CPA Attestations for Pre-Qualifications, Accounting and 280E - Principles and Mitigation Strategies
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The document discusses corporate structures and tax strategies for cannabis businesses. It recommends: 1) Using a C corporation structure for retailers to contain tax liability within the corporation and protect shareholders. 2) Using pass-through entities like S corporations or LLCs for producers/processors, as 280E impacts are less significant for them. 3) Segregating operations to take advantage of different tax treatments, like holding real estate in a separate entity to claim more aggressive depreciation deductions. 4) Developing intellectual property holdings and licensing agreements to generate deductible expenses and offset operating income within the cannabis business entity.
CPA Attestations for Pre-Qualifications, Accounting and 280E - Principles and Mitigation Strategies
- 1. + Tax & Accounting CPA ATTESTATIONS FOR PRE-QUALIFICATIONS, ACCOUNTING AND 280E - PRINCIPLES AND MITIGATION STRATEGIES SIMON GUMMA, CPA, CGMA
- 2. + 280E Overview • Cost of goods sold is only deduction available to businesses trafficking in cannabis for federal tax purposes • Some states do not apply 280E for state income tax purposes (Oregon) • Focus on capitalizing as many expenses as possible to COGS; this is actually the IRS’s preferred position
- 3. + 280E Defined • Involves expenditures in connection with the illegal sale of drugs • No deduction or credit shall be allowed…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.
- 4. + The Importance of Corporate Structure 3 main options: • C corporation o Pays corporate level tax o Less tax efficient than a pass-through • S corporation o All shareholders must be individuals o Reasonable salary to owner operators • Limited liability corporation (LLC) o Very flexible entity o Pass-through income could be subject to S.E. tax
- 5. + The Importance of Corporate Structure What entity type makes the most sense by industry segment? • Retailer • Wholesaler/distributor • Producer/processor How ownership structure influences entity choices • What functional role does the ownership group play in the operation of the business? Does entity type even matter? (YES!)
- 6. + CorporateStructure: Retailers C Corp is preferred vehicle to operate dispensary or recreational cannabis store • Tax liability is contained inside the corporation o Some retailers are not profitable after taxes • Shareholders not liable for taxes of the business individually o Protects shareholders’ other assets from potential liens and levies
- 7. + Corp. Structure: Retailers • Not as tax efficient as pass-through entity ◦ Downside protection could be more important in EARLY years •Low salary, high dividend strategy o Ability to control timing of dividends o Can also take loans from corporation tax free. Must eventually be repaid.
- 8. + Corp. Structure: Retailers • S Corp can hold a tax trap for the unwary • Non-deductible or partially non- deductible salary gets taxed again at individual level via W-2
- 9. + Corp. Structure: Retailers • “Reasonable salary” can potentially cause double taxation o IRS could demand higher “reasonable salary” • Highly profitable retailer could make switch to S corp after business is established, profitability metrics determined • Compare C vs. S corps side-by-side o Assume salary is non-deductible & dividends are o Maxed to make determination
- 10. + Corp. Structure: Retailers LLC • Also a pass-through entity, so tax liability determined at individual level • Income is subject to self employment tax + income tax o Can be a substantial amount • Same downside issues as S corp: o Tax liability is individual liability o Exposes owners to potential tax liens and levy
- 11. + Revenue $1,000,000 COGS (500,000) Gross Margin 500,000 SG&A (non-deductible) (400,000) Pretax income 100,000 Tax (corp. rate) (170,000) After tax loss $ ( 70,000) Corp.Structure:Downsideprotection(C Corp) • Example of why it makes sense to use a C corp. when non-deductibles are relatively high • Company is experiencing an economic loss after taxes • Wise to contain the tax liability inside the corporate entity rather than passing it through to the individual shareholders
- 12. + Corp. Structure:Wholesaler/Distributor • Tax impact similar to retailers • C corp is preferred entity • Delivery and sales expenses are significant and are generally NOT deductible for tax purposes • Expenses of receiving goods ARE deductible
- 13. + CorporateStructure:Producers& Processors • 280E impact not as significant • Traditional net income is closer to taxable income as compared to retailers • C corporation protections are less urgent
