burden.
With that in mind, as a cannabis business owner, you’ll want to make sure that there’s no holes to be poked in the calculation of yoru cost of goods sold. This means you’ll want to keep everything thoroughly documented, and you might even want to consider using a formula every year for consistency.
Additionally, you have the ability to create a separate business within your cannabis business that is eligible for business deductions. As long as the new business has genuine value and revenue generation with documentation, you can you can allocate some of your expenses to that portion of your business to reduce the overall impact of 280E.
Closely related to Code 280E is Code 263A, which deals with capitalization of indirect expenses. If you have a way of connecting an expense to your actual inventory, you can capitalize it using Code 263A.
While this may seem insignificant initially, there are actually several things that can go into 263A. The amount of space your inventory takes up can be used to allocate a portion of rent, utilities, and maintenance based on what percentage of the total property is used. If you keep your inventory locked up, you can allocate the cost of a new lock if you choose to install one. Not everything can be capitalized, so you’ll want to ask your accountant for the best course of action!
Another important part of the tax code relating to cannabis is Section 471. Section 471 is associated with determining your total cost of inventory. The problem with this is that it may lead some businesses to deduct costs related to inventory that they aren’t eligible for.
To understand how to properly use 471, use must know whether your business operates as a reseller or producer. Depending upon which, the calculation for cost of good sold differs. If you’re a reseller, you’ll calculate COGS by adding the price of inventory to any transportation costs. Producers get to include direct and indirect costs in their calculation.
Professional Accounting Services
When it comes to cannabis accounting, there is certainly much to learn! Because the industry is still fairly new, standards and laws are still being understood and developed. This means that the way the law works today might not be how it works a few years from now.
The cannabis market is simply enormous, so there will be no shortage of small businesses looking to enter the industry. This is fantastic, but cannabis comes with its own set of ramifications relating to tax.
For 2019, the three most important sections of tax to cannabis include Code 280E, Code 263A, and Section 471. These all loosely deal with the calculation of expenses and inventory cost, which are calculated differently than other industries because cannabis is still federally illegal.
Trying to understand tax law when it comes to cannabis can be quite confusing! Fortunately the tax experts at Felde CPA Group are equipped to handle any cannabis tax questions you might have! The best way to protect and ensure your cannabis revenue through the year is to stay in compliance by working with a tax professional! Working with Felde is a surefire way to help strategize for your cannabis business!