How To Structure Your Cannabis Business With a Sound Tax Strategy
FAS CPA & Consultants
The setup of your cannabis enterprise will determine your success or failure after a year in the industry. Therefore, we recommend that you carefully consider your options rather than just jumping in.
Your Legal Entity
Before some states, such as California, regulated medical marijuana, most cannabis enterprises were nonprofits. However, in a regulated state market, there are more options for structuring a cannabis enterprise. Selecting a model depends on many factors, but some of the determinants are:
- Your role in the industry:
- Grower
- Distributor
- Partner
- County and local regulations
- Projected growth
Your Options
- Nonprofit:
- California cooperative corporations: cooperatives can operate as both for-profits and nonprofits.
- For profits
- B-Corporations: Now authorized at the state level (in California). A B-corporation is a so-called benefit corporation that is a for-profit with a particular social and environmental performance score.
- C-Corporations: A C-corporation is a for-profit corporation that is taxed separately from its owners. Your C-corporation will be taxed on its corporate income, and as owner, you will be taxed on your return for all payments received from the cannabis business. Double taxation is unfair, but the C-corporation will create a firewall against any personal tax liabilities.
- S-Corporations: Like a C-corporation, an S-corporation is also a for-profit model, but it pays no taxes. The profit or loss of your cannabis enterprise is divided amongst the shareholders. In turn, every shareholder must report this income (or loss) on their income tax return. The liability falls on the individual, and the repercussions are endless, depending on how successful your cannabis enterprise becomes.
Before you select, we recommend that you consult a qualified tax professional.
Click To Download Our Free Tax Guide: 10 Tax Tips for Cannabis Investors and Entrepreneurs
Your Growth Goals
If you plan on multiple locations and holdings, you can structure your operation to account for different levels of liability. For example, if you have various corporate entities, you can limit your liability within each. EXAMPLE: If one of your locations shuts down or gets sued, your other locations remain independent.
However, multiple corporate entities can be a challenge logistically, especially for the ambitious who wants to go huge or not at all.
It is more efficient to run branches under a single corporate entity, but you have to be risk smart.
Needs Of Your Investors
Investors are interested in your company’s:
- Assets
- Inventory
- Cash receivables
- Profit potential
The investors want to see your entire business model, including:
- Trademarks
- Intellectual property
- Physical location
How you structure your company will be of great importance to the investors. For example, in a multi-entity structure, the investors can choose the locations and sub-companies they will fund. This can be very attractive when you offer participation to individuals with a low-risk tolerance. This widens the pool of potential funders. But, keep in mind, different ownership stakes can create a conflict of interest for management. It is not easy to cope with many influential voices without creating conflict.
Compensation And Benefits Structure
According to tax law section 280E, on their tax return, a cannabis business can claim a deduction for the costs of goods sold, BUT NOT for any sales or marketing costs. It will help if you become well informed on the payroll tax, executive compensation, and healthcare benefits you will be accountable for as a California cannabis entrepreneur. We recommend that you consult a tax professional in your community to gather the required information.
Compliance
What do you need to be compliant? This is the essential question. Compliance will make or break your business in the long run. Make sure that you:
- Know all the forms you must fill out.
- Know all the licenses you require.
- Know how to account for all your expenses.
Compliance varies from district to district and county to county, AND between federal and state levels. Therefore, if you plan to open locations in different parts of California, you will have to research each area’s compliance requirements separately.
Taxes For Foreign Cannabis Investors
Many foreign investors in the US Cannabis industry are unaware of the additional tax reporting requirements they must meet. Amongst these requirements are Forms 5471 and 5472 that have to be filed accurately and on time to avoid harsh penalties.
Form 5472
Form 5472 is an information form that provides particulars about any enterprises with owners, partners, or shareholders from any non-US country. All cannabis enterprises must disclose all their transactions with their international partners, owners, and shareholders. C Corps and LLCs with 25 percent or more foreign ownership, shareholders or partners, must submit Form 5472 annually.
WARNING: Failure to file Form 5472, OR merely filing it late, will result in an IRS penalty of $25,000.
The aim is to stop foreign tax evasion and money laundering and prevent companies from claiming unlawful tax exemptions. In addition, the form helps the agency enforce tax payments on transactions between US and foreign actors.
Form 5471
Form 5471 shares the purpose of Form 5472 and applies to US persons[1] – even to those that live overseas – that are officers, directors, or shareholders that own at least ten percent of a foreign corporation.
A Foreign Corporation
Defined as any legal entity formed under the laws of any country except the US, whether it qualifies as an LLC for US tax purposes or not. According to US tax rules, ‘any non-US entity will be classified as a corporation by default as long as the owners have limited liability.’
WARNING: failure to file Form 5471will expose you to a fine of $10,000 for each tax year skipped PLUS an additional penalty of $10,000 for failure to provide the information required within ninety days after the IRS provided notice of failure. AFTER THAT, a fine of $10,000 will be added every thirty days until the filing of the information.
A Reportable Transaction
On Form 5472, you must disclose all reportable transactions. A reportable transaction includes any exchange of property or money with the foreign shareholder, including:
- Payment for sales
- Rent
- Royalties
- Interest
The payment of dividends does not qualify as a reportable transaction.
Some typical transactions a cannabis company would include are:
- Exchange of
- Money
- Commission
- Sales
- Rental Income
- Expenses paid on behalf of a foreign entity
- Capital contributions made to the cannabis venture by a foreign investor
- Transactions relating to the use of property in the US
- Payments related to acquisitions or dissolutions
- Sale or purchase of inventory
A RELATED PARTY: Any direct or indirect foreign shareholder who owns at least 25 percent of the reporting corporation. It also refers to a range of other entities. It is a broad term that requires a qualified CPA for a full explanation.
Penalty Abatement
Possible but unlikely – abatement is rarely, if ever, granted. The process begins with a letter to the IRS that explains the situation. Then, after considering your argument for a period of between six and eight months, the IRS will approve your case or not.
The forms are due with your annual tax return. For 2020, taxpayers can still file Forms 5472 and 5471 before the July deadline.
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