16 Tax Tips for Cannabis Operators in 2023

September 11, 2023

A comprehensive round-up of tax pointers for plant-touching businesses in the cannabis industry from CJBS Senior Partner Matt Bergman, CPA. 

Cannabis’s federal illegality and stringent regulations for state-legal businesses make taxation in the cannabis industry difficult to navigate–and that’s an understatement. 

CJBS Senior Partner Matt Bergman, CPA, knows these complexities well, having operated in the cannabis space since 2015. 

To provide a valuable resource to cannabis operators within his network, Bergman started a weekly LinkedIn post in March called #TaxTipTuesday. We’ve rounded up his first six months of tax tips in this blog. 

In this compilation (and in no particular order), Bergman offers pointers from Section Code 280E of the Internal Revenue Code, to depreciation, expense allocation, audit readiness, and more. 

Let’s get into it! 

1.  You Need to Work with a Knowledgeable Cannabis CPA 

Tax professionals who specialize in the cannabis industry are well-versed in the unique tax challenges and opportunities that cannabis businesses face.

A knowledgeable tax advisor understands the intricacies of properly allocating expenses between COGS and non-COGS categories.

A tax professional can identify deductions beyond COGS that are allowable under tax regulations. (While Section 280E imposes limitations, there are still opportunities to optimize deductions through careful planning and accurate reporting.)

In the event of an audit (and these are increasing in the cannabis industry), having a cannabis tax professional on your side provides a level of confidence and expertise. They can help you prepare for the audit, organize documentation, and communicate with tax authorities on your behalf.

2. You May Want to Use the Cash Accounting Method 

Here are just some reasons why cash accounting may be beneficial for your business:

Simplicity. This is an easier-to-use accounting method because you record cash coming in and out when revenue is received and expenses are paid.

Section 280E. With cash accounting, expenses are deductible when paid, rather than whey they are incurred.

Better Cash Flow Management. Cash accounting creates real-time representation of cash flow to give businesses a clearer picture of their financial position.

Inventory. Cannabis businesses deduct the COGS when products are sold and costs are paid, rather than accounting for inventory as a current asset as is done in the accrual method of accounting.

3. Understand How Cost Segregation Works 

Reclassifying assets into different categories with shorter depreciation periods may help cannabis operators take advantage of tax benefits because they allow for greater deductions up front.

For example, in a manufacturing facility, equipment such as extraction equipment or filtration systems could potentially be reclassified. For a dispensary, display cases or security systems may be eligible for reclassification.

4. Make Sure to Register for Tax Accounts 

Make sure you are properly registering for tax accounts to comply with sales and excise tax obligations.

To do this, you must:

  • Identify the applicable taxing authorities
  • Complete and submit the proper registration forms
  • Pay fees (if necessary)
  • Comply with reporting requirements
  • Keep track of renewal or update requirements

5. Understand How Cannabis Business Expenses Are Allocated 

When a cannabis company is involved in both the production and retail sale of cannabis, it needs to allocate its expenses between these two activities.

Under IRC Section 280E, which all plant-touching cannabis companies must adhere to, deductions for the production or acquisition costs of cannabis products (COGS) are allowed.

Deductions for retail-related expenses are subject to the limitations of the same section.

Some expenses can be directly allocated to either the production or retail side of the business. This is called direct allocation.

A reasonable allocation method must be used for expenses not traceable to a specific activity. This is called indirect allocation.

Allocating expenses based on percentage of revenue generated by each activity is one approach for indirect allocation. (There are others as well.)

6. Keep This In Mind If You’re Paying Cannabis Business Taxes in Cash 

If you are a cannabis business paying your taxes to the IRS in cash, you need to make sure you’re transporting that cash safely.

If you don’t have your own fleet, make sure to schedule an appointment ahead of time with a secure transport service to help you make that delivery.

Also, be sure to note that the IRS imposes a 10% fee for those who do not use an electronic filing service and instead pay in cash, so you’ll need to take this into account when you make your payment.

7. Keep Informed of Cannabis Tax Laws, or Hire a CPA  

Tax laws change at the local, state and federal levels, and it’s critical to have a deep understanding of all applicable regulations that apply directly to your business.

But the reality is: It’s difficult for a small or medium-sized business owner who is juggling so many responsibilities to have a firm grasp on all the changes.

This is why hiring a firm with qualified industry CPAs who intricately study tax laws is critical to the success of your business.

You don’t want to underestimate what you owe, nor do you want to leave money on the table.

8. Make a Plan for Paying Your Taxes On Time 

Cannabis businesses need to have a plan for HOW they will pay their taxes, before it’s crunch time.

That’s because cannabis companies are cash-heavy businesses navigating financial workarounds and banking restrictions in order to operate compliantly.

Knowing ahead of time the method you’ll be using to make your payments is important to ensure you don’t run into any last-minute snags or late payment penalties.

9. Properly Deduct Your Charitable Giving 

Many cannabis companies are involved in substantial give-back efforts within their communities. 

If your business is considering donating to charity and looking to take deductions for those contributions, it’s important to ensure that charity is registered as a 501(c)(3) with the IRS.

