Cannabis Legalization: Legal in Some States, Illegal Federally
With legalization spreading rapidly across the nation, the cannabis industry is only just beginning to thrive. Faced with an absence of large accounting firms in the high-growth, complex space, cannabis companies must adapt their financial practices to keep up with an increasingly competitive landscape. Those who fail to remain in compliance with strict state and federal regulations will find themselves at risk of steep penalties or even shutdown, potentially costing investors hundreds of thousands of dollars.
This intricate niche, which consists of farming, chemical manufacturing, food production, and retail, is primed to grow and it is very important for business owners in this niche to work with CPAs, in order to plan for taxes and to remain in compliance.
While the industry is relatively new and IRS provided tax guidance can still be unclear, there are some rules not in question. For example, the IRS requires all taxpayers to report all income regardless of whether it was obtained legally or illegally. At the same time, Section 280E of the tax code states that a taxpayer cannot deduct expenses related to income they obtain illegally. Section 280E specifically applies to Schedule I and II (Cannabis) controlled substances. When Congress passed this section, an exclusion was added to allow for costs of goods sold to be deducted. However, the IRS subsequently issued advice on how to value cost of goods sold for purposes of Section 280E, which results in less favorable treatment by the IRS. Running a business costs money. As a business owner, you have to pay for overhead, employees, marketing, as well as many other expenses depending on your business. A good tax advisor helps you plan for taxes and understand which expenses can be deducted or how they can be deducted.
While Section 280E provides some answers for federal tax planning, the states are different, as some have passed laws allowing for medical and recreation cannabis use. It is important to consult a tax advisor if you are a new business owner in this growing industry. There are plenty of legal ways to plan for taxes and take advantage of deductions that are available to you (per the IRS). If you are planning a foray into the cannabis industry or know someone who is, please have them call us at Elias Strauss CPAs. We would be happy to advise them and help guide them.