Tag Archives: tax

How Section 280E is Still Hindering the Cannabis Industry

By Jay Jerose
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The cannabis industry is an unprecedented industry and one under constant review and control. Following the November 2020 elections, fifteen states and Washington DC have legalized adult use cannabis, a number that will continue to grow as legalization slowly becomes more widely adopted in other states. Beyond that, a continuously growing number of states allow residents to purchase legal medicinal cannabis, and many have also decriminalized adult use. However, it still remains a Schedule I substance under the Controlled Substances Act and is therefore illegal on all accounts at the U.S. federal level, which creates a number of issues for businesses in the cannabis industry duly operating in states where it has been legalized.

Not only is it difficult for cannabis companies to avail themselves of alternative banking solutions, but there are also obstacles in place preventing these companies from taking advantage of notable tax deductions. The primary obstacle being Internal Revenue Code (IRC) Section 280E.

What is Section 280E?

Section 280E is a relatively short code section, only 77 words to be exact, but it carries significant weight and can have a debilitating effect on the taxable income of marijuana [sic] related businesses (MRB). Section 280E of the IRC prohibits taxpayers who are engaged in the business of trafficking certain controlled substances, including cannabis, from deducting typical business expenses associated those activities. Section 280E, which was enacted in 1982 during the “War on Drugs” era, has become increasingly relevant for cannabis businesses. The cannabis industry has grown substantially in recent years with annual market values expected to reach $30 billion by 2025.

However, while Section 280E greatly restricts the tax deductions of state-legal cannabis businesses, there is some reprieve. Current IRC provisions permit state-legal cannabis businesses, including growers, producers, wholesalers or retailers, to deduct the Cost of Goods Sold (COGS) in computing their US federal income tax liability, despite the application of Section 280E.

Impact of Section 280E on Businesses

 What does Section 280E mean for cannabis businesses today? It is intended to prevent dealers from claiming tax deductions for their business expenses, interpreted to include state-legal cannabis businesses, reduced deductions that result in increased taxable income and MRBs will face higher federal tax rates. 

The IRC disallows any deductions or credits paid or incurred during a tax year if those deductions or credits relate to trafficking controlled substances. The courts have taken the position that the term “trafficking” in this case means “engaging in a commercial activity – that is, to buy and sell regularly.” Simply, the law denies cannabis businesses any U.S. federal income tax deduction for ordinary and necessary business expenses, despite being duly licensed as a legal business in their state of operation.

Typically, the ability to deduct ordinary business expenses means that a business is subject to federal tax on its net income (i.e., gross receipts minus expenses). However, the definition of Section 280E and the classification of cannabis as a Schedule I substance severely hinders legal cannabis companies from taking advantage of tax deductions for actual economic expenses incurred in the ordinary course of business, which results in a significantly higher effective tax rate as compared to other businesses.

Legal Actions and Challenges to Section 280E

There have been court challenges and concessions made to Section 280E. Specifically, the 2007 court case Californians Helping to Alleviate Medical Problems, Inc., v. Commissioner. This court case reinforced the precedence that Section 280E does not apply to cost of goods sold. The Internal Revenue Service (IRS) defines cost of goods sold to be “expenditures necessary to acquire, construct or extract a physical product which is to be sold.” Generally, for a retail MRB, this means that the direct cost of acquiring cannabis products for resale. Deductions for rent, utilities, wages, insurance and other operating costs common to ordinary businesses are generally disallowed. New York State has specifically indicated that it intends to follow Section 280E for its own income tax calculations, disallowing these same deductions against New York taxable income

Tax Court and Section 280E

The Tax Court has also been aggressive in tamping down efforts by MRBs to separate cannabis related and non-cannabis related activities. The courts argue that these separate activities constitute a single trade or business when they share a close and inseparable organizational and economic relationship. In addition, the risk of cannabis related activities tainting a taxpayer’s other business concerns exists if services or employees are shared between an MRB and a non-MRB. Allocation of expenditures to cost of goods sold, as well as any allocations of costs between MRB and non-MRB entities, need to be well thought out and supported by defensible tax and accounting positions.

