"The times they are a-changin" sang 60’s icon and Nobel Prize winner Bob Dylan, but I’m not sure even he could have predicted the rapid change occurring in the United States regarding the cannabis business.
While still illegal at the federal level, pot is currently legal for recreational use in 4 states, joining 23 others plus the District of Columbia, which allow marijuana for medical purposes. Three of those states have passed laws for recreational use that have yet to take effect. While on the surface, it appears that growth in the industry might rival that of the late 90’s "dot-com boom," there are some significant issues to consider before jumping feet-first into a new venture.
Here are 4 things you need to know about taxes and marijuana.
1. You must report illegal income to the Internal Revenue Service.
The IRS still classifies marijuana as a controlled substance and trafficking of these drugs is a federal offense. However, the IRS requires marijuana businesses to file federal income tax returns. Further, any illegal income must be claimed on your tax return. Remember, Al Capone was famously prosecuted for tax evasion.
So if you’re allowed a marijuana license in your state, but don’t want to serve time in a federal prison, what do you do? Something called the Cole Memo applies here. It refers to a written order from U.S. Attorney General James Cole to the Assistant U.S. Attorneys, essentially de-funding federal prosecutions of compliant state-licensed cannabis businesses. Essentially, it lays down the guidelines for dealing with this industry.
Nick Richards, an attorney and adjunct professor of law at the University of Denver, Sturm College of Law in Colorado, adds this is especially true for the medical side of cannabis. "If a marijuana business is compliant with robust state regulatory requirements, and doesn’t offend any federal priority enforcement areas (such as sales to kids and across borders), then the Cole Memo should cover the business and individuals involved. There is less certainty regarding the application of these federal policy statements to recreational cannabis."
2. You can’t write off all of your expenses.
Most entrepreneurs who have started a business understand that writing off expenses that are necessary to keep your business working smoothly is an essential part of managing your bottom line. As challenging as that is on its own, the IRS Code 280E throws a wrench into the gears. It cites that businesses with income derived from illegal activity, such as trafficking of narcotics, are not allowed to take ordinary business expense deductions.
Strangely enough, this doesn’t include expenses for producing cost of goods sold (COGS). So, a business owner with a storefront for selling medical or recreational marijuana could take a deduction for costs of growing the plants, but not rent for the retail space, employee salaries or even advertising.
3. Cash is king.
Banks are federally regulated and therefore will not recognize marijuana companies as legitimate businesses for fear of violating federal law. This means that most marijuana business owners are stuck running an all-cash business. Credit cards can’t be used due to the lack of a banking relationship.
Security alone can be an expensive (and non-deductible) enterprise with all that cash lying around, and the news regularly reports break-ins or attempted robberies of marijuana establishments. While there appear to be more banks willing to do business with the cannabis industry, it is still limited compared to their non-marijuana counterparts.
Additionally, the Bank Secrecy Act of 1970, established to prevent money laundering, requires banks to report cash transactions of greater than $10,000. This means that even if banks are able to stay within the guidelines and service marijuana businesses, the responsibility of the banks to prepare a Currency Transaction Report (CTR) for cash of over $10,000 and a Suspicious Activity Report (SAR) for suspicious or related deposits of less than $10,000. The additional maintenance on such an account can make the cost for the business owner prohibitive, with a price tag possibly over $1,000 a month.
4. Document everything.
The most important thing for the marijuana business is the same as any business–keeping good records of your income and your expenses. Because of the added scrutiny on this type of business, coupled with the uncertainty of ever-changing legislation, it becomes even more crucial that record keeping be a top priority for a marijuana entrepreneur.
As a lawyer who has dealt with audits of this sort, Richards cautions, "Record keeping is mandatory. Keep all paper receipts for at least six years; hire and consult with a professional regarding large ticket items (purchases, contracts, etc.)." If you are willing to put the effort into this part of the business, you will be prepared in case of an audit. Along with keeping stringent records, get a good tax pro who understands the industry.
The times are, indeed, changing.
News Moderator: Katelyn Baker
Full Article: 4 Things To Know Before Starting A Pot Business
Author: John Hewitt
Contact: Inc.
Photo Credit: Getty Images
Website: Inc.
