The Mythical Tax-Advantaged Cannabiz
Not every entrepreneur has the cash to simply start up a new business, especially not a cannabiz enterprise. Often, they have a plan and strategy but still need one key thing – capital. New entrepreneurs typically need to seek out investors and ultimately must dilute their stock or membership interest to get up and running. This is difficult enough, considering that many start-up cannabiz are overvalued, making them less attractive to initial investors. What these new cannabiz owners don’t always realize is how potentially small their profit margin could be as a result of dilution, start-up costs, expansion, and taxes.
Whether she’s paying in bags of cash in-person at the statehouse, or she’s one of the lucky taxpayers that “gets” to pay via an account at a financial institution, every cannabiz owner hates watching a large chunk of their hard-earned revenues disappear to the regulatory bodies that are often in turmoil with their new industry. Thankfully, there are a few ways to help cannabiz taper some of the impact of taxes while they are trying to grow.
An after-tax profit can be difficult to achieve, especially since the IRS found in 2015 that, according to IRC § 280E, businesses dealing in controlled substances may only take deductions on costs of goods sold. Marijuana is still recognized as a Schedule I controlled substance under federal law, so cannabiz cannot deduct other business expenses related to their operations.
Working with a trusted tax professional is key here. They can help prepare adequate corporate governance in compliance with state laws, and they should determine what type of business structure will yield the most asset protection with the lowest total tax impact. Like any other type of industry, there is no “one size fits all solution” to choosing a business structure, and there are certain benefits to choosing an S corporation, C Corporation, or partnership. In most states, cannabiz are organized as limited liability companies “LLCs” and taxed as corporations or partnerships. In all scenarios, the entity will be limited to a federal deduction only on cost of goods sold. Often, partners and members of LLCs taxed as partnerships will pay more in total taxes upon disposition of their interest in the company, because partners suffer the extra burden of the nondeductible partnership expenses, which causes them to recognize more of a gain on their investment. However, this is not always the result, and the complications of taxation in a new sector of business continue to highlight the need for the help of an experienced tax professional.
Additionally, incorporating traditional tax planning strategies – like the type applicable to any other type of business – are sometimes available to cannabiz in the same ways. These will be limited by the IRC and subject to ownership regulations of the state in which the cannabiz operates.
Ambitious entrepreneurs are also considering ancillary businesses. These are lines of business that are essential to the cannabis industry that never come in contact with cannabis. Not subject to the same scrutiny and regulations (although each state has different rules that apply here), sectors like packaging, marketing, or equipment manufacturing can be set up in entirely separate legal entities. Checking with an experienced cannabiz attorney and tax planner will help determine if this is a strategic business move.
Establishing a tax-advantaged cannabiz isn’t a myth. While there’s no way to escape the tax burden placed on this highly regulated industry, there are best-practices and planning steps a cannabiz owner can take to avoid paying more than their fair share of taxes.
