It’s Monday morning, and your first appointment is with an existing client who wants to talk to you about starting a new business. What you do not realize is the business is a marijuana dispensary. Not having any other clients in the cannabis industry, you might be wondering what this all means for you, your firm and the client.
As of 2018, 29 states plus Washington, D.C, have legalized marijuana for medical use. Out of those 29 states, nine plus Washington, D.C, have legalized it for recreational use. A 2017 Gallup poll showed that 64 percent of Americans support legalization. This is a good indicator that the cannabis industry is not going away. Actually, it may be just getting started. However, since marijuana is not legal in any form under federal law, it makes the accounting and taxes a little tricky.
You may be asking yourself, how does your client file a tax return and pay taxes on the sale of a product that is illegal under federal law? The IRS, under Internal Revenue Code section 280E, says:
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.
Under federal law, marijuana (cannabis) is considered a schedule I drug.
Since many of the expenses associated with running a business that sells marijuana are disallowed, your client will likely end up paying substantially more taxes than if they had been able to deduct the expenses they incurred in their normal course of business. This tax burden is a significant impact to their profitability.
Even though section 280E disallows expenses and credits paid for in a trade or business engaged in trafficking of marijuana, it does not apply to cost of goods sold (COGS). What does this mean? Well, for dispensaries, not much, since they still will not be able to deduct most of their expenses. Growers and farmers, on the other hand, will be allowed to deduct a good portion of their expenses as COGS. This includes costs incident and necessary to production including direct material costs, direct labor costs, utilities, maintenance, rent, taxes necessary in production, depreciation, factory administrative costs, employee benefits and insurance.
What does all of this mean for accounting professionals? For one, there is a growing industry that needs accounting professionals to specialize in their line of business. Accounting professionals often look to niches as a way to specialize and grow, and right now, they have a unique opportunity to work with firms in the cannabis industry or start their own firm. A number of years ago, you could count the number of CPA firms engaged in this niche on one hand, and now it’s growing at a rapid pace as evidenced by this list of ever-growing firms. And if you’re worried about keep in your CPA license in good standing and being “of good moral character” working for the cannabis industry does not throw that into question. It may mean, however, that you are going to be scrutinized more carefully.
Tax laws and the need for accurate accounting information makes this a great niche for accountants. In addition to federal and state income taxes filings, an accounting professional can service this industry in many other areas. Many states require other taxes to be paid such as excise tax, cultivation tax, sales and use tax, local taxes, and payroll taxes. There are also many opportunities for tax planning around section 280E as well as the automation and accuracy of information in real time necessary to make sure that your clients’ books are up to date.
The market and need for services is enormous. The legal cannabis industry should be generating over $20 billion in revenue by 2021, according to Arcview Market Research, which means there are many opportunities for knowledgeable accountants to enter this specialty and grow their practice.