+

Tax & AccountingCPAATTESTAT IONSFOR PRE-QUALIFICATIONS,ACCOUNT INGAND

280E - PR INC IPLESANDMIT IGAT IONSTRATEGIES

SIMON GUMMA, CPA, CGMA

+

280E Overview• Cost of goods sold is only deduction available to businesses trafficking in

cannabis for federal tax purposes

• Some states do not apply 280E for state income tax purposes (Oregon)

• Focus on capitalizing as many expenses as possible to COGS; this is actually the IRS’s preferred position

+

280E Defined

• Involves expenditures in connection with the illegal sale of drugs

• No deduction or credit shall be allowed…in carrying on any trade or business if

such trade or business (or the activities which comprise such trade or business)

consists of trafficking in controlled substances.

+

The Importance of Corporate Structure3mainoptions:

• Ccorporationo Payscorporateleveltaxo Lesstaxefficientthanapass-through

• Scorporationo Allshareholdersmustbeindividualso Reasonablesalarytoowneroperators

• Limited liability corporation(LLC)o Veryflexibleentityo Pass-throughincomecouldbesubjecttoS.E.tax

+

The Importance of Corporate Structure

What entity type makes the most sense by industry segment?• Retailer• Wholesaler/distributor• Producer/processor

How ownership structure influences entity choices• What functional role does the ownership group play in the operation of the business?

Does entity type even matter? (YES!)

+

Corporate Structure: RetailersCCorpispreferredvehicletooperatedispensaryorrecreationalcannabisstore

• Tax liability is contained inside the corporationoSome retailers are not profitable after taxes

• Shareholders not liable for taxes of the business individuallyoProtects shareholders’ other assets from potential liens and levies

+

Corp. Structure: Retailers• Not as tax efficient as pass-through entity◦ Downside protection could be more important in EARLY years

•Low salary, high dividend strategyo Ability to control timing of dividendso Can also take loans from corporation tax free. Must eventually be repaid.

+

Corp. Structure: Retailers• SCorpcanholdataxtrapfortheunwary

• Non-deductibleorpartiallynon-deductiblesalarygetstaxedagainatindividuallevelviaW-2

+

Corp. Structure: Retailers• “Reasonablesalary”canpotentiallycausedoubletaxationo IRScoulddemandhigher“reasonablesalary”

• HighlyprofitableretailercouldmakeswitchtoScorp afterbusinessisestablished,profitabilitymetricsdetermined

• CompareCvs.Scorpsside-by-sideo Assumesalaryisnon-deductible&dividendsareo Maxedtomakedetermination

+

Corp. Structure: Retailers

LLC• Alsoapass-throughentity,sotaxliabilitydeterminedatindividuallevel• Incomeissubjecttoselfemploymenttax+incometaxo Canbeasubstantialamount

• SamedownsideissuesasScorp:o Taxliabilityisindividualliabilityo Exposesownerstopotentialtaxliensandlevy

+

Revenue $1,000,000

COGS (500,000)

GrossMargin 500,000

SG&A (non-deductible) (400,000)

Pretaxincome 100,000Tax(corp. rate) (170,000)

After taxloss $(70,000)

Corp. Structure: Downside protection (C Corp)

• ExampleofwhyitmakessensetouseaCcorp.whennon-deductiblesarerelativelyhigh

• Companyisexperiencinganeconomiclossaftertaxes

• Wisetocontainthetaxliabilityinsidethecorporateentityratherthanpassingitthroughtotheindividualshareholders

+

Corp. Structure: Wholesaler/Distributor• Taximpactsimilartoretailers• Ccorp ispreferredentity• DeliveryandsalesexpensesaresignificantandaregenerallyNOTdeductible fortaxpurposes

• ExpensesofreceivinggoodsAREdeductible

+

Corporate Structure: Producers & Processors

• 280Eimpactnotassignificant• Traditionalnetincomeisclosertotaxableincomeascomparedtoretailers• Ccorporationprotectionsarelessurgent

+

Corp. Structure: Producers & Processors

• Scorp orLLCisbestoptiono Dependsonownershipstructure,operationalfunctions ofowners

• Pass-throughentitiesaremoretaxefficient

• Oneleveloftaxvs.Ccorp

+

Producers/Processors: Ownership Example

• ThreeownersoTwoinchargeofproductionoOneinchargeofadmin,distributionandmarketing

• BestoptionwouldlikelybeLLC• Requirementtopay“reasonablesalary”toadminpartnerwouldcreateadoubletaxtoextentofhisorhernon-deductiblewages