- 14. + Corp.Structure:Producers& Processors • S corp or LLC is best option o Depends on ownership structure, operational functions of owners • Pass-through entities are more tax efficient • One level of tax vs. C corp
- 15. + Producers/Processors:Ownership Example • Three owners oTwo in charge of production oOne in charge of admin, distribution and marketing • Best option would likely be LLC • Requirement to pay “reasonable salary” to admin partner would create a double tax to extent of his or her non-deductible wages • LLC not required to pay a “salary” • Weigh cost against self-employment tax
- 16. + RetailTax Strategies • Split cannabis sales away from paraphernalia, branded merchandise and other items or services • Best method is to physically divide premises and put respective operations in separate entities • Separate books and records
- 17. + RetailTax Strategies • Separate employees • Must be a real and substantial business; should be able to stand on its own • Opportunity for deductible brand marketing
- 18. + Producer/ProcessorTax Strategies Segregate Your Operations • Producers and processors should hold any land, building and equipment in an entity separate from the one that is considered to be trafficking. • Lease back to operating entity • This entity will not be subject to 280E and therefore not subject to deduction restrictions
- 19. + Producer/ProcessorTax Strategies • Opportunity to take more aggressive tax depreciation deduction oSection 179 oBonus depreciation • Those methods not availablein cannabis COGS due to clear reflection of income issues • Changes the character of the income or loss to rental
- 20. + Effectof SeparateEntitieson Depreciation Assets placed in service Land 200,000 Building 500,000 Improvements 130,000 Equipment - 7 year 400,000 Equipment - 5 year 50,000 To t a l 1,280,000 Comparison of First Year Depreciation Leasing Company (not subject to 280E) 270,013 Grow Operation (Entity subject to 280E) 81,442 Additional Depreciation allowed 188,571 Potential Tax Savings @ 35% $ 66,000 Note: If the overall income of the Leasing Company allows for the § 179 deduction, the first year depreciation would total $461,442 producing a potential tax savings of $133,044!
- 21. + Producer/Processor Tax Strategies • Creates potential opportunity to offset operating income • Be sure to charge commercially reasonable rents. Don’t get cute! • Lease agreement should be in writing • Creates different opportunities for investors that don’t want direct connection to cannabis oWork-around for out-of-state investors if your state prohibits
- 22. + Producer/Processor Tax Strategies Intellectual property • Another segregation strategy • Hold all brands, recipes and production or processing methods outside of operating entity • Should have a business purpose for doing so
- 23. + Producer/Processor Tax Strategies License to operating entity for a fee, which can be deductible • Should be written agreement Opportunity to license to “partners” in other states Operation of entity is not subject to 280E because • Licensing is not trafficking
- 24. + Setting Up – Corporate Structure is Your First Defense Why Do You Need Two LLC’s & A C Corp? 1. Once entity is the actual cannabis enterprise holding the license. 2. The other entity is the management company providing goods and services to the cannabis enterprise 3. Management company marks up the goods & services, creating a higher COGS 4. The third is to hold the share of the management company 5. Utilize Sec. 1202 Small Business Stock Capital Gains Exclusion
- 25. + Qualified SmallBusinessStock (QSBS) Considerations for 100% Gain Exclusion Five criteria must be met to qualify: 1. The stock must have been directly acquired via an original issuance from US C corporation (Sec. 1202(c)(1)) 2. Both before and immediately after stock issuance, the C corporation’s tax basis is gross assets < $50 million (Sec. 1202(d)(1)) 3. The C corporation and shareholders must consent to supply documentation regarding QSBS (Sec. 1202(d)(1)(C)) 4. The C corporation conducts certain qualified active trades or businesses (Sec. 1202(e)) 5. The stock must have been held for at least 5 years (Sec. 1202(b)(2))
- 27. + Michigan Taxation of MedicalMarihuana 3% Excise Tax – NEW • The Medical Marihuana Facilities Licensing Act • File and remit quarterly; 30 days after the end of the calendar quarter 6% Sales or Use Tax • The General Sales Tax Act / The Use Tax Act
- 28. + Tax Tips: Do… Keep good accounting records Have a written operating agreement, written leases, written royalty agreements Hire a good attorney and CPA
- 29. + Tax Tips: Don’t… Cut corners Listen to advice that seems too good to be true Procrastinate
- 30. + Thank You