With tax deadlines looming in March and April, now is the time to be gathering materials for your accountants.
One of the most despised phrases that will be said for the next few months: “Tax season is upon us.”
Every tax professional is counting down the days to March 15 (S-Corp and multi-member partnerships) and April 15 (C-Corp, individuals, single-member LLCs, schedule C only) deadlines. The GreenGrowth CPAs tax team counts down each day like the days until Santa arrives, except Santa (IRS) only takes instead of gives. (“Ho, ho, ho! Give me all your hard-earned dough, dough, dough!”)
We understand that every day, the stress builds for cannabis operators until they take the initial step to begin the tax return process. To help unburden your minds, we will provide some practical guidance to assist you.
Let us work off the correct assumption that taxes will be reviewed for a regular entity eventually. Cannabis is still federally illegal, and the IRS applies 280E to cartels and state-legal cannabis operators alike, so it would seem logical to pay attention to how you operate your business and file your tax returns. There is an entirely higher level of complexity and oversight by the IRS for cannabis operators and their tax filings versus how they deal with ordinary businesses because they know that most operators of cannabis businesses will file incorrectly. IRC 280E is very restrictive on purpose, and the federal government generates revenue from its misinterpretation and the negative consequences of noncompliance, including but not limited to penalties, fines and interest.
Empirical evidence from some of our legal partners out in early legalization states says that the audit rate is approximately 17 percent for cannabis businesses compared to the 1.5 percent for ordinary businesses. It is not hard to find the cannabis businesses either because states have a published list of licensed commercial entities and all the relevant information an auditor would need to get started. What is even more astonishing is that most CPAs in any state won’t touch a cannabis tax return, and they are doing this for your benefit and probably theirs too.
So if cannabis is federally illegal with a high audit rate and compounded by a tricky tax code that is different from what 99.87 percent of traditional CPA firms have experience with, then why would you try to tackle cannabis taxes on your own?
When speaking to prospects who are in the cannabis industry, I encourage them to seek out multiple tax firms to find a comfortable fit for their operation, and I stress that the firms should be cannabis-specific with deep experience in the industry. Let me clarify that prior experience is not buying an e-book, attending one class in Colorado and then pivoting your tax practice from oil and gas in late 2018 or early 2019 to cannabis to take advantage of this so-called “green rush.”
“Lawrence, you work for a cannabis-specific firm. Of course you say that.” Agreed, and I have never hidden the fact that I try to help float my boat by riding the overall CPA specialist tide. But I also do it for your benefit. The real point to focus on is that I know for a fact who does not want you to act on this sound advice: your competition.
I get referrals from clients all the time, typically from another vertical operation or from across the state but never for someone that is “across the street,” if you will. They disclose to me as much, and some clients even wish to restrict who we work with. As of January 2020, there are more than 5,400 cultivators, 1,400 manufacturers and 2,200 dispensaries in the state of Oklahoma. It is quite crowded out there. Let’s be real here. Your competition doesn’t want you to seek out a cannabis specialist, and they surely don’t want you to seek out an industry association to learn about the business. Your competitors want you to use your big brain to stay “too smart” to pay anything other than a rock-bottom fee for services. They know that rock-bottom fee will end up costing you much more money in the future, and they now have one less competitor to deal with.
If you don’t believe that you need a cannabis-specific CPA firm to help, you can just wait a few years for when the IRS and Oklahoma Medical Marijuana Authority (OMMA) come knocking at your door, asking you to reconstruct all of your financials for their fine-tooth-comb audit and no general CPA will help you out.
A truly bulletproof tax return requires year-round tax planning and service. Here are a few strategic items to maximize your return or minimize your bill. If not feasible now, there are some detailed items to collect at tax time to reduce your tax exposure and mitigate the impact of an audit. Remember, audits are only painful if you’re not ready for them.
1) Understand what “cost of goods sold” and 280E are.
COGS is the direct costs associated with producing the goods you sell. This will be different from one business to another. (What is a COGS for a cultivator might not be a COGS for a dispensary). There is tons of valuable content online that will describe it in laypersons terms.
2) Create detailed job descriptions for your employees.
Being comprehensive on job descriptions can give you and your CPA a fighting chance to deduct employee wages. Some job duties will open up wages to deductions that many businesses assume would not be eligible.
3) Save all receipts.
Let’s assume you are a cannabis operator named Teale. She made some money and then immediately reinvested it back in the business. She even only purchased items that qualify for COGS. In this scenario, with no receipts, she cannot prove where the money went; therefore, the IRS will assume that she still has all of that cash and will pay full taxes on it. The onus is on her to prove where your money went. Luckily, Teale had a detail-oriented CPA she took advice from and knew to keep all her receipts. Ideally save and catalog electronically, but a shoebox full of receipts is way better than no shoebox full of receipts.
4) Be a student of the industry.
“I didn’t know” is not a solid excuse. Wouldn’t any logical or smart business owner err on the side of being safe and asking a professional for help and not just assuming something doesn’t apply to them? Stay up-to-date by reading new regulations and leaning on your team of tax professionals to keep up with the ever-changing cannabis industry. If there is one constant in cannabis, it is that matters change all the time and you need to keep up or you will fail.
“Lawrence, we have done some of this. What now?” No one likes taxes; everyone hates doing taxes even more. In our experience, just starting the process helps reduce stress. Action relieves anxiety. Whether you tackle this on your own or find someone you wish to work with, here is a solid starting list of miscellaneous documents and information to gather:
- Tax returns for prior years, if applicable
- Copies of sales, excise and local tax returns
- Cash-handling log
- Articles of incorporation
- IRS-issued EIN (Employer Identification Number)
- Monthly bank statements, if applicable
- Balance sheet
- Profit and loss statement
- List of owners/business partners and their ownership percentages
- Social Security numbers for each partner
- Building information to include lease and tenant improvement receipts
- QuickBooks and point-of-sale login info
- Gross receipts — THC versus non-THC
- Returns and allowances
- Business checking/savings account interest (1099-INT)
- Other income
Cost of Goods Sold
- THC purchases
- Non-THC purchases
- Bank charges and finance fees
- Contract labor (1099-Misc and 1096)
- Computer and internet bills
- Health insurance
- Other insurance
- Interest expense (mortgage and business loan)
- Meals and entertainment
- Office supplies
- Rent (building, business vehicles, equipment)
- Repairs and maintenance
- Miscellaneous supplies
- Taxes paid
- Licensing fees
- Transportation and travel
- Wages paid to employees
- Payroll tax returns
- Employee benefits
*There is literally no way to disclose for each person reading this what expenses on this list are deductible in their operation.