The Future of MRBs and Section 280E

All indications point to an increased frequency of IRS audits of MRBs compared to audits of non-cannabis related businesses. Therefore, documenting the methodology behind the calculation of costs of goods sold is even more important for MRBs. It is vital to consult with a tax advisor to ensure you are maximizing your cost of goods sold deductions and preparing the best documentation possible to support your 280E tax positions.


Disclaimer: The information presented in this article should not be considered legal advice or counsel and does not create an attorney-client relationship between the author and the reader. If the reader of this has legal or accounting questions, it is recommended they consult with their attorney or accountant.

Connecticut Legalizes Cannabis

By Cannabis Industry Journal Staff
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Update: Governor Ned Lamont has signed S.B. 1201 into law, officially legalizing cannabis in the state of Connecticut


On June 16, 2021, the Connecticut House of Representatives voted to pass their version of S.B. 1201, a bill that legalizes adult use cannabis. Following the House’s approval of the changes, the bill made its way back to the Senate on June 17, where they approved all changes. It now heads to the Governor’s desk, where Gov. Ned Lamont is expected to sign it into law.

Connecticut Governor Ned Lamont

With Gov. Lamont’s signature, Connecticut will become the 19th state in the country to legalize adult use cannabis. The bill is slated to go into effect on July 1, just a couple of weeks away.

Come July 1, adults in Connecticut can legally possess up to 1.5 ounces of cannabis in public and up to five ounces at their home. The bill allows for adults to grow at home, just not until 2023 unless you are an existing patient registered in the medical program.

According to the Marijuana Policy Project (MPP), the bill will expunge cannabis records for low-level crimes and puts “the bulk of excise tax revenues into a Social Equity and Innovation Fund, which will be used to promote a diverse cannabis industry and reinvest in hard-hit communities.” Half of the cannabis business licenses issued will go to social equity applicants that can receive funding, workforce training and other types of assistance from the program.

Connecticut state flag

DeVaughn Ward, senior legislative counsel at MPP, says the bill includes provisions to repair harm done by the prohibition of cannabis. “The Connecticut Legislature’s commitment to legalizing cannabis through a justice-centered approach is commendable,” says Ward. “For decades, cannabis prohibition and criminalization has harmed some of the state’s most vulnerable communities. This bill not only ends this failed and unjust policy, but it also includes measures that will work to repair the harm that it has caused. This state will be a model for others to follow.”

The bill includes strong protections for employees, tenants and students by limiting discriminatory actions based on positive drug tests. It also dedicates 25% of tax revenue from cannabis to go toward mental health and substance use treatment.

Interestingly, the bill has a THC cap in it. Cannabis flower sold at dispensaries is capped at 30% THC content and concentrates (except for vape carts) are capped at 60% THC. To read more about the nuances of the legislation, the MPP has a helpful summary of the bill you can find here.

New York Legalizes Adult Use Cannabis

By Cannabis Industry Journal Staff
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On March 31, 2021, New York Governor Andrew Cuomo signed The Marijuana Revenue and Taxation Act (MRTA) into law, legalizing adult use, home cultivation and possession of cannabis for adults over 21 immediately. Upon signing the bill this morning, previous cannabis-related convictions are automatically expunged, according to the Governor.

The bill establishes the Office of Cannabis Management, which will launch and manage the regulatory system for the commercial cannabis market in New York.

According to Steve Schain, senior attorney at Hoban Law Group, the Office of Cannabis Management will have a five-member board that will oversee not just the adult use cannabis market, but also medical cannabis as well as the state’s hemp market. For the medical market, the new legislation provides for more patient caregivers, home cultivation and an expanded list of qualifying conditions.

New York Governor Andrew Cuomo
Image: Chris Rank, Flickr

Troy Smit, deputy director of the New York NORML chapter, says the bill might not be perfect, but it’s a massive win for the cannabis community. “It’s taken a great amount of work and perseverance by activists, patients, and consumers, to go from being the cannabis arrest capital of the world, to lead the world with a legalized market dedicated to equity, diversity, and inclusion,” says Smith. “This might not be the perfect piece of legislation, but today, cannabis consumers can hold their heads high and smell the flowers.”

