Cannabis Tax and Accounting
The cannabis industry is highly regulated by federal and state laws. While for Federal purposes cannabis is currently a Schedule I controlled substance and therefore illegal to distribute, as of October 2017 29 states and D.C. have legalized the selling and use of cannabis to some degree. Conflicts between federal and state laws have raised tax issues that will become more acute to the public as more businesses get involved, especially in the states where cannabis is legal. It is important to seek advice from professionals knowledgeable in this industry to ensure proper compliance and risk management.
Careful consideration and attention are needed to properly comply with federal and state laws.
- Cash Business: The cannabis industry operates mostly with liquid cash primarily due to the limited access to banking services such as checking accounts, etc. This causes record keeping and transaction tracking, two important aspects that support compliance, to be extremely challenging.
- Federal Law: Cannabis is currently a Schedule I controlled substance and is considered illegal. The IRS requires companies in the trafficking business to report all revenues and disallows all business deductions other than the cost of goods sold. It is important to be familiar with IRC §280E and the limitations it imposes on the deductibility of business expenses for federal purposes. Effective tax rates can range from 75% to 90% of net income. Engaging professionals knowledgeable in this area specifically is imperative to properly structure and report activities to minimize tax while capturing adequate support to optimize audit defense. IRS audits are eminent for cannabis-related businesses.
- State Law: States that have legalized cannabis may allow some deductions and each state has different income tax laws. State and local sales and excise tax on the farming and dispensing of cannabis may apply and should be considered.
- High Tax Audit Risk: The cannabis industry has a high IRS and State audit risk and high effective federal tax rate. In addition to adequate record keeping, having knowledgeable professionals in this specific industry will be crucial to minimizing taxes and providing adequate audit defense.
- State Financial Statement Assurance Requirement: Audited financial statements may be required for the licensing application process. In addition, certain states require annual audits for cannabis businesses.