New Perspectives on Navigating IRS Cannabis Tax Policies

Following the release of cannabis tax compliance reports from the IRS, pursuant to a FOIA request filed by Marijuana Business Daily, we revisit strategies for dealing with examination and oversight.

The most advantageous middle ground between paying a high effective tax rate and a tax rate similar to your stated taxes could refer to the following example.

Let’s assume $2.5 million in revenues, a 40% COGS, 15% operating expenses, a California tax rate of 8.84% and a C Corporation rate of 21%. (Please note, this is just an illustration!) Remember that in California, the state has given a break to cannabis businesses in that it does not charge state tax on gross income, but rather on net income before tax. Notice the effective tax rate in this example:

Gross Revenues                         $2,500,000

40% Cost of Goods Sold             1,000,000

Gross Income                              1,500,000

15% Business Expenses                375,000

Income Before Tax                      1,125,000

280E Taxable Income                  1,500,000

State Tax @ 8.84%                           99,450  (Income before tax, not Gross income)

Federal Tax @21%                         315,000

State and Federal                            414,450

Effective Tax Rate                                 37% (Much better than a 70% effective tax rate)

Income After Taxes                       $710,550

Pointer #1:

The IRS has stated that they favor the bulk of expenses reflected in the Cost of Goods Sold category, and the taxpayer must be careful in his accounting/bookkeeping records to only reflect expenses that are qualified under the category of general business expenses as applicable to IRC 280E.

Accordingly, this applies to the Cost of Goods Sold, as well.

The example above shows a good mix between Cost of Goods Sold and general expenses to illustrate that good accounting can result in a favorable effective tax rate when applying IRC 280E.

It is interesting to note that several states within the U.S. do not charge a state income tax. Now, if a cannabis owner were to form their corporation in a state with no income tax, they have just saved themselves a load of money. Many states that allow cannabis have decided to give their cannabis entrepreneurs a state tax break by not charging the state tax rate on the gross income; rather, they charge just like they would on a normal federally legal business—on the income before tax.

Which states do not charge a state income tax?  Here are the ones listed as of this publication: Alaska, Florida, , New Hampshire, South Dakota, Tennessee, , Washington and Wyoming.

Pointer #2:

It could be quite advantageous to incorporate a plant-touching business under the umbrella of a “C” Corporation. 

The reason for this is because a “C” Corporation does not have personal liability falling back to the owners. Since plant-touching businesses are federally illegal, it’s beneficial to insulate the owners from as much personal liability as possible.

Of course, each cannabis

More New Perspectives on Navigating IRS Cannabis Tax Policies