If you are conducting business in cannabis in the State of California, there are several taxing authorities that have interest in your business, specifically: Internal Revenue Service (IRS), Franchise Tax Board (FTB), California Department Of Tax & Fee Administration (CDTFA) and your local jurisdiction (municipality). Additionally, if your business has workers, the Employment Development Department (EDD) will also be scrutinizing your business.
Each of these agencies believes that cannabis businesses are doing well and are “cash-cows”. Truth is many now are struggling to survive due to different reasons including oversupply of product, lack of access to financing markets, saturation of competing businesses and extensive regulatory procedures.
Under I.R.C. §280E, taxpayers cannot deduct any amount for a trade or business where the trade or business consists of trafficking in controlled substances…which is prohibited by Federal law. Cannabis, including medical cannabis, is a controlled substance. While I.R.C. §280E disallows cannabis-related businesses to deduct “ordinary and necessary” business expenses, it would be unconstitutional for the IRS to disallow businesses to deduct Cost Of Goods Sold when calculating gross income. This concept was first applied in the Tax Court case of Olive vs. Commissioner Of Internal Revenue, 139 T.C. 19 (2012).
Assembly Bill 37 passed in 2019 (which is effective for tax years starting January 1, 2020 through December 31, 2024) provides that IRC Section 280E no longer applies to licensed individual taxpayers operating under the personal income tax law.
Assembly Bill 195 passed in 2022 made substantial changes to cannabis taxes.
Cannabis Excise Tax – Cannabis retailers are now responsible for reporting and paying the cannabis excise tax to the CDTFA for retail sales of cannabis or cannabis products made beginning January 1, 2023. The first cannabis retailer excise tax return and payment of the cannabis excise tax are due by May 1, 2023.
Cultivation Tax – Beginning July 1, 2022, the cultivation tax no longer applies to harvested cannabis from licensed growers entering the commercial market. To penalize unlicensed cultivators, Cannabis Tax Section 34015.1(a)(1) imposes a tax liability on the unlicensed person required to be licensed with the Department Of Cannabis Control (DCC) who possesses, keeps, stores, or retains for the purpose of sale, or sells or offers to sell any cannabis or cannabis products. Section 34015.1(a)(2)(A) requires the department to ascertain “as best it may” the category and amount of the harvested cannabis deemed as having entered the commercial market, and the average market price or gross receipts, based on any information within the department’s possession or that may come into its possession, of the retail sale of the cannabis or cannabis product deemed as purchased from a cannabis retailer. Section 34015.1(a)(2)(A) provides that if a penalty is to be imposed, the penalty shall be 25% of the amount of tax or $500.00, whichever is greater.
Local Jurisdiction (municipality)
Depending on the type of cannabis business being conducted (i.e., Cultivation, Manufacturing, Retail, etc.), specific local taxes will apply. It is important to check the local ordinances to see how these taxes are calculated and when reported and paid.
Closing Your Cannabis Business Does Not Automatically Insulate You From Liability
Don’t think that just because you close your cannabis business, you will not have personal exposure for outstanding tax liabilities. The sales and excise taxes collected when product is sold is deemed by the CDTFA to be a “trust fund liability” meaning that because the business is collecting the tax on each sale to then remit to the State, the failure to remit these funds will not only rest on the business but also its responsible persons (business owners, officers, etc.).
Municipalities which also tax cannabis businesses in the form of a “gross receipts tax” may also recognize this concept in their ordinances and thus impose liability to responsible persons as well.
What Should You Do?
- Have The Proper Legal Structure In Place
Different business types have specific tax requirements. The business type (entity type) you choose impacts the types of deductions and credits you can take.
- Maintain Good Books & Records
You must keep accurate and complete records to support your income and deductions for your income tax returns. This includes sales and purchase records, invoices, receipts, and other books related to your income and expense transactions.
- Have Tax Counsel Assure That All Taxes Are Being Accounted For In Each Sale
Ignorance is not a defense. If you were supposed to charge a tax on the sale and you do not, the tax is still due to the taxing authority which now the business must pay.
- Have Tax Counsel Establish An Accounting System To Maximize Deductible Expenses
Cannabis businesses at both the Federal and State level may deduct Cost Of Goods Sold which should include not only direct costs but also indirect costs. Additionally, licensed cannabis business can deduct ordinary and necessary business expenses on their California returns. Unlicensed cannabis businesses taxed under personal income tax law may only deduct cost of goods sold.
- Make Sure All Tax Returns Are Prepared Accordingly And Timely Filed
Late-filed tax returns will be subject to late-filing penalties and where applicable late-payment penalties and interest.
Given that cannabis is still illegal under existing Federal law you need to protect yourself and your marijuana business from all challenges created by the U.S. government. While cannabis is legal in California, that is not enough to protect you. It’s coming down that the biggest risk is TAXES. So it is best to be proactive and engage an experienced cannabis tax attorney in your area who is highly skilled in the different legal and tax issues that cannabis businesses face. Let the cannabis tax attorneys of the Law Offices Of Jeffrey B. Kahn, P.C. located in Orange County (Irvine), the Inland Empire (Ontario and Palm Springs) and other California locations protect you and maximize your net profits. And if you are involved in crypto currency, check out what a bitcoin tax attorney can do for you.