If you are donating your time, there are other ways to take deductions, such as the mileage to drive to a location to volunteer. If you are donating goods or equipment, you can claim deductions for the fair market value of these items.

It’s important to keep good records for any type of charitable deduction.

10. Report Large Cash Transactions to the IRS 

Cannabis businesses–because cannabis is federally illegal–have limited access to banking. Therefore, they are largely cash businesses.

This not only heightens security measures for cannabis companies, but exchanging large amounts of cash also means cannabis companies must take special measures to properly report income to the IRS.

The IRS requires all businesses that receive $10,000.01 or more in a single transaction or related transactions report this to the IRS using Form 8300. The form must be filed by the 15th date after the transaction.

Form 8300 also requires information about the business that received the cash and the person conducting the transaction on behalf of the company, among other things.

If a business fails to report a transaction totaling more than $10,000—the penalties are steep, from hefty fines to even imprisonment.

For these reasons it’s important to take these requirements seriously and handle them with utmost diligence.

11. Adhere to Regulations for Remote Employees 

If you hire remote employees, there are a few things to keep in mind to stay compliant with the IRS.

First, you will need to register your company with the state in which your employee works (if different from yours).

Next, you will need to check to see if you need to register with unemployment and labor agencies from those states.

You will also need to brush up that state’s labor laws and ensure you’re in compliance with those, as well.

Some exceptions exist, however, such as states that enact “convenience of employer”—where you are only responsible for taxes in your state.

So, what if your employee lives in another state, and commutes into your state to work?

You may be on the hook for tax liabilities in each state unless there is a “reciprocal” agreement between those two states that prevents your business from being taxed on both ends.

12. Consider Your Year-End Inventory 

It’s possible you’ll be on the hook for a higher tax bill if you have an inventory surplus at the end of the year.

Therefore, inventory management in your business is critical.

Management of inventory can be done with a management system or physical counts (or some combination of both).

You can also value your inventory in a number of ways, including:

1) Cost (value of item at purchase price)

2) Lower of cost or market (compare cost with current market value)

3) Retail (selling price less the markup percentage)

It’s also important to caution here not to understate your inventory for the purposes of lowering your tax obligation. This will negatively impact your business in the event of an audit.

13. Discuss Depreciating Assets With Your Tax Advisor 

The IRS defines depreciation as an annual income tax deduction that allows you to recover the cost or other basis of certain property over the time you use the property.

Depreciating assets (for example, a cannabis trimming machine) reduces earnings that are used to calculate tax owed.

The key phrase here is “over time,” or in other words, throughout an asset’s useful life. To be compliant with IRS regulations, you may not be permitted to recognize the asset all at once.

There are several methods of depreciation, and your CPA can help you determine which will be compliant and make the most sense for the financials of your business.

14. Utilize the IRS Mobile App 

Yes, there’s an app for that.

It’s called IRS2Go, and it’s available for Amazon, Google Play and Apple users.

IRS2Go allows businesses to pay their taxes on the app through a prepaid virtual or physical card.

It also boasts free tax software to help you prepare and file your taxes.

15. Prepare for When (Not If) Your Cannabis Business Will Be Audited 

In the past year or so, IRS cannabis business tax audits have ramped up.

In other words, if you run a plant-touching operation, you should operate with the understanding that an audit will be a “when,” not “if” scenario. It’s more important than ever to ensure your business is prepared in the event of an audit.

Here are a few things you can do in the event of an audit, or in preparation of one:

1. Be cordial to your auditor. No matter how inconvenienced you may be by the audit process, rudeness will not work in your favor.

2. Keep detailed documents. Anything that was correlated to a deduction should be properly documented and filed in an organized and easily accessible manner.

3. Ensure your communications with the auditor are in writing. Written notices and email are best, which provide a record of correspondence in case they need to be called upon in the future.

4. Work with your cannabis tax attorney or CPA to walk through what will happen in the event of an audit. This will help you feel more prepared in the event the IRS comes knocking.

16. Your Cannabis Business Could Qualify for a R&D Deduction 

IRS Code Section 280E severely limits the deductions a cannabis business can take. 

Typically, expenses other than those surrounding cost of goods sold (COGS) are nondeductible. However, there are some potential additional deductions cannabis businesses should know.

One of those deductions is research and development (R&D).

While R&D deductions hasn’t always been permitted, the federal government has fairly recently opened the door to these deductions for cannabis businesses.

Perhaps your business is developing a new formulation, testing new production strategies and/or equipment, building in-house software or creating a breeding program. These activities may be considered R&D and are potentially deductible.

At CJBS, we describe ourselves as Cannabis CPAs Who Care. We work with our clients as partners, treating their businesses just like we’d treat our own. If you are in need of financial, tax, or accounting services or guidance, please get in touch with our team here

DISCLAIMER: Any Tax or professional advice contained in our communication is not intended or written to be used, and cannot be used, for the purpose of (1) avoiding penalties under the Internal Revenue Code, or (2) promoting, marketing, or recommending to another party any transaction or matter that is addressed herein. In addition, unless otherwise specifically stated, any advice provided shall not be deemed to be formal tax advice. It is important to consult with your certified public accountant (CPA) tax professional on all matters relating to the taxation of your cannabis business.