How to Structure Your CANNABIS BUSINESS
FAS CPA & Consultants
Cannabis: A whole new industry
The cannabis industry is a hot new niche for entrepreneurs, and it brings a lot of new questions and issues to the accounting industry. From 280E to corporate structuring, it is all new.
“Section 280E of the Internal Revenue Code forbids businesses from deducting otherwise ordinary business expenses from gross income associated with the “trafficking” of Schedule I or II substances, as defined by the Controlled Substances Act. The IRS has subsequently applied Section 280E to state-legal cannabis.
Right now, banking for the cannabis industry is probably the number one obstacle facing the new entrepreneurs, and one can spend weeks, months even, delving into the intricacies of SAFE (Secure and Fair Enforcement Banking Act).
The problem with banking for cannabis entrepreneurs
“Even though over 35 states have legalized medical cannabis in some form and more than 10 others have recreational cannabis laws, the mainstream banking industry has been mostly unable to provide services to lawful cannabis companies. That is because federal law still views cannabis as an illegal Schedule I drug subject to the Controlled Substances Act—on par with drugs such as heroin.
This intricate federal overlay has prevented the banking industry from being able to service not only cannabis companies but also non-plant touching ancillary businesses working with cannabis companies. Consequently, banks are forced to sit on the sidelines while cannabis companies try to figure out what to do with their growing cash reserves.
Banking remains a problem for cannabis enterprises, and it makes no difference whether you are a retailer or a producer, and it afflicts even CBD producers and retailers.
At the moment, there are a lot of discussions that are trying to make sense of all of this by defining how specific enterprises handle the marijuana plant, but the answer differs from one industry professional to another, albeit attorneys or accountants.
The Essence Of The Banking Situation
There are vast discrepancies between state laws regulating cannabis and federal law, which still makes any form of cannabis business illegal; hence Federal Deposit Insurance Corporation-insured banks (FDIC-insured banks) cannot risk banking cannabis clients. Some non-FDIC insured community banks and credit unions are open for business, but not all of them by a long shot. Due to the uncertainty and the scarcity of supply, many of the banks that do offer banking for cannabis enterprises, charge massive so-called ‘cannabis-premiums’ – thousands of dollars upfront fees for the right – or opportunity – to open a cannabis trading account, and on top of that, exorbitant month-over-month fees over-and-above the usual transactional fees.
Click To Download Our Free Tax Guide: 10 Tax Tips for Cannabis Investors and Entrepreneurs
The cannabis supply chain is not a simple vertical supply chain that can be divided into producers and retailers. There is a multitude of intermediaries along the way.
So yes, it all starts with farmers (producers) who are the cultivators of cannabis plants. The farmers often deliver to manufacturers. These manufacturers process the plants into various other products, like cannabidiol (CBD), which is low in tetrahydrocannabinol (THC).
From manufacturers, a long supply chain includes:
⇒ Professional Service Providers
⇒ Service Providers
Problems With Patents And Trademarks
The nature of the cannabis industry is such that some products are based on unique processing, which has to be protected by patents, and a minimal scope does exist for such patent registrations already, but it is still almost impossible to register any trademarks for the industry without slipping through dubious loopholes and bargaining on specific exemptions.
As Far As Tax Are Concerned
As mentioned above, cannabis business costs and expenses cannot be deducted from gross income before tax, so the bottom line can be skinny indeed. While this is tough to comprehend for many business owners, the way it affects the valuations of cannabis enterprises is a significant problem.
Cannabis entrepreneurs survive only if they preserve substantial reserves for tax purposes, and again, this is tough because it directly affects the survivability of the enterprise.
Investment Climate In The Cannabis Industry
As the cannabis supply chain moves from black to grey and from grey to legitimate markets, a lot of investment is going into existing and new cannabis operations. For those that come from the grey-and black markets, it’s a totally new experience to have to report to various interested parties after years of ‘reporting’ only to themselves. Of course, a lot of new questions arise in respect of business structuring.
The accounting profession has to make sure that investors are protected while the businesses are structured in a way that will not penalize the owners in respect of 280E or any other federal law enforcement issues. Some investment structures are simple – a mere holding company and the owners of the enterprise. There are some very complicated structures out there too – there is no question of a one-size-fits-all solution.
Even when you take two producers who produce the same cultivar in the same state on the same type of property, the answer for them can be completely different based on a host of different variables. If, for example, the business belongs to the family, the S corp structure is an option. It will save self-employment tax 15%, compared to a LLC. If the business belongs to non-related partners, the LLC is the choice, though the partners will pay 15% self-employment tax in addition to income tax.
The industry is new, and there are no roadmaps. There are guidelines for all kinds of industries, of course, but no hard and fast rules, whether you are talking about real estate or non-profits. When you are talking about the cannabis industry; however, you always have to start from scratch.
Discrepancy Between Federal and State Laws
Whenever you are confronted with the differences between state and federal law in respect of cannabis production and distribution, there exist large grey areas that are very hard to define. The grey area and resultant confusion, and the subsequent lack of certainty that goes with it, has a genuine accounting, or call it financial ramification for the cannabis business.
Check Our Tax Planning For U.S. Cannabis Investors
Cannabis As A Going Concern
In a situation where the federal government can close down all cannabis enterprises overnight, there is a nagging question whether a cannabis enterprise can be considered a going concern. Despite this, financial modeling for cannabis enterprises to apply for financial assistance can still be done, although it has to be done on a specific state basis: every state is different.
Cannabis Enterprises and State Law
At the moment, there are 33 states in which some variations of cannabis enterprises are legalized. In some states, recreational use is allowed, along with with medical use, and some only medical use.
It is challenging to keep abreast of the different regulations in different states, different approaches to applications, and different requirements, and it is evolving all the time, so a lot of changes to existing rules come through consistently too.
In some states, applications to trade or produce cannabis focus on the financial plan, Illinois is a case in point. They award something like 65 points overall to the content and quality of the economic model which has to show how your enterprise will function financially over one, three and five years. In some other states, you can get away only with the provision of a pro forma balance statement, and they focus on social issues and compliance, software and other issues.
This causes severe complications when you are dealing with operators that operate in multiple states and are expected to be up to date on all regulations in all states.
Size of Industry
In 2018 the cannabis industry achieved revenue of $10.8 billion. Initially, estimates were for the cannabis to eventually reach revenue targets of up to $15 billion, but these estimates have been adapted lately, and now predicts revenue of as much as $100 billion per year within the next three years.
Just imagine what can be accomplished if the remaining 17 states and territories join in and if all the legal and other complications are removed, and a stable market is formed.
Readers should note that this article is only intended to convey general information on these issues and that FAS CPA & Consultants (FAS) in no way intends for the contents of this article to be construed as accounting, business, financial, investment, legal, tax, or other professional advice or services. This article cannot serve as a substitute for such professional services or advice. Any decision or action that may affect the reader’s business should not rely solely on the contents of this article, but should rather be consulted on with a qualified professional adviser. FAS shall not be responsible for any loss sustained by any person who relies on this presentation. This article is subject to change at any time and for any reason.
Check The Video Version Tax Planning For CANNABIS INVESTORS
We Are Just A Message Away From You. Get A Consultation
Accounting Firm providing Accounting Advisory, Tax Planning and Offshore Strategies to grow your business and protect your assets.
Our Clients Reviews
How To Get A U.S. Banking License Email Us Today Support@fascpaconsultants.com and Get An Offshore Strategy Review I Want...