Accounting For Medical Marijuana Businesses Explained
The Complexity of MMJ Accounting
Basis of the Issue: How Cannabis is Classified (Scheduled) Federally
Schedule I Controlled Substances
Substances in this schedule have no currently accepted medical use in the United States, a lack of accepted safety for use under medical supervision, and a high potential for abuse.
Some examples of substances listed in Schedule I are: heroin, lysergic acid diethylamide (LSD), marijuana (cannabis), peyote, methaqualone, and 3,4-methylenedioxymethamphetamine (Ecstasy). (from https://www.deadiversion.usdoj.gov/schedules/ )
The Courts and IRS Law 280E
No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances (within the meaning of schedule I and II of the Controlled Substances Act) which is prohibited by Federal law or the law of any State in which such trade or business is conducted. (McElroy, "Taxpayers Trafficking in a Schedule I or Schedule II Controlled Substance -- Capitalization of Inventoriable Costs", 2015)
Why are my Cannibis Business Expenses not Tax Deductible?
Business Setup - Can it Help?
A Sole Proprietorship is one individual or married couple in business alone. Sole proprietorships are the most common form of business structure. This type of business is simple to form and operate, and may enjoy greater flexibility of management and fewer legal controls. However, the business owner is personally liable for all debts incurred by the business.
A General Partnership is composed of two or more persons (usually not a married couple) who agree to contribute money, labor, and/or skill to a business. Each partner shares the profits, losses, and management of the business, and each partner is personally and equally liable for debts of the partnership. Formal terms of the partnership are usually contained in a written partnership agreement.
A Limited Partnership* is composed of one or more general partners and one or more limited partners. The general partners manage the business and share full in its profits and losses. Limited partners share in the profits of the business, but their losses are limited to the extent of their investment. Limited partners are usually not involved in the day-to-day operations of the business.
A Limited Liability Partnership* is similar to a General Partnership except that normally a partner does not have personal liability for the negligence of another partner. This business structure is used most commonly by professionals such as accountants and lawyers.
A Corporation* is a more complex business structure. As a chartered legal entity, a corporation has certain rights, privileges, and liabilities beyond those of an individual. Doing business as a corporation may yield tax or financial benefits, but these can be offset by other considerations, such as increased licensing fees or decreased personal control. Corporations may be formed for profit or nonprofit purposes.
The Limited Liability Company (LLC)* and the Limited Liability Partnership (LLP)* are the newest forms of business structure in Oklahoma. An LLC or LLP is formed by one or more individuals or entities through a special written agreement. The agreement details the organization of the LLC or LLP, including: provisions for management, assignability of interests, and distribution of profits or losses. Limited liability companies and limited liability partnerships are permitted to engage in any lawful, for profit business or activity other than banking or insurance.
*Registers with the Secretary of State (as listed on https://www.sos.ok.gov/corp/organization.aspx)
IRS (Federal) Designations
IRS (Federal) Designations
Recordkeeping and Accounting
Petitioner essentially reads our Opinion in CHAMP to hold that a medical marijuana dispensary that allows its customers to consume medical marijuana on its premises with similarly situated individuals is a caregiver if the dispensary also provides the customers with incidental activities, consultation or advice. Such a reading is wrong. Petitioner also has not established that the Vapor Room’s activities or services independent of the dispensing of medical marijuana were extensive. We perceive his claim now that the Vapor Room actually consists of two businesses as simply an after-the-fact attempt to artificially equate the Vapor Room with the medical marijuana dispensary in CHAMP so as to avoid the disallowance of all of the Vapor Room’s expenses under section 280E. We conclude that section 280E applies to preclude petitioner from deducting any of the Vapor Room’s claimed expenses. (Nitti, 2018)
Recordkeeping, recordkeeping, recordkeeping. This should go without saying, but if you work in an industry in which the IRS has a tool at its disposal to deny ALL OF YOUR NON-COGS DEDUCTIONS, you had better be meticulous in your record keeping. As we discussed above, if you've got a (substantial) second line of business, treat it like one, separately recording revenue and expenses. But even if you don't, you HAVE to maintain consistent, thorough, and defensible allocations of costs between G&A expenses (that are subject to Section 280E) and COGS (which are not). To argue that you have half-a-million in COGS without bothering to record opening or ending inventory is to set yourself up for a quick defeat. (Nitti, 2018)
How Expenses Work and Why it Matters for Cannabis
Expenses Vs Assets (General FYI, not specific to cannabis, but important)
OpEx Expenses vs Cost of Goods (COGS) and Accounting
Cost of Goods Sold
Cost of Goods Sold
Cost of Goods Sold are expenses directly related to the producing of or purchasing of inventory. For dispensaries, only the cost of the product plus any shipping necessary to get the product to the dispensary can be allocated as Cost of Goods purchases.
