Editor’s note: This article was contributed by Cannabis Tax Solutions.
Just when you think you have 280E figured out – BAM! Here comes another curveball. Recent court cases (Alterman and Alpenglow, among them) have empowered the IRS even more, and have seemingly weakened landmark cases like CHAMP.
Attorneys representing clients in audits have told Cannabis Tax Solutions the IRS has now taken the position that if you do not have “enough” non-cannabis revenue from products such as glassware and T-shirts, you will not be able to take related deductions. What is enough? Good question, and one we are still trying to figure out. Another adverse position the IRS is taking: advertising. If you have your brand name or logo on T-shirts, hats, or any non–cannabis item you sell, it can be construed as advertising, which falls directly under 280E. Disallowed deduction.
So, what can you do to protect yourself? In the past, the belief was as long as you accounted for the non–cannabis activities separately — such as different classes in QuickBooks — you would be ok. It doesn’t appear this will fly anymore. The single biggest step you can take now is to set up your non–cannabis activity as a totally separate entity. Completely segregating the businesses will give you a much better path to justifying the revenues and fully legitimate deductible expenses for the non–cannabis activity.
Another crucial factor in determining the success or failure of your cannabis business is choosing which professionals to work with. Cannabis Tax Solutions have had several new clients come to us with tax returns and financials prepared by non-cannabis accountants that bordered on criminal — they were that bad. No 280E recognition, balance sheets not tied out, incorrect codes, no disclosures. If you hire professionals that don’t know 280E (accounting and legal) then you are digging a huge hole for yourself. This industry is filled with very complex accounting, tax, and legal issues; not having the proper people in place will kill your business.
One of the biggest things you can do to help yourself is simply taking time to review your own books and tax returns. Don’t put your complete faith and trust in your accountant/tax preparer — it’s YOUR business, after all. Make sure you know what’s going on inside. Look at the tax return to make sure the proper 280E adjustments are being recorded. Does it pass the common sense test? You would be surprised. You may also want to engage in a 280E analysis by a qualified professional who knows what to look for.
Legal deductions are lost by failing to track and document employees whose work involves production-related activities that qualify as cost of goods sold (COGS) deductions, as well as non-production activities disallowed under 280E. Using technology such as Würk’s cannabis time-tracking and attendance software system to track employee activities can also help produce records that can satisfy the IRS. This is as bulletproof a way as anything to show where employees are working to back up employee-related expenses that may be deductible.
Of course, bookkeeping is always an ongoing issue. And truly, having great bookkeeping practices will help you both in the long and short run. If the books are in order, chances are those deductions in question will have a greater chance of being accepted under audit. If you can’t get banked, don’t worry — creating cash logs and having the proper backup in the way of receipts will go a long way for providing a complete accounting environment.
Speaking of environment, another important consideration is how you are structured as an entity. Should you be taxed as a C corp? S corp? Something else? How do other shareholders and investors fit into this equation? Are there outside states to consider? How will this decision affect exit strategy? There is the potential for tons of moving pieces, so make sure they are all covered.
If you want to keep your doors open, having a perpetual tax planning and projection initiative is imperative. You should always be looking at actual versus budgeted numbers, forecasts, and anything else that will ultimately tilt the (tax) bottom line. Don’t let a million dollar tax bill sneak up on you — be aware! And don’t wait until December to perform this most critical task. Federal and State income, payroll, marijuana-related taxes — including excise and sales tax — all need to be accounted and planned for. Staying current with all tax liabilities is crucial for long term success. If you fall behind, seek immediate help for formulating a plan to catch up. Once you get on the IRS radar, in conjunction with being a federally illegal business, it can be a quick recipe for disaster.
Until Marijuana is removed as a Schedule 1 drug, it will still be the Wild West when it comes to figuring out what you can and can’t do for maximizing your deductions and minimize taxes. Seek out the best representation and you will be on your way to providing your business with the best chance to survive and succeed.