• LLCnotrequiredtopaya“salary”• Weighcostagainstself-employmenttax

+

Retail Tax Strategies• Splitcannabissalesawayfromparaphernalia,brandedmerchandiseandotheritemsorservices

• Bestmethodistophysicallydividepremisesandputrespectiveoperationsinseparateentities

• Separatebooksandrecords

+

Retail Tax Strategies• Separateemployees• Mustbearealandsubstantialbusiness;shouldbeabletostandonitsown• Opportunityfordeductiblebrandmarketing

+

Producer/Processor Tax StrategiesSegregateYourOperations

• Producersandprocessorsshouldholdanyland,buildingandequipmentinanentityseparatefromtheonethatisconsideredtobetrafficking.

• Leasebacktooperatingentity• Thisentitywillnotbesubjectto280Eandthereforenotsubjecttodeductionrestrictions

+

Producer/Processor Tax Strategies• OpportunitytotakemoreaggressivetaxdepreciationdeductionoSection179oBonusdepreciation

• Those methods notavailable incannabisCOGSduetoclear reflection ofincomeissues

• Changesthecharacter oftheincome orloss torental

+

Effect of Separate Entities on DepreciationAssetsplacedinservice

Land 200,000

Building 500,000

Improvements 130,000

Equipment- 7year 400,000

Equipment- 5year 50,000

Total 1,280,000

ComparisonofFirstYearDepreciation

LeasingCompany (notsubject to280E) 270,013

GrowOperation (Entity subject to280E) 81,442

Additional Depreciation allowed 188,571

Potential Tax Savings @35% $66,000

Note:IftheoverallincomeoftheLeasingCompanyallows forthe§ 179deduction, thefirstyeardepreciationwould total$461,442producing apotential taxsavings of$133,044!

+

Producer/Processor Tax Strategies• Creates potential opportunity to offset operating income• Be sure to charge commercially reasonable rents. Don’t get cute!• Lease agreement should be in writing• Creates different opportunities for investors that don’t want direct

connection to cannabisoWork-around for out-of-state investors if your state prohibits

+

Producer/Processor Tax Strategies

Intellectual property• Another segregation strategy• Hold all brands, recipes and production or processing methods outside of

operating entity• Should have a business purpose for doing so

+

Producer/Processor Tax Strategies

License to operating entity for a fee, which can be deductible

• Should be written agreement

Opportunity to license to “partners” in other states

Operation of entity is not subject to 280E because

• Licensing is not trafficking

+

Setting Up – Corporate Structure is Your First Defense

Why Do You Need Two LLC’s & A C Corp?1. Once entity is the actual cannabis enterprise holding the license.

2. The other entity is the management company providing goods and services to the cannabis enterprise

3. Management company marks up the goods & services, creating a higher COGS

4. The third is to hold the share of the management company

5. Utilize Sec. 1202 Small Business Stock Capital Gains Exclusion

+

Qualified Small Business Stock (QSBS)

Considerations for 100% Gain ExclusionFive criteria must be met to qualify:

1. The stock must have been directly acquired via an original issuance from US C corporation (Sec. 1202(c)(1))

2. Both before and immediately after stock issuance, the C corporation’s tax basis is gross assets < $50 million (Sec. 1202(d)(1))

3. The C corporation and shareholders must consent to supply documentation regarding QSBS (Sec. 1202(d)(1)(C))

4. The C corporation conducts certain qualified active trades or businesses (Sec. 1202(e))

5. The stock must have been held for at least 5 years (Sec. 1202(b)(2))

+

Beginningin2015,forthefirsttimesinceitsenactmentin1993,Sec.1202allowsnoncorporatetaxpayerstoexcludefromfederalincometax100%ofthegainonthesaleofcertainqualifiedsmallbusinessstock(QSBS),limitedtothegreaterof$10millionor10timestheadjustedbasisoftheinvestment.

+

Michigan Taxation of Medical Marihuana3% Excise Tax – NEW

• The Medical Marihuana Facilities Licensing Act• File and remit quarterly; 30 days after the end of the calendar quarter

6% Sales or Use Tax• The General Sales Tax Act / The Use Tax Act

+

Tax Tips: Do…� Keep good accounting records

� Have a written operating agreement, written leases, written royalty agreements

� Hire a good attorney and CPA

+

Tax Tips: Don’t…� Cut corners

� Listen to advice that seems too good to be true

� Procrastinate

+

Thank You