Why it Matters
Why it Matters
If accounting is lackadaisical, it may lead to costly ramifications. In the following example, we will look at the difference in properly allocating inventory purchases to Cost of Goods Sold vs OpEx.
Not properly categorizing COGS results in tax paid on $200,000, instead of $50,000!!!
Accounting and Taxation
- Contract Labor
- Display Cases
- Professional Fees
- Licenses and Fees
Audit and Audit Ready
New IRS 199A Risk vs Reward
Article by: Brad Cocheran
Bloomenthal, Andrew. How Operating Expenses and Cost of Goods Sold Differ? 13 Apr. 2020, www.investopedia.com/ask/answers/101314/what-are-differences-between-operating-expenses-and-cost-goods-sold-cogs.asp.
Choosing the Structure of Your Business or Organization. www.sos.ok.gov/corp/organization.aspx. Oklahoma Secretary of State Website
Cost of Goods Sold for Marijuana Companies. 5 Aug. 2016, www.californiacannabiscpa.com/blog/cost-of-goods-sold-adjustments-for-marijuana-related-companies.
FindLaw's United States Ninth Circuit Case and Opinions. 9 June 2015, caselaw.findlaw.com/us-9th-circuit/1707249.html.
Fishman, Stephen. Can Medical Marijuana Dispensaries Deduct Their Business Expenses? 31 Oct. 2014, www.nolo.com/legal-encyclopedia/can-medical-marijuana-dispensaries-deduct-their-business-expenses.html.
Fortenberry, Jeramie. Double Taxation vs Pass-Through... 24 June 2019, www.fortenberrylaw.com/double-taxation/.
Hecht, Peter. Medical Marijuana Dispensary Takes on IRS over What It Calls 'Punitive' Taxes. 23 Feb. 2014, www.washingtonpost.com/politics/medical-marijuana-dispensary-takes-on-irs-over-what-it-calls-punitive-taxes/2014/02/23/25fa6458-9cd3-11e3-ad71-e03637a299c0_story.html.
Marijuana Business Cost of Goods Sold ("COGS") Overview. 18 July 2016, www.californiacannabiscpa.com/blog/marijuana-business-cost-of-goods-sold-cogs-overview.
United States, Congress, McElroy, W. Thomas. “Taxpayers Trafficking in a Schedule I or Schedule II Controlled Substance -- Capitalization of Inventoriable Costs.” Taxpayers Trafficking in a Schedule I or Schedule II Controlled Substance -- Capitalization of Inventoriable Costs, 23 Jan. 2015. https://www.irs.gov/pub/irs-wd/201504011.pdf. Accessed 11 Apr. 2020.
Nitti, Tony. Ninth Circuit: Legal Or Not, Marijuana Facility Cannot Deduct Its Expenses. 10 July 2015, www.forbes.com/sites/anthonynitti/2015/07/10/ninth-circuit-legal-or-not-marijuana-facility-cannot-deduct-its-expenses/#3a282f481d9a.
Nitti, Tony. The Top Tax Court Cases Of 2018: It Wasn't A Good Year For The Marijuana Industry. 17 Dec. 2018, www.forbes.com/sites/anthonynitti/2018/12/17/the-top-tax-court-cases-of-2018-it-wasnt-a-good-year-for-the-marijuana-industry/#2a03267dc55c.
Taxes & Accounting for Oklahoma Cannabis Businesses. 27 Aug. 2019, cbpok.org/taxes-accounting-for-oklahoma-cannabis-businesses/.
Zollars, Ed. Business Consisted Solely of Selling Controlled Substances, No Deductions Other Than Cost of Sales Allowed. 14 June 2018, www.currentfederaltaxdevelopments.com/blog/2018/6/14/business-consisted-solely-of-selling-controlled-substances-no-deductions-other-than-cost-of-sales-allowed.