How the Growing Cannabis Industry is Impacting Accounting and Finance Professionals
The floodgates are officially open in the Garden State! On Oct. 27, 2022, the Cannabis Regulatory Commission awarded the first annual licenses to eager recreational-use applicants. The untapped markets are endless, with the industry now ready to catapult to meet demand.
However, with anything sweet must come the sour. And accountants will be in high demand to navigate operators through the challenging aspects of cannabis, beginning with immensely unfavorable income taxes.
IRC Section 280E Implications
The issue lies within IRC Section 280E, which states rather simply, “No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of the trafficking in controlled substances (within the meaning of Schedule I and II of the Controlled Substances Act).” However, the Section 280E disallowance does not apply to the cost of goods sold (COGS). This allows a grower, producer, wholesaler or retailer of marijuana to deduct from its gross receipts the COGS, despite the language of Section 280E.
Accounting and finance professionals servicing cannabis clients must be vigilant and focus on the costs that should be classified as inventory, which eventually make their way through the cost of goods sold. General and administrative expenses are no longer deductible, and as tax practitioners, we are not used to seeing this with typical business tax returns. Unfortunately, plenty of examples of tax court cases support the reality of this code section. If you are a plant-touching company and try to get creative or challenge Section 280E, it will likely result in an unfavorable outcome.
New Jersey and several other states mirror the federal tax code as it pertains to Section 280E. On the bright side, some states have decoupled from federal regulation, and New Jersey is on track to follow suit. The state recognizes that for a business to succeed and thrive in this blossoming industry, they do not have to impose harsh tax regulations for new companies, but instead allow them to grow and contribute to the economy. You can follow the progress of the legislation at njcpa.org/cannabis.
As most operators lack the depth of expertise surrounding these tax concepts, accounting and finance professionals will play a critical role in the overall well-being of the sector.
Beyond taxes, accountants will no doubt be in high demand to maintain accurate books and records for cannabis operators. There is no shortage of users of financial statements in this industry. From fund-raising activities to business disputes, reliance on financial reporting is a common denominator. Savvy Garden State entrepreneurs recognize this and budget for spending on either internal or outsourced accounting roles.
While accounting needs for a start-up may seem like standard fare for any sector, cannabis brings something very different to the table. Enter the cash-based cannabis industry! Fortunately, we have left the era of executives driving cash-stuffed duffle bags to neighboring states’ institutions open for deposit. Yet the traditional banking system is still inaccessible to plant-touching entities with federal illegality intact.
Transacting primarily in cash creates a massive opportunity for fraud. Combined with the fact most start-ups lack the resources to develop or implement internal cash controls, it is a recipe for disaster. Accounting and finance professionals will be needed to contribute the knowledge and tools necessary to safeguard such cash-intensive businesses.
In this booming, evolving industry, there is no doubt a built-in demand exists for high-value cannabis accounting services. There are fundamental accounting and tax roadblocks businesses in this sector need to tap into CPAs for. We are well-suited to help them overcome barriers and support the cannabis industry’s growth to its full business potential.
Ryan Brandt, CPA, MSA, is a senior manager at Withum. He is a member of the NJCPA Cannabis Interest Group.
Sean P. Linde
Sean Linde, CPA, is a senior manager at Withum. He is a member of the NJCPA Cannabis Interest Group.
This article appeared in the Spring 2023 issue of New Jersey CPA magazine. Read the full issue.