The cannabis industry is undoubtedly the fastest growing industry in the United States and has created one of the greatest business opportunities in the 21st Century. In the continental US, it all began in 1996 when the state of California adopted Proposition 215, which permitted the medical use of cannabis in this state. Since then, some 29 states, including the District of Columbia, Puerto Rico and Guam have all legalized the medical use of marijuana and 9 of these states (and the District of Columbia) have also legalized recreational use of consumers 21 years old and older. In fact, 95% of the US population lives in a state with legal access to some form of cannabis, which includes the 13 states where cannabinoid (CBD) oil is legal.
On November 8, 2016, California voters approved the Control, Regulate and Tax Adult Use of Marijuana Act (Prop 64), which legalized the recreational use of cannabis by adults who are 21 years and older. In response to this ballot initiative, the California legislature passed Senate Bill (S.B. 94), which amended Prop 64 by streamlining the requirements for licensing and regulating medical and adult-use of commercial cannabis. Under the new system, California cannabis businesses must register with the California Department of Tax and Fee Administration (CDTFA) for sellers’ permits and cannabis tax permits if applicable to their type of business. Cannabis businesses must also obtain the appropriate cannabis license(s) for their activities. On January 1, 2018, retail sales of recreational cannabis began, and California taxes relating to these sales went into effect. As the legal cannabis market grows in California, cannabis businesses must be aware of the various tax implications facing the industry.
For federal income tax purposes, IRC Section 280E prohibits deductions for expenses incurred by operating “any trade or business…that consists of trafficking controlled substances (within the meaning of schedule I and II of the Controlled Substances Act).” Marijuana is a schedule I controlled substance, and the IRS uses section 280E to disallow cannabis businesses from deducting ordinary and necessary business expenses. However, IRC Section 280E does not prevent cannabis businesses from taking deductions for costs of goods sold (COGS). California generally uses federal taxable income as the starting point to determine state taxable income. With regards to IRC Section 280E, however, California takes a middle-of-the-road approach and (unlike for federal income tax purposes) allows deductions for a cannabis business filing a corporate franchise tax return. Because California’s personal income tax conforms to IRC Section 280E,4 a cannabis business operating as a sole proprietorship and taxed as a partnership is treated less favorably than its corporate counterpart. Additionally, in some circumstances, California’s laws are harsher than Section IRC 280E. For example, if a court finds that a cannabis business is engaged in criminal profiteering or related activities, the business may not deduct any expenses, including COGS. Thus, every cannabis business should engage a competent CPA knowledgeable about the limitations on IRC Section 280E.
On January 1, 2018, California began imposing a 15 percent excise tax upon cannabis purchasers. This tax is based on the cannabis’ average market price when purchased at retail. A sale’s average market price depends on whether the purchaser bought the cannabis through an arm’s length or non-arm’s-length transaction. Retailers, such as cannabis dispensaries, are required to collect the excise tax from their customers and pay it to their cannabis distributors. The distributors then must report and pay the cannabis excise tax to the CDTFA.
California also implements a cultivation tax upon all harvested cannabis that enters the commercial market.13 Cannabis cultivators must pay this tax to either their distributor or their manufacturer. The rate of cultivation is $9.25 per dry-weight ounce of cannabis flowers, $2.75 per dry-weight ounce of cannabis leaves, and $1.29 per ounce of the fresh cannabis plant. The flower category includes all dried flowers of the cannabis plant, whether trimmed or untrimmed, while the leaves category includes all other parts of the dried cannabis plant. The fresh category includes all parts of the plant, so long as the cultivator weighs the unprocessed cannabis within two hours of harvesting.
Specialized forensic accounting skills are very helpful in negotiating the complex accounting, tax and valuation issues that come up often when starting a business in this space. We have the industry expertise to help you negotiate through the complex accounting, tax, and valuation rules & regulations facing many business entrepreneurs in the cannabis industry and have included several PowerPoint presentations that demonstrate our expertise and skill in this space.