Tag Archives: Medical Marijuana

Thinking of starting a cannabis business in Maine? New laws will keep you on your toes. Part II- “Adult Use” Market

During 2018, the Maine Legislature passed two Bills dealing with the future of marijuana business in Maine that are to become effective this week. Both are designed to end the wild west nature of the industry but they have very burdensome tax and operating rules. This three-part series breaks down some of the business, accounting and tax issues surrounding the future of Medical and Adult use marijuana sales in Maine. Part I looked into the impact of the new rules on Dispensaries and Caregivers. Part II reviews the “adult use” market and Part III looks to the future of the cannabis industry.

Part II

This week the Marijuana Legalization Act becomes law. Tasked with helping Legislators through the maze of regulations is newly engaged Los Angeles consulting firm, BOTEC. The Portland Press Herald reported that BOTEC will likely finish writing the rules by the end of April 2019. Once implemented, license applications will be considered for marijuana retail stores, cultivation facilities, product manufacturing, testing facilities and social clubs. Only after the first licenses are issued will seeds be planted for the adult use market.

For now, the Marijuana Legalization Act is law but there is no mechanism for anyone to apply for licenses. The Act, as it exists, does make it clear that the initial owners of marijuana businesses will be residents of Maine, who have approval from local authorities to conduct marijuana business operations. If the business is incorporated, its officers, directors, managers and the majority of its shareholders are required to be Maine residents. All applicants, directors, employees or other closely related individuals will be subject to strict background check provisions ensuring that owners will not have past drug violations, outstanding court-ordered payments and are compliant with federal and state taxing authorities.

Up for grabs, each owner can have:

    • Cultivation facility licenses, up to 3 facilities with total plant canopy not to exceed 30,000 square feet. No single facility can exceed 20,000 sqft.
    • Marijuana store licenses, up to 4 stores with direct or indirect financial ownership.
    • Testing facility licenses, these owners can have no financial interest in any other type of marijuana establishment.
    • Manufacturing licenses, issued for the production, blending, infusing and other preparation, including extraction of cannabis.

So who is in charge? Just about everybody. Under section 104.3 the following have their hands in the mix: The Departments of, Alcoholic Beverages, Agriculture, Health, Labor, Audit and Financial Services and of course the Department of revenue. It is also very clear that none of these licenses will be granted without the approval of local municipalities.

Subchapter 4 of the Act states that when it comes to who licenses are granted to. “…a municipality may regulate marijuana establishments within the municipality…”. As set forth, those approved business owners will be granted a conditional license subject to local authorization.

On the accounting side, even though most transactions are conducted with cash, adult use marijuana licensees are required to keep complete business records that are open to inspection by the State. Seed to sale records must be kept for the current year, plus the two immediately preceding tax years. Like medical marijuana businesses, adult use businesses should pay particular attention as to how they set up their chart of accounts, so that costs of goods sold can be accurately accounted for.

Unlike the rules governing the medical side, which require a financial audit, the adult use licensee may be required to submit to an audit. The auditor would be selected by the Department with all costs billed to the licensee. It is curious to me that caregivers are required to be audited, while adult use business owners may be subject to audit.

Taxes on the adult use market include sales tax of 10% on sales to the consumer. It is made clear that it is the retailers responsibility to collect and remit sales tax. Excise taxes paid by growers will increase the overall cost to consumers with tax of up to $335 per lb. of flowering plant, $90/lb. trim, $1.50 on seedlings and $0.30 on seeds.

Adult use growers and manufacturers should waste no time in applying for sales exemption certificates. (The same sales tax exemptions exist for adult use agriculture and manufacturing operations as described in Part I for dispensaries and caregivers.) Note that courts have concluded that sales taxes should be netted against sales and not reported as an expense, so that they are not considered as part of a 280E adjustment.

Business owners will have to consider what entity type is best. It is likely that some form of corporate ownership will be most advantageous but it will vary depending on individual circumstances. Both the new 21% corporate tax rate and the 199A deduction for sole proprietors and flow through entities are applicable but the benefit of both are reduced by the burdensome impact of 280E. Interestingly enough, for Maine income tax purposes, the adult use market is not allowed to deduct normal operating expenses picked up under code section 280E. Needless to say it is wise to consult with a tax professional to decide which entity type is best and to carefully consider the implications of 280E.

