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What You Need to Know About Cannabis and Tax Liability

By Samantha Schafer, on February 9th, 2023

If you are new to the cannabis space, taxes may be the very last thing on your mind—but they shouldn’t be. The broad misconception for entrepreneurs in this industry seems to be that it is only the dispensary owners that will have to worry about paying an exorbitant amount in taxes, not the processors or the cultivators. And while there may be a shred of truth to that statement, it isn’t a fact. The fact is that taxation of enterprises in the business of growing, processing, and selling cannabis is complex and requires more than a rudimentary understanding of accounting.

IRC Sec. 280E

The elephant in the room when talking about cannabis taxation is IRC Sec. 280E, which states “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 consists of trafficking in controlled substances which is prohibited by Federal law or the law of any State in which such trade or business is conducted.”

If you run a cannabusiness, you may be wondering, if I cannot take any deductions, am I paying tax on my gross revenue? The answer is not necessarily. One thing that all cannabusinesses have in common is inventory. And it is the accounting for that inventory that gives accountants and CPAs a little more room to take advantage of categorizing various costs as Cost of Goods Sold (COGS) under IRC Sec. 471.

Cost of Goods Sold (COGS) under IRC Sec. 471

When we think of COGS, it is fairly easy to figure out that you have the basic cost of products – for the cultivator, you have the cost of clones and seeds, for processors, you have the cost of flower and trim, and for dispensaries, you have finished products like gummies or pre-rolls. But what about all the other costs that these entities have? Under IRC Sec. 471, there are allowable costs that can be included in COGS, and they become deductible for income tax purposes. Where in the past, a Federally legal business may not have been very concerned with proper cost accounting, this is an area that cannabusinesses cannot ignore. Without proper costing of expenses, your entity may be leaving tax deductions on the table, or on the opposite end of the spectrum, you may be taking deductions that are not allowed.

Contact an Accountant Working in Cannabis

Once your legal team has assisted you in getting your license to operate a cannabis business, you have cleared one of the most difficult hurdles for entry into this industry. Your next stop should be to engage an accountant or CPA working in cannabis to assist you with setting up your books and records to properly classify your expenses to make sure that COGS is accurate and therefore your tax liability is accurate as well.

If you need further guidance or have any questions on this topic, our strategic advisors are here to help. Please do not hesitate to reach out to our trusted experts to discuss your specific situation.

This material has been prepared for general, informational purposes only and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. Should you require any such advice, please contact us directly. The information contained herein does not create, and your review or use of the information does not constitute, an accountant-client relationship.

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