The MRTA sets up a two-tier licensing structure that separates growing and processing licenses from dispensary licenses. The bill includes a social equity aspect that requires 50% of the licenses to be awarded to, “minority or women-owned business enterprise, service-disabled veterans or distressed farmers,” says Schain.

New York City
Image: Rodrigo Paredes, Flickr

Melissa Moore, New York State director of the Drug Policy Alliance, says she’s proud of the social equity plan the bill puts in place. “Let’s be clear — the Marijuana Regulation and Taxation Act is an outright victory for the communities hit hardest by the failed war on drugs,” says Moore. “By placing community reinvestment, social equity, and justice front and center, this law is the new gold standard for reform efforts nationwide. Today we celebrate, tomorrow we work hard to make sure this law is implemented fairly and justly for all New Yorkers.”

Schain says the new tax structure in the bill shifts to the retail level, with a 9% excise tax and 4%-of-the-retail-price local excise tax (split 25%/75% between the respective counties and municipalities). Revenue from cannabis taxes will enter a fund where 40% will go to education, 40% to community grants reinvestment fund and 20% to drug treatment and public education fund.

It appears that businesses already established in New York’s medical market get a head start on the new adult use market, while other businesses enter the license application process, according to Schain. “Although the existing Medical Marijuana licensees should be able to immediately to sell Adult-Use Cannabis, it will take up to two years for the New York’s Adult Use Program to launch and open sales to the public,” says Schain.

Wyoming Lawmakers Introduce Bill to Legalize Cannabis

By Cannabis Industry Journal Staff
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Update: The House Judiciary Committee has passed the legalization bill, HB0209, by a 6-3 vote. After moving out of the Judiciary Committee, the bill now awaits a floor hearing, which is expected to come within the next week or two during the legislative session that ends on April 2. 

A bipartisan group of lawmakers in Wyoming have introduced a bill to legalize cannabis in the state’s legislature. First reported by Buckrail.com, HB0209 was assigned on March 2. The bill would legalize possession, home grow and sales for adults, as well as establish a regulatory framework for licensing, tracking and taxation.

In November 2020, voters in Montana and South Dakota passed ballot measures that legalize adult use and sales of cannabis. About a month after Election Day, the University of Wyoming conducted a poll that found roughly 54% of Wyoming residents now support legal adult use cannabis. In 2018, UW found that 85% of Wyoming residents support medical cannabis legalization.

In March of 2019, Wyoming Governor Mark Gordon signed a bill into law that essentially legalized hemp in the state. That bill was a boon for the state’s agricultural economy, giving many farmers a much-needed boost in their crop diversity.

Wyoming Governor Mark Gordon

You can find the current version of HB0209 here. Sponsors of the bill include: Representatives Jared Olsen (R-Laramie), Mark Baker (R-Sweetwater) Eric Barlow (R-Campbell/Converse), Landon Brown (R-Laramie), Marshall Burt (L-Sweetwater), Cathy Connolly (D-Albany), Karlee Provenza (D-Albany), John Romero-Martinez (R-Laramie), Pat Sweeney (R-Natrona), Cyrus Western (R-Sheridan), Mike Yin (R-Teton) and Dan Zwonitzer (R-Laramie) and Senators Cale Case (R-Fremont) and Chris Rothfuss (D-Albany).

According to Buckrail, if the bill becomes law, Wyoming could get roughly $49.15 million in tax and license fee revenue in 2022. That number would mean a sizable windfall for the state that saw an 8.5% decline in tax revenue in 2020. Governor Gordon proposed budget cuts as high as 15% for agencies across the state last year. Most of the revenue generated from cannabis taxes would be earmarked for education.

Wyoming’s tax revenue is notoriously limited when it comes to diversity: the state makes its money on oil and gas, and that’s about it. Earlier this year, the Biden administration halted oil and gas leasing on federal land, hitting pause on a nearly half-million-acre deal. If the pause on oil and gas leasing on federal lands continues or were to become permanent, Wyoming stands to lose tens, if not hundreds, of millions of dollars every year.