The Act also begins to open a window to the future with provisions that expire in 2021 & 2022. What does the future hold? Will cannabis businesses be overwhelmed by federal restrictions? What impact will the Harborside Health Center US Tax Court ruling have on potential investors? Part III of this series will highlight my thoughts on the impact of these and where the industry is going.

James Boulette, CPA has been advising medial cannabis dispensaries in ME and MA since laws were enacted allowing for legal sales. He is one of New England’s leading experts in the application of 280E.  He can be reached at 207-873-1603.

Marijuana Sales and the Monster Hiding in the Tax Code –How To Minimize the Damage of Section 280E

Marijuana is currently legal in some form in 30 States, Washington DC, Guam and Puerto Rico. It is quickly becoming a major economic driver in many states as reflected in Colorado. Through September, the Cannabis industry in Colorado alone has surpassed the one-billion-dollar mark. Despite the overwhelming support of legalized cannabis, the federal government continues to enforce tax policy that will, if not change, tax the industry out of business.

The simple solution would be for Congress to pass legislation that would remove Marijuana from the list of Schedule 1 drugs. There are currently a host of bills that attempt to do just that. The most promising and straight forward is H.R. 1810 – Small Business Tax Equity Act of 2017. H.R. 1810, introduced by Carlos Curbelo (R- FL), is co-sponsored by 38 other members of the House from both sides of the isle. H.R. 1810 simply states that Section 280E of the Internal Revenue Code would not be applicable to “marijuana sales conducted in compliance with State law”.

Unfortunately, nothing seems that simple for our elected officials. Few members of Congress, even those members whose states have legalized cannabis, are willing to take a stand against those who are against Marijuana reform- namely big pharmaceutical and big alcohol companies.

Courts continue to strictly interpret code Section 280E by disallowing all deductions for trade or business expenses in connection with listed Schedule I & II drugs. Deductions from gross income are allowed for costs of goods sold (COGS). The IRS has taken the position that the definition of COGS is defined by code Section 471. Those businesses that both produce and distribute marijuana can take guidance from the Regulations found in section 1.471 of the code. Under these Regulations, includable costs consist of production facility: rent, maintenance, utilities, direct materials, tools, supplies, testing, production wages and production overhead. Specifically excluded costs include: general and administrative, marketing, selling, advertising, distribution, and other expenses not associated with production.

So how can cannabis companies afford to stay in business?

Let’s look to a few critical cases to better understand the constraints of Section 280E.

Review of the 2007 CHAMPS v Commissioner., 128 TC 173 case is critical in helping us to better understand that only those trade or business expenses related to marijuana trafficking should be disallowed under Section 280E. CHAMPS established that businesses can have multiple activities and that those not involving “trafficking” are not precluded by Section 280E. CHAMPS charged a fee for extensive caregiving services and provided a set amount of medical marijuana. The court concluded that the taxpayer had not one but two businesses and therefore, those business expenses not related to “trafficking” of a controlled substance were deductible. The court allowed the proration of costs between the two “businesses”

The second direction giving case is the 2012 Martin Olive v Comm., 139 TC 19, also known as the Vapor Room case. Quite the opposite from the facts presented in the CHAMPS case, Mr. Oliver kept inadequate records and was not able to establish that he conducted more than one business. The court concluded that in order for a taxpayer to establish multiple businesses, it must be engaged in these other activities with a profit motive. Simply giving away free munchies, coffee and advice did not escalate to a spate business unit. The case did, however, give guidance to an acceptable cost of goods sold percentage of roughly 75%.

In the most recent cannabis case decision released on October 23, 2017(Feinberg v. Comm., TC Memo 2017-211), the US Tax Court decided in favor of the IRS with respect to costs disallowed under Section 280E. The IRS victory in this case hinged mainly on the taxpayers’ inability to support its deduction as it related to cost of goods sold. The court concluded that the taxpayers did not “maintain sufficient reliable records to allow the Commissioner to verify the taxpayer’s income and expenditures.” The court did not rely on post audit reclassification of cost of goods sold items. Alas, there is no substitute for good record keeping.

