Cannabis is a complex industry. In addition to facing many of the same challenges found in the alcohol, tobacco, and pharmaceutical industries, cannabis operators must also navigate inconsistent regulations between different cities and states, while simultaneously taking care not to violate Federal regulations that still don’t recognize cannabis as a legal product.
This conflict places cannabis businesses in a precarious position when it comes to accounting. Due to IRS code §280E, cannabis entities are restricted from claiming the typical tax deductions and credits for expenses afforded to other businesses, substantially raising their tax liability by default.
Despite this, cannabis businesses can still lower their tax liability through intelligent cost tracking. By tracking the Cost of Goods Sold (COGS) across the supply chain, cannabis operators can maximize the minor deductions that are afforded to them, lower their liability, and keep their businesses doing what they do best.
IRS code §280E is a problem for cannabis operators (and their accountants) because it restricts tax paying entities from claiming deductions/credits for any trade or business operations that “consist[s] of trafficking in controlled substances” prohibited under Federal law. While this is fairly straightforward for single-entity cannabis companies, it creates complex accounting issues for companies that have entities in multiple categories.
This archaic classification of cannabis products as “illicit drugs” under Federal law necessitates that all companies with cannabis business entities clearly separate these operations from their non-cannabis activities. Failing to do this appropriately can result in significant monetary problems, such as the $11 million judgment against Harborside in 2020, as well as possible business license revocation and criminal penalty.
Companies looking to lower their tax liability should focus on claiming deductions for COGS. While §280E restricts companies from claiming deductions for business expenditures related to the sales/trade of cannabis, it does allow deductions for costs and expenses associated with the production of goods. This allowance includes the direct costs of producing goods, such as material procurement expenses, but excludes indirect costs like product distribution.
For cannabis cultivators, manufacturers, processors, and retailers, COGS is the only allowable deduction under §280E. This is why it is imperative that cannabis entities accurately track these costs to lower their tax liability as much as possible.
For a more in-depth explanation of how COGS applies to businesses, check out this information from Investopedia. Make sure you are working with certified cannabis CPAs throughout the process of filing taxes for your business.
In response to accusations of undue bias against the cannabis industry, the IRS has stated that they only target taxpaying entities with a high risk of non-compliance (classifying cannabis businesses in this group by default). They very rarely fail to win judgments. Cannabis operators must rely on integrating Cannabis Enterprise Resource Planning (ERP) software solutions to facilitate their COGS tracking and accounting processes.
By integrating specialized ERP solutions, cannabis businesses can protect their interests, lower liabilities, and mitigate the risks associated with inaccurate §280E claims. Cannabis ERP solutions help ensure the creation of meticulous records, providing clear distinctions between direct costs related to production and the indirect costs that are non-deductible.
While manual tracking with written spreadsheets may have been practical when an operation was small, it just isn’t viable for businesses hoping to scale. The complexities of methodical cost tracking across supply chains and the subsequent COGS calculations create too much of a burden for growing companies to carry out by hand while simultaneously ensuring cost-effectiveness and data accuracy. Even conventional accounting software solutions can struggle to meet the specific needs of cannabis businesses under §280E.
Cannabis manufacturers, processors, and retailers should partner with proven ERP companies and expert CPAs to secure cost-tracking solutions that work for them. Companies specializing in these technological solutions for growing enterprises leverage sophisticated materials tracking applications, Warehouse/Inventory Management programs, and industry-tailored accounting tools to protect their interests in a risky compliance environment.
These resources also lower the expenses related to cost tracking, making sure cannabis operators have the detailed records they need for all accounting processes without any unnecessary financial sacrifices. In addition, leadership can further use the data acquired during cost tracking to enhance business intelligence, helping cannabis operators propel their enterprises beyond the competition – while helping to keep their companies compliant.