So, what does the least populous state in the country do when they can no longer generate revenue from oil and gas? Simple. Legalize cannabis.

Learning from The First Wave Part 3: Seven Basic Questions About Local Cannabis Ordinances & Real Estate

By Todd Feldman
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Part One of this series took a look at how the regulated cannabis market can only be understood in relation to the previous medical market as well as the ongoing “traditional” market. Part Two of the series describes how regulation defines vertical integration in California cannabis.


If you are considering getting involved in California cannabis, imagine the following sentence in ten-foot-tall letters made out of recently ignited $20 bills:

Before you put any money down on property, carefully examine the local cannabis ordinance and tax rates. 

This article is written in the form of advice to a newbie cannabis entrepreneur in California, but it will discuss issues that are also of significance to investors, as well as (to various degrees) cannabis entrepreneurs in other states.

Here are seven basic questions that you need to ask about local regulations (in order, except for Number 7).

1. What’s Your Jurisdiction?

If you’re in city limits, it’s the city. If you’re outside city limits, it’s the county.

2. Does the Jurisdiction Allow Cannabis Activities?

If the answer is yes, go to the next question. If the answer is no, pick another jurisdiction.

3. Where Does the Jurisdiction Allow Cannabis Activities?

A zoning ordinance will limit where you can set up shop. The limitation will probably vary by license type.

4. How Does the Local Ordinance Affect Facility Costs?

The short answer is: in many ways. Your local ordinance is a Pandora’s box of legal requirements, especially facility-related requirements.1 Read your local cannabis ordinance very carefully.

Generally speaking, the cannabis ordinance will set out two types of requirements – those that are specific to cannabis and those that apply generally to any business.

Looks great but . . . where are the sprinklers? Does it need a seismic upgrade? How about floor drains?
Photo by Wilhelm Gunkel on Unsplash

Cannabis-specific requirements:

  • Typically incorporate state cannabis laws by reference.
  • Have significant overlaps with state cannabis laws. For example, the state requires commercial-grade locks and security cameras everywhere cannabis may be found on a given premises. Local ordinances generally include similar requirements – keep in mind that you will need to comply with a combined standard that satisfies both state and local requirements.2
  • Vary greatly according to type of activity. For example, manufacturers will need to comply with Health & Safety Code requirements that can have a major impact on construction costs.
  • Vary greatly by jurisdiction when it comes to equity programs.

General requirements:

  • Include by reference building and fire codes, which can require very expensive improvements. Note that this means your facility will be inspected by the building department and the fire department.
  • Can include anything from Americans with Disabilities Act (ADA) requirements to city-specific requirements, such as Design Guidelines.
  • Will be zealously enforced because you’re a cannabis business.

5. What is the Enforcement Policy?

It may be that your local jurisdiction will give you temporary local authorization after meeting some, but not all, of the requirements. For example, you may be able to begin operations once you’ve provided your city or county with your cannabis permit application, a zoning clearance and a business permit. In this jurisdiction, you would be able to bring your building up to code sometime after you begin operations.

On the other hand, your local jurisdiction may require you to meet every requirement – from cannabis-specific security requirements to general building code and ADA requirements – before you can begin operations. Depending on the type of cannabis business (and facility condition), this might be inconsequential. Or it might mean that you will have to pay more than a year’s worth of rent (or mortgage) before you can start making money.

6. Can You Choose a Facility That Saves You Time and Money?

Of course, you won’t have to spend much time or money bringing your facility up to code if it’s already up to code. How likely it is that you will find such a facility varies wildly according to the type of cannabis activity in question. In general:

  • Service-side activities (delivery retail, storefront retail, distribution) are in many respects similar to their non-cannabis counterparts. From a facilities standpoint, the major differences come from security requirements. So, it may be possible to save time and money by choosing a facility that is already up to code for a similar use.
  • Manufacturing activities are trickier, since you will need food-grade facilities and equipment. You may be able to save money by setting up shop in a commercial kitchen.
  • Extraction with volatile solvents is a special (and particularly expensive) case, since it is inherently dangerous and requires special facilities.
  • Outdoor cultivation may be relatively unproblematic if it has an appropriate water source.
  • Indoor cultivation is expensive because of climate-control and lighting requirements. Buildings potentially suitable for large-scale indoor grows frequently come with significant problems. Former warehouses will typically require major power upgrades, while former factories may have inconvenient architecture and/or hidden toxic waste. In all cases, internal reconstruction is likely to be necessary, and will trigger all sorts of building and fire code requirements.