As a Certified Public Accountant (CPA) who specializes in the industry and has represented clients through multiple IRS audits, my take away is simple: It is foolhardy for one to believe that by some magical process, Section 280E will go away or will be retroactively repealed. Until legalized cannabis is exempt from Section 280E provisions, industry businesses should make every effort to direct the predominance of their expenses into production. CEO’s, CFO’s and specialists should concentrate their time and resources on production, manufacturing and inventory controls. Multiple business units should be established, each with its own written plan for profitability. Job descriptions should indicate which positions have inventory production, control or monitoring responsibilities. CPAs familiar with cannabis can play an important role in helping business owners set up a chart of accounts, identify business units and develop strong internal controls needed for success.

It is clear to me that IRS audits in this industry will not go away any time soon. Every company should prepare themselves for this eventuality. For now, good accounting records and well thought out business units will reduce the strain of Section 280E and allow all involved to keep their heads above water. To survive the long term, however, the industry must get Congress to remove marijuana from the grips of Section 280E. It will be beneficial if all involved give their representatives in Washington, DC a heads up that H.R. 1810 – Small Business Tax Equity Act of 2017 is the simplest solution.

Jamie Boulette, CPA has 30 years of tax experience and is managing director of Perry, Fitts, Boulette & Fitton CPAs with offices in Bath and Oakland. He can be reached at jboulette@pfbf.com

 

Will Taxes Mean the End of Marijuana Reform?

Last November, Maine voters approved the legalization of recreational marijuana. Since then, entrepreneurs in the industry have begun gearing up now for what will become a real growing frenzy. Warehouse space is being gobbled up by speculators looking to participate in what is already a multibillion-dollar industry. However, all parties should be wary of IRS Code Section 280E.

The states that have legalized marijuana impose sales or excise taxes which are generally passed directly to the consumer of between 10% and 30%. Colorado alone is expected to report sales in excess of $1,000,000,000 with a tax structure that includes a 2.9% sales tax, a special recreational sales tax of 10% plus a 15% excise tax. Needless to say, State and local governments in Colorado are cashing in. What is not so widely known is that the federal government is also cashing in and the entire industry is at risk.

By my count, 23 states now allow for medical or recreational use but the federal government has made no headway in removing marijuana from its list of Schedule 1 controlled substances. The significance of this categorization is important because IRS Code section 280E denies most deductions incurred by businesses trafficking any substances listed on Schedule 1. Since the Maine tax code piggybacks the federal code, it also disallows trafficking/selling related expenses. Currently, corporations in Maine face a federal and state tax rate of 45% on its gross profit. Without the ability to deduct ordinary business related expenses, the industry could see effective tax rates between 80-90% of income.

So how does Congress protect Maine’s marijuana industry? The fix is simple. Congress should remove marijuana (sold legally under state law) from the list of Schedule 1 drugs. To a limited degree, many bills addressing parts of this issue have been put forth and sit in committee somewhere, each seemingly stonewalled. The most recent bill introduced into the House, “States’ Medical Marijuana Property Rights Protection Act” gives some insight to the magnitude of the problem of using your property to grow marijuana. The bill removes real estate from the list of items that can be forfeited as a result of a violation of the Act.

The Controlled Substances Act currently imposes forfeitures which include, among other things, the forfeiture of “All real property, including any right, title, and interest… any lot or tract of land and any appurtenances or improvements, which is used…a violation of this subchapter…”. The aforementioned bill only sets out to remove from the penalty section the forfeiture of real property but does not remove Marijuana from the list of Schedule 1 substances.

This should be a reminder to all, even those merely renting warehouse space, that until the federal law removes legal marijuana from its Schedule 1 list, the life of the industry is on the line.

Jamie Boulette, CPA has 30 years of tax experience and is managing director of Perry, Fitts, Boulette & Fitton CPAs with offices in Bath and Oakland. He can be reached at jboulette@pfbf.com or 371-8002.