Many accountants do not know how to handle the disparity between state and federal law and how they impact the approach you take when filing taxes. As a business owner, you may not know what to do either. While it is advisable that you seek out the help of an accountant who specializes in assisting cannabis business owners, it is also important that you understand tax law and how it affects you.
Filing Taxes at the State Level
Because your business is legal within the state or states you are operating in, filing state taxes is pretty straightforward. In general, you are treated like any other business. The biggest concern here is whether or not there are special taxes that the state applies specifically to your industry or the products you sell. Make sure to follow the instructions of your CPA, CFO, or financial consultant as to what taxes apply to your specific location. As long as you understand the tax laws and follow them, all should be well.
Filing Taxes at the Federal Level: Section 280E
The federal government does not currently acknowledge state law regarding substances they classify as Schedule I or Schedule II drugs. This crosses over to all federal agencies, including the IRS. As marijuana is classified as a Schedule I drug, cannabusinesses are required to follow tax code written for businesses that traffic Schedule I drugs.
These businesses file under section 280E. This begins by classifying your income as illegal on your federal tax return. From there, you need to be very careful about any deductions you list.
COGS is restricted to the expenses of the production of a product. If you are a cannabis producer, this means the seeds, soil, water, plant food, and whatever expenses are incurred when cultivating or harvesting the plants. While any deduction helps, this leaves much of your expenses ineligible for writing them off.
So, what are expenses you cannot write off? Those associated with distribution, sales administration, management, marketing, overhead, and support. These expenses are things like rent, employee expenditures, accounting, and more. This means that compared to companies in other industries, your tax burden is significant, and it can turn what would be a profitable venture into one that is operating in the red.
Best Practices in Filing Taxes
Under section 263A of the Internal Revenue Code, you can allocate certain indirect expenses to COGS under defendable allocation methodologies. However, this is tricky to do and is better done by a knowledgeable accountant. This will allow you to lower your tax burden somewhat.
You also need to be diligent about tracking expenses by category. If you make legal deductions but do not have solid records backing you up, the deductions may not be allowed. It is also recommended that you pay quarterly tax payments to reduce the risk of penalties.
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