7. What Are the Local Cannabis Taxes?

Cannabis tax rates may be determinative. For example, Oakland imposes a 6.5% gross receipts tax on manufacturers that have gross receipts of less than $5M, and 9.5% on manufacturers that have gross receipts over $5M. In comparison, Santa Rosa only imposes a 1% gross receipts tax on manufacturers.

Local cannabis ordinances and taxes can make or break your business, so you need to understand them before you commit to a location. The seven basic questions listed above are designed to get you started.

This article is the opinion of the author and is not intended to be legal or other advice.


References

  1. For example, see Part II of the City of Oakland’s Administrative Regulations and Performance Standards, and The City of Los Angeles’s Rules and Regulations for Cannabis Procedures No. 3 (A)(14).
  2. For example, compare 16 CCR § 5044 (“Video Surveillance System”) with The City of Los Angeles’s Rules and Regulations for Cannabis Procedures No. 10 (A)(7).

Learning from the First Wave Part 1: How Law Shapes the California Cannabis Industry

By Todd Feldman
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As a cannabis lawyer, I spend a lot of time thinking about the ways that regulations affect a cannabis company’s bottom line. Since I’m in California, the ways are many.

In late 2017 I became the chief compliance officer for an Oakland startup that carried out delivery, distribution, cultivation and six manufacturing operations. A big part of my job was preparing my company, along with several equity cannabis companies, for California’s First Wave of cannabis licenses.

For the most part, First Wave licensees came from California’s essentially unregulated medical cannabis market, and/or from California’s by-definition unregulated “traditional” market. When California began issuing licenses in January 2018, many First Wavers were unprepared because their businesses practices had evolved in an unregulated market. A big part of my job was to help them adapt to the new requirements. As a result, I saw the regulations, and the effects of regulations, in sharp relief.

Regulation touches virtually every aspect of the legal cannabis industry in California. So anyone who wants to understand the industry should have at least a basic understanding of how the regs work. I’m writing this series to lay that out, in broad strokes.

Some key points:

  • The regulated market must be understood in relation to the previous unregulated (medical) market as well as the ongoing traditional market.
  • Regs define the supply chain.
  • Regs are designed to ensure product safety and maximize tax revenue.
  • Many regulations mandate good business practices.
  • Local enforcement of building, health and safety codes tends to be zealous and costly.

A Tale of Three Markets

California’s regulated cannabis market can only be understood in relation to the medical market that preceded it, and in relation to the traditional market (illegal market) that continues to compete with it.

The Before Times

California’s legal medical cannabis market goes back to 1996, when the Compassionate Use Act passed by ballot measure. One fact that shaped the medical market was that it was never just medical – while it served bona fide patients, it also served as a Trojan horse for adult-use (recreational) purchasers.

Another fact that shaped the medical market was a near complete lack of regulation. On the seller’s side, you had to be organized as a collective. On the buyer’s side, you had to have a medical card. That was it.

Meanwhile, the cannabis supply chain was entirely unregulated. This tended to minimize production costs. It also meant that a patient visiting a dispensary had no way of verifying where the products had been made, or how.

The Regulated Times

Licensing under the Medical and Adult-Use Cannabis Regulation and Safety Act (the “Act”) began on January 1, 2018. It was the beginning of legal adult-use cannabis in California. It was also the beginning of the Regulated Times, as the Act and accompanying 300-plus pages of regulations transformed the legal cannabis market.

 For example:

  • The Act defines the cannabis supply chain (as a series of licensees).
  • Across the supply chain, the internal procedures of cannabis companies are subject to review by state agencies;
  • Cultivators and manufacturers cannot sell directly to a dispensary – they must go through a distributor;
  • All cannabis must be tested for potency and a long list of contaminants by a licensed testing laboratory before it may be sold to consumers;
  • And beginning in 2019, all licensees were required to participate in the California Cannabis Track and Trace (CCTT) program, which is designed to track all cannabis from seed to sale.

