Minnesota. Ohio. Oklahoma. Pennsylvania. These are among four states that have a good chance of legalizing recreational marijuana in 2023. If all of the political and societal dominos fall into place, they would join the other 29 states that have done so.
After enjoying a sales bump during the early stages of the pandemic, the US cannabis industry in 2022 showed signs of slowing down in the face of regulatory and economic challenges, including declining demand. As a result, legal cannabis markets across the country, particularly mature markets, are facing a supply glut that is driving down wholesale and retail prices.
This year, several federal legalization bills up for congressional debate will push for legislation aimed at ending the federal prohibition on cannabis. One of the more interesting items to keep an eye on is the Secure and Fair Enforcement (SAFE) Banking Actwhich if re-introduced in 2023 would provide protections to financial institutions and various other professional service firms doing business with state-legal cannabis businesses.
As the cannabis market continues to make its presence felt, it has captured the attention of the accounting profession. Insightful Accountant sat down with Kristin Kowalski, partner at The Bonadio Group‘s Tax practice, to get a feel for the market and its opportunities. Kristen has a decade of experience providing tax compliance, consulting and advisory services to multi-state corporations and flow-through clients in the manufacturing, technology and real estate industries.
Here additional areas of interest include inbound international organizations, tax credits, accounting for income taxes and transaction planning. Kristin is also a member of Bonadio’s cannabis and industrial hemp team.
Give us a snapshot of today’s cannabis market.
It’s a complex environment that varies widely from state to state. Here in NY, the legal market is just beginning to take shape; there were a lot of flowers grown this year by conditional cultivators and so far no retail outlets for it to be sold. Nationally, the industry is still waiting for the SAFE Banking Act to pass, which would alleviate the issues of securing banking and traditional financing. Overall, it’s a challenging, evolving, and exciting industry to be part of.
What are the most important things cannabis businesses need to worry about as it relates to tax issues?
Because cannabis is listed as a controlled substance and is illegal for federal purposes, cannabis operators are subject to IRC Section 280E, which is the section that prohibits deductions and credits for businesses that traffic controlled substances. Because of 280E, the only reduction to taxable income is through the cost of goods sold and costs that are permitted to be capitalized to inventory under IRC Sec. 471. The effective tax rate is extraordinarily high as a result and the tax liability can sink a business without proper planning.
What makes this market so different from other retail businesses?
Because of the federal legal status there is no interstate commerce with cannabis. The market conditions and prices are different within each state depending on the supply and demand. Additionally, cannabis businesses are faced with more regulatory oversight and higher costs for everything (insurance, security, taxes, legal fees, etc.). But, there are similarities too, and like other retail categories it’s highly competitive and branding and customer experience are key.
What are the areas cannabis operators must navigate carefully and how can having the right accountant help?
Accounting for inventory costs can be tricky, and if done incorrectly (or too aggressively) can lead to crippling tax assessments and penalties later on. The right accounting partner can also help with things like managing the cash position of the business, tax planning, and helping the owners/stakeholders/investors understand the financial health of the organization.
What are the best ways for accounting professionals to approach adding cannabis businesses to their client lists?
First, contact your professional liability insurance carrier. Second, learn as much as you can about the industry in your state and the relevant accounting and tax issues. From there, work on growing your network—things like attending cannabis industry events and leveraging existing client and attorney relationships.
Why should cannabis operators outsource their bookkeeping?
What’s the pitch for accounting professionals? There are many reasons, but the best (in my opinion) is that outsourcing frees up the owner/operator to focus on running the business and handling the extra challenges of the industry. Along with being cost effective compared to hiring a controller or on-staff bookkeeper, there is peace of mind that comes with having an accountant with cannabis experience and knowing documentation and records are in place for regulatory reporting and the inevitable audits.
Can you share an anecdote of a business that you helped?
Earlier this year we worked with a new company that is preparing to apply for a retail license. We contributed by reviewing their financial forecast part of their business plan and helped them to understand their expected tax position resulting from Section 280E (federal, state and NYC) and their choice of operating entity. We’re looking forward to seeing them get their license and open their store, hopefully in 2023.
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