Preparing for the Future of Your Cannabusiness [Blog Post]
December 6, 2016
The following SC&H Group blog post discusses the importance of remaining current on industry-specific financial events, allowing cannabusinesses to maintain tax and regulatory compliance, effective strategic planning, and the most advantageous results—now and in the future.
While 25 states and Washington D.C. have already legalized medical cannabis, there is still uncertainty as to how the industry will be regulated going forward.
Therefore, emerging cannabusinesses should work with an advisor to understand the topics under discussion and remain current on new and shifting regulations. Only then can they create effective business and financial plans, and be fully prepared to achieve short- and long-term success.
Understanding State Tax Laws
Across the country, state income tax rules typically follow the lead of federal rules.
In the case of cannabusinesses, this can present issues due to Section 280E of the Internal Revenue Code, which disallows indirect costs from being deducted. With many states also disallowing deductions for indirect costs, the effective federal and state tax rates may be significantly higher for cannabusinesses relative to other industries.
Such is the case in the state of Maryland, but tax laws are still evolving. There are not many cannabusiness-specific tax rules, and the ones that exist are general.
Further, Maryland, like most states, has several tax credits available to cannabis manufacturers. For instance, suppose growers and processors make efforts to create more efficient processes and operations. Since Maryland follows the current federal guidelines, some of those changes would be considered eligible expenditures for a research and development credit.
While there is still uncertainty as to how the State Comptroller’s Office will determine cannabusiness regulations, it is a top priority for financial advisors and other businesses serving the cannabusiness industry. In fact, many advisors are proactively presenting these tax issues to the Comptroller to help provide clarity to administrators, cannabusinesses, and taxpayers.
Looking to the Future
Although cannabusinesses must comply with Section 280E currently, there are indications that change may be coming.
In fact, Harborside Health Center, the country’s largest medical marijuana dispensary, is currently in tax court to argue the application of Section 280E. The case is examining the intent of Section 280E for state-sanctioned medical cannabis dispensaries and whether it should be applied to them.
In addition, a bill before Congress known as HR 1855 could add the following language to 280E: “…unless your trade or business consists of marijuana sales conducted in compliance with state laws.” If passed, this change may ultimately minimize Section 280E’s effects on cannabusinesses.
The growth in the cannabis industry has been unprecedented. As the legalization of medical cannabis accelerates across the country the likelihood of change at the Federal level increases. But that change will not happen overnight and entrepreneurs in the industry must be prepared for lean times from a tax standpoint until that day comes.
Preparing for Potential Tax Liabilities
With a higher effective tax rate, cannabusinesses will have larger tax bills then their non- cannabis counterparts. In addition, because of Section 280E, it is possible that these cannabusinesses could generate negative cash flow after taxes despite having positive net income. This can be problematic for investors if the business is operating as a pass-through entity such as an LLC. Therefore, they should work with an advisor to manage their working capital needs, investor relations and expectations.
Cannabusinesses should also determine their short-and long-term goals and work with an advisor to understand how they can effectively be achieved within the constraints of Section 280E. Particular focus should be on early stage planning for taxes and cash flow –and avoiding having to react after the fact.
An advisor with established tax, audit, and consulting experience can provide insight on the latest tax rules and best practices for industry-specific financial events to deliver the most advantageous results.
Want to learn more about the tax rules that could affect your cannabusiness? Or, do you need help building a strategic financial plan? Contact SC&H Group’s Medical Cannabis Advisory practice here for more information.