Just as importantly, the Act establishes a dual licensing system – that is to say, in order to operate, a cannabis company needs a local permit (or other authorization) as well as a state license. In fact, local authorization is a prerequisite for a state license. And your local jurisdiction will have its own rules for cannabis that apply in addition to the state rules, up to and including a ban on cannabis activities.

Needless to say, operating in the Regulated Times is a lot more complicated and expensive than it was during the Before Times.

Especially when you consider the taxes. For example, in the City of Los Angeles, sale of adult-use cannabis is taxed at 10%, which means that any adult-use purchase in L.A. gets a 34.5% markup:

  • 15% state cannabis excise tax, plus
  • 10% Los Angeles Adult Use Cannabis Sales tax, plus
  • 5% sales tax.

Note that the distributors must collect the excise tax from the retailer, so the 15% markup is not necessarily visible to the consumer. Similarly, consumers are generally unaware that there is a cultivation tax of $9.65 per ounce (or about $1.21 per eighth) of dried flower that the distributor has to collect from the cultivator.

Theoretically, all of this might be unproblematic if licensed retailers were only competing with each other. Which brings us to:

The Traditional Market

The traditional market is the illegal market, which is to say, the untaxed and unregulated market.

Legalization of adult-use cannabis was supposed to destroy the traditional market, but it hasn’t. As of early 2020, the traditional market was estimated to be 80% of the total cannabis market in California. This is not surprising, since the traditional market has the advantages of being untaxed and unregulated.

The traditional market has a pervasive negative effect on the legal market. For example, the traditional market tends to depress prices in the legal market and tends to attract talent away from the legal market. Some of these effects will be discussed in the following articles.

This article is an opinion only and is not intended to be legal advice.

The Cannabis Industry and Tax Implications of Entity Structure: Issues to Consider

By Calvin Shannon
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This piece is intended to provide some considerations that current and potential license holders should think about as they work with advisors to make entity selection decisions or consider potential tax elections. Please note that this article is a high-level overview and is not intended to declare the best type of entity structure for a license holding entity. Although there are numerous tax variables that should be contemplated, tax issues are not the only concerns relevant to determining entity type. In addition, some states may tax entities differently than how the entity is taxed for federal purposes.

First, let’s look at the legal entity types that may be set up to hold a license, operate a business and what that may mean for how an entity is taxed. Often, entities are set up as either limited liability companies or corporations.

If a limited liability company is organized and the entity is owned by only one owner, a single member LLC, the default tax treatment would be that the entity is disregarded for tax purposes. In other words, it would not file a separate federal income tax return, except in some states including CA, TX, TN and RI. All the tax consequences of the activities within the legal entity are reported on the tax return of the owner of the entity.

If a limited liability company is set up and the entity is owned by more than one owner, a multiple member LLC, the default tax treatment would be that the entity is taxed as a partnership. An entity taxed as a partnership reflects the tax consequences of the activities within the legal entity on a partnership return. The partnership generally does not pay tax on the activity, but rather the taxable income and loss are passed through to the owners of the LLC. The owners of the LLC reflect the taxable income or loss on their tax return and are responsible for paying any resulting tax. In the rare instance of an entity being audited, there is a possibility that the entity may have to pay tax on the partners behalf, depending on the ownership structure. Either a single member LLC or a multiple member LLC may elect to treat the LLC as a C-corporation or an S-corporation for tax purposes.

The Taxation of C-Corporations & S-Corporations

The default treatment for an entity set-up as a corporation is the entity will be taxed as a C-corporation. An entity taxed as a C-corporation, including an LLC electing to be taxed as a C-corporation, pays the tax on any taxable income generated by activities within the entity.  Additionally, any distributions of earnings from the C-corporation to the owners of the entity are generally considered dividends which are required to be reported as taxable income by the owners when received. In other words, the earnings of an entity taxed as a C-corporation are potentially taxed twice. Once, as they are earned within the entity, and then again upon distribution to the owners of the entity.

