One of the most important issues in the industry for cannabusiess owners to address and understand is 280E, part of a dense IRS code that states “no deduction or credit shall be allowed for any amount paid or incurred during the taxable year if such trade or business consists of trafficking in controlled substances (Schedule 1 or 2).”
In a presentation at the Marijuana Business Conference held in Las Vegas in mid-November, business accountant Dean Guske discussed that part of the tax code and how cannabis business owners could work with it.
His overall solution to working with the IRS and their 280E tax code begins with advice on how to set up your corporation – as a C-Corporation, an S-Corporation, or a Limited Liability Corporation (LLC). He warns against setting up a business as a sole proprietorship (“You are just asking for trouble”).
A C-corp is a tax-paying entity, where an owner figures taxable income and the corporation itself pays tax. The owner only pays tax on what he takes out of the company, he explained, like salaries or dividends. He said that many lawyers prefer all cannabis businesses be C corporations. “I think here is alot of merit to that,” Guske said.
The S-corp does not pay tax. All shareholders need to be individuals, there is a reasonable salary requirement, and taxes are paid for individually on whatever the corporation profit there is at the end of the year.
The third entity, LLC-corp, is very flexible. Here, the repass-through income is subject to self- employment tax, which is 15.3 percent of the first $120,000, in addition to an income tax.
The impact of 280E hits the various parts of the industry differently, he said, so choosing the entity to create is critical for retailers, wholesalers and distributors, and producers and processors.
For example, he prefers that retailers structure themselves as C-corps because the 280E impact is quite a bit more than on the distributor or the producer/processor. “For a retailer, their main function is selling. So the deductions that they are allowed to take is primarily on what they are buying to sell.”
“What retailers should do is use a low salary/high dividend strategy, because you are not going to be able to deduct your own salary,” he said. “You take your earnings through dividends.”
Some retailer owners don’t want to do that, and say they would rather be an S-corp. “The problem with that is your salary is not deductible on an S-corp return, and the S-corp then pays you. So you pay tax twice at maximum rates. It’s ordinary income two times.”
Another downside with an S-corp is that you are supposed to give yourself a “reasonable salary,” he said. “But the IRS could come and do an audit and say ‘That $70,000 you are paying yourself is not reasonable. We think you should be at $250,000.’ Then you have to spend money defending the salary for a retail shop owner.”
He also recommends splitting the business for retailers. For example, having one business selling paraphenalia and t-shirts, with an ATM inside, set up adjacent to the dispensary.
“These would then be non-trafficking sales apart from the dispensary, and not subject to 280E,” he said. It would be best to do this using two physically separated buildings. “I also like to see those operations as two separate legal entities,” Guske said. “A C-corp for your dispensary and an S-corp for your branded merchandise.”
He advises maintaining separate accounting books and separate payrolls for the two entities. “The cannabis-side operations would be where most of your sales would be,” he said. “But you would be surprised at how much revenue can be generated from an ATM.” For example, he said that the ATM fees generated $350,000 in the state of Washington last year. “It can be a good source of real money.”
With all of the federal scrutiny on the industry, it’s important to act like real business owners who know all of the rules. “If we are doing things right and are good business people, that helps everybody in the industry,” he said. “We do not want to be known as an industry with bad managers.”