Soon after your opening launch celebrations, you face the grim realities of your first tax return as a Cannabis business owner. (Cue Death Star music.)
Section 280E of the tax code states that “No deduction or credit shall be allowed” for businesses that are prohibited by Federal law. Section 280E explicitly mentions businesses that deal in “trafficking” substances that fall under Schedule I and Schedule II of the Controlled Substances Act.
This is potentially devastating for cannabis businesses, and raises the effective tax rate of a retail or production business to 70%, up from what should be in the neighborhood of 30%. That’s based on a business with $1,000,000 gross receipts, cost of goods sold (COGS) of $650,000, with as much as $200,000 in allowable deductions for a non-cannabis business and $0 allowable deduction for the cannabis business. In that scenario, the non-cannabis business will pay tax on $150,000 of income after deductions, while the cannabis business will pay tax on $350,000 of income after deductions, despite the fact that their COGS were the same, dollar-for-dollar.
Four Easy Ways to Save 40% on Your Tax Bill Every Quarter
- Establish a second business for every operation that is not directly related to your cannabis inventory. Name it and claim it. Have one business that is just the cannabis business. If you are a retail cannabis business, the only activity in that business will be the buying and selling of your product. If you are a production business (grower or producer), keep at least one other item in your line that is not cannabis related so that you can handle the tax consequences of §280E. Keep inventory lists separate, according to the differentiated revenue streams. In a retail operation, branded items, other health or wellness products, accessories, and accoutrements — these can be inventoried and their associated costs can be deductible. For example, if you have a dispensary, but you also sell glassware or cleaning products, keep those in a separate business. Voila! You now have deductions that you can claim! Most of your rent, utilities, and marketing of anything not expressly cannabis – entirely legal deductions.
- Document each and every item separately. Many cannabis businesses make the mistake of thinking, “What’s the use of keeping books if I can’t claim deductions?” Big mistake! If you receive goods from a supplier, make sure you have them ship the cannabis products separate from any other goods you may acquire from them. Doing so will create a fool-proof way to trace expenses that are solely related to cannabis, and help your other deductions survive the scrutiny of an audit.
- Micro-manage the tasks that your staff performs while on the clock. If you are a producer, your employee spends a great deal of time with tasks such as checking timers on lights, running water lines, locking and unlocking cabinets, running spreadsheets, cleaning work tables. If, out of one hour, that employee spends 45 minutes with hands off of the cannabis products and you can document it, you have just found a way to claim 45 minutes of that employee’s time on your taxes. Document these tasks, minute-by-minute. Score! You’ve just made the majority of your employees’ wages deductible. Now take it one step further and cut checks from two separate businesses each pay period for your employees. They will still be making the same hourly wage, but it will come from two separate business entities.
- Pay yourself a bigger salary in your non-cannabis business than in your cannabis business. You ARE paying yourself, through your business, right? Being in business is a big time commitment; avoid burnout and personal detriment by paying yourself a sustainable salary. As CEO, Manager, Founder, or whatever your title might be, cut yourself a bigger check from the non-cannabis business than you do from the cannabis business. Go ahead. Be aggressive with this. If you have structured the two businesses so that the cannabis-inventory-based business is only 10-20% of the total enterprise activity, you can get away with paying yourself 80-90% of your salary from the non-cannabis business, and the remaining 10-20% of your salary from the cannabis business.