Law Prior to 2018 – Non-Profit MBCs Ruled
Medicinal cannabis businesses in California generally operated as nonprofit mutual benefit corporations prior to 2018.
Although these medicinal cannabis businesses formally are incorporated as nonprofit mutual benefit corporations, they do not meet the requirements for income tax exemption described in Internal Revenue Code (IRC) Section 501(c) or California Revenue and Taxation Code (R&TC) Section 23701, Meaning they must file Form 1120, U.S. Corporation Income Tax Return and Form 100, California Corporation Franchise or Income Tax Return. Additionally, IRC Section 280E applies to these business, which can severely limit the ability to deduct expenses resulting in a higher effective tax rate. However, they can deduct ordinary and necessary business expenses for California purposes.
Non-profit mutual benefit corporations are limited by their inability to pay dividends and be sold as there is no stock to sell. Members generally secure their returns via wages and through liquidation of any assets on dissolution.
Current Law – Total Legal Entity Freedom and Flexibility
The Adult Use of Marijuana Act (Proposition 64) passed with 57% voter approval and became law on November 9, 2016. The Medicinal and Adult-Use Cannabis Regulation and Safety Act (MAUCRSA), SB 94, passed on June 27, 2017. It established a comprehensive system to control and regulate the cultivation, distribution, transport, storage, manufacturing, processing, and sale of medicinal and adult-use cannabis, and related products.
Businesses operating under these state licenses can choose any form of valid business structure for their business. They are able to operate on a for-profit or not-for-profit basis. They are not eligible for California franchise and income tax exemption, as they do not meet the requirements as described in IRC Section 501(c) or California R&TC Section 23701. This means California cannabis business now have the flexibility to choose from a variety of legal entities to best suit the needs and tax profiles of their owners. These entities include, but are not limited to Limited Liability Companies (tax as: Disregarded Single-Member LLC, Partnerships,& C-Corporation), C-Corporation, S-Corporations, and Limited Partnerships.
Converting a Nonprofit Mutual Benefit Corporation to a Stock Corporation
California allows for the conversion of an Mutual Benefit Corporation (MBC) to a general stock corporation by Restating the articles of incorporation of the nonprofit MBC. There is a $30 associated filing fee. The restated articles must include:
- The name of the Corporation.
- The following general stock purpose statement: The purpose of the corporation is to engage in any lawful act or activity for which a corporation may be organized under the General Corporation Law of California other than the banking business, the trust company business or the practice of a profession permitted to be incorporated by the California Corporations Code.
- The number of shares of stock the corporation is allowed to issue.
- If there are outstanding membership interest, the articles must include a statement of the effect of the restatement on those interests.Within 90 days of filing the amended articles of incorporation, a Form SI-550 Statement of Information must be filed with the Secretary of State. This form is free to file if filing to meet the 90 day requirement otherwise it is $25 initially and annually thereafter. If this is the initial SI-550 then the Service of Process information must be included within the amended articles of incorporation in the previous step.
That’s it! Your corporation is now a general for-profit stock corporation which allows for dividends and buying and selling of company stock and allow for more sophisticated legal tax structuring.
Converting to anything other than a C-Corporation
In order to convert to another legal entity type such as a LLC or LP, the MBC first must convert to a general stock corporation and then convert from there. This is because the conversion of the MBC to a general stock corporation was technically not a conversion, but merely a restatement of its purpose statement and issuance of stock, as it was already a corporation from the beginning, however now with its newly attained for profit status it can convert from corporation to a multitude of other forms. The California Secretary of state website has a large listing of various legal conversion forms.
Additionally, tax only elections can be made with the IRS via Form 2553 and/or Form 8832 which allow the corporation to be taxed as an S-Corporation, Partnership, or disregarded entity depending on the fact pattern without further legal conversions at the state level.