Taxes are already particularly demanding for most business owners, but cannabis entrepreneurs have to deal with a lot more hurdles thanks to unique tax laws and restrictions. With so many rules and limitations in place for both state and local taxes, it's easy to feel overwhelmed trying to keep up. That's why working with a tax professional like Redbud Advisors is important when it comes to handling your tax burden. Specializing in accounting for cannabis businesses, we know the industry's challenges as well as some of the most effective strategies to reduce your business' taxable income (and keep more of your hard-earned money!).
IRC 280E: The Biggest Obstacle
Being in the cannabis business means you've probably already heard about Section 280E of the Internal Revenue Code. It's a federal tax code that prevents businesses involved with Schedule I or II substances (like cannabis) from deducting normal business expenses. This means you can't write off typical costs like rent or salaries even if your cannabis business is perfectly legal under state law.
What you can deduct, however, are expenses related to the cost of goods sold (COGS). This tax deduction includes things like cultivation, production, and inventory costs. You have to maximize these deductions legally, which requires careful bookkeeping and a proper grasp of your business operations.
How Cannabis Businesses Can Achieve Maximum Tax Savings
For individuals, there are a number of techniques to save on taxes. There are things like the earned income tax credit, tax-deductible contributions (e.g. health savings accounts, flexible spending accounts, retirement accounts), planning capital gains and/or capital losses, deduction of qualified medical expenses, deduction of charitable donations, and so on. For businesses—cannabis businesses, to be more specific—there are also a few ways to lower your adjusted gross income (AGI), and consequently, reduce taxes.
Take a look at some of the most beneficial techniques:
1. Maximize Your Cost of Goods Sold (COGS)
A top tax-saving strategy is to maximize your cost of goods sold (COGS) as this is one of the few tax deductions cannabis businesses can legally claim. COGS includes expenses directly related to producing your product. For cultivators, this might involve seeds, soil, and labor costs associated with growing. For dispensaries, it could include the cost of purchasing inventory from suppliers.
2. Separate Cannabis and Non-Cannabis Activities
If your business handles both cannabis and non-cannabis products or services, consider separating these activities into different entities. For example, you could set up one entity to manage your cannabis operations and another for non-cannabis activities like selling branded merchandise. Doing so lets you allocate more expenses to the non-cannabis entity, avoiding the limitations of 280E.
3. Keep Detailed and Accurate Records
In the cannabis industry, detailed and accurate record-keeping isn't just a good idea—it's a must. It's important to have a paper trail of all your expenses, be it the money spent on production or the process of maintaining payroll records. This makes it easier for you to file and pay federal income taxes and have a clear picture of your tax bill even before tax season comes around. We recommend investing in software that tracks inventory and expenses, or getting assistance from cannabis CPA firms like Redbud Advisors.
4. Take Advantage of State-Level Deductions
One silver lining for cannabis entrepreneurs is that some states allow certain tax deduction types that the federal government does not. For example, states like California and Colorado have tax codes that permit businesses to deduct operating expenses from their tax liability; this would otherwise be restricted under 280E.
5. Invest in Tax-Advantaged Assets
Another smart move is reinvesting in your business in ways that can lower your taxable income. For example, upgrading equipment or expanding your facilities might qualify for depreciation deductions. Certain states also offer tax credits for energy-efficient upgrades or investments in sustainable practices, which can apply to cannabis businesses.
6. Schedule Regular Tax Planning Sessions
Tax laws affecting cannabis businesses are always evolving, so you should always make sure that you're updated. Scheduling regular tax planning sessions with a tax advisor or tax professional can help you adjust your strategies to meet new regulations, avoid penalties, and even find new opportunities for tax savings.
7. Protect Yourself from Audits
Cannabis businesses are at a higher risk of being audited, so being ready for this possibility is a solid tax strategy. The best way to protect yourself is by being prepared: keep receipts, invoices, and financial records organized. Additionally, avoid red flags like sloppy bookkeeping or overly aggressive deductions.
8. Plan for Long-Term Growth
Taxes aren't just about the here and now—they're also about preparing for the future. As your cannabis business grows, your tax strategies will need to evolve right with it. For example, expanding into new states, opening additional locations, or launching new product lines can all have important tax implications that can't be overlooked.
Common Mistakes to Avoid
Even with the best intentions, cannabis entrepreneurs sometimes make mistakes that cost them money or lead to compliance issues with the Internal Revenue Service (IRS). We want to make sure you avoid these typical mistakes as much as possible, so we've put together a list of common pitfalls to watch out for:
1. Mixing Personal and Business Expenses
Always keep personal and business finances separate—this applies to just about every business in any industry. Using personal funds for business expenses (or vice versa) is not only irresponsible, but it can also lead to a lot of complications that could've easily been avoided during tax season.
2. Failing to Document Cash Transactions
Many cannabis businesses operate heavily in cash, but failing to document these transactions properly can lead to big problems and complications down the line.
3. Ignoring 280E Compliance
Don't assume you can write off expenses to lower your tax bill just because they seem business-related. It's always smart to double-check whether all deductions are allowed under 280E so there are no surprises when it's time to pay taxes.
4. Handling Accounting Yourself
Cannabis taxes are complicated. Trying to handle everything yourself can lead to a lot of costly mistakes, especially when you're busy handling other aspects of the business as well. Hiring accountants familiar with the cannabis industry and letting them handle your income taxes is a smart investment that will definitely pay off.
Redbud Advisors Can Help You Maximize Your Returns
Taxes might be one of the biggest challenges faced by cannabis entrepreneurs, but with professional assistance from tax advisors and accountants, it's something you can easily overcome.
At Redbud Advisors, we understand the specific and unique needs of the cannabis industry. As a full-service cannabis accounting firm, we're ready to help you go about complicated tax laws and maximize your tax savings.
Ready to maximize your returns? Contact Redbud Advisors today to get started!
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