An entity set-up as a corporation, a single member LLC or a multiple member LLC may elect to be treated as an S-corporation. Like an entity taxed as a partnership, an S-corporation does not pay tax at the entity level, but rather passes the taxable income and loss through to the owner or owners. Additionally, like a partnership, distributions from an S-corporation are not taxable as dividends to the owner when received.

Since we covered how different entities are taxed based on how they are set-up, and what elections they may or may not make, we will explore some of the issues that should be considered when making an entity selection. We will also address potentially electing to treat an entity one way or another for tax purposes. 

S-Corporations 

Advantages: The advantages of an S-corporation are limited to the avoidance of double taxation associated with C-corporations, as well as some potential benefits of lower Social Security and Medicare taxes.

Disadvantages: The primary disadvantage of an S-corporation for a license holding company is any non-deductible expenses resulting from 280E are passed through to the owner(s), which then reduces the ownership’s tax basis in its investment in the entity. A reduction in tax basis is determinantal to owners of an entity because the basis is used to reduce taxable income when/if the owner liquidates ownership in the entity.

Other disadvantages of S-corporations include but are not limited to restrictions on ownership of the entity, a requirement for reasonable compensation paid to owners and a lack of flexibility in the allocations of earnings among owners.

Partnerships

Advantages: The advantages of a partnership include but are not limited to the avoidance of double taxation associated with C-corporations, flexibility in the allocation of earnings and losses among owners, and flexibility in the type of owners of the entity.

Disadvantages: Like S-corporations, the primary disadvantage of a partnership is any non-deductible expenses resulting from 280E are passed through to the owner(s).

Other disadvantages of partnerships include potential self-employment taxes on earnings allocated to active owners, potential complexity in the allocations of taxable income and losses among partners in entities with many owners or different classes of ownership.

C-Corporations

Advantages: In contrast to S-corporations and partnerships, the tax basis resulting from the ownership’s investment in the entity is not subject to reductions from non-deductible expenses being passed through to owners. This protection of tax basis is particularly important to owners of license holding entities.

An additional advantage of C-corporation tax treatment may be a lower tax rate applied to taxable income.

Disadvantages: The most significant disadvantage of C-corporation tax treatment is the potential double taxation of earnings that might be applicable if the entity does have earnings that are distributed.

In addition to the items address above, the advantages and disadvantages of the entity type and related tax elections, additional considerations include:

  1. How much of the 280E nondeductible expenses will the taxpayer be subject to?
  2. How much earnings will the entity be distributing to the owners?
  3. How complex is the entity’s ownership?
  4. The lack of certainty regarding whether or not the qualified business income deduction (QBID) enjoyed by pass-through entity owners is allowable as a deduction by owners receiving pass-through income from an entity subject to 280E.
  5. Are there plans for selling the entity and if so, what is the time horizon for doing so?

At Bridge West, we advise taxpayers to consult with cannabis advisors who have experience in the industry, can help navigate the complexities of tax compliance and Code Section 280E and are experienced with entity structures.

MORE Act Passes the House – Is Legalization Around the Corner?

By Steve Levine, Alyssa Samuel
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On Friday, December 4, 2020, the US House of Representatives passed the Marijuana Opportunity Reinvestment and Expungement Act of 2019 (the MORE Act), which would effectively legalize cannabis by removing it from the Controlled Substances Act. The bill (H.R. 3884) has several key components:

  • Most importantly, the bill would remove cannabis from the list of controlled substances in the Controlled Substances Act, as well as other federal legislation such as the National Forest System Drug Control Act of 1986. This would effectively end many of the obstacles created by the federal illegality of cannabis such as the lack of access to banking, tax consequences such as 280E, adverse immigration impacts and threats of federal criminal enforcement.

    Rep. Earl Blumenauer (D-OR) donning his cannabis mask as he presides over the Congress
  • Second, not only does the bill preclude future prosecution for cannabis-related crimes, the bill is designed to be retroactive and would provide for the expungement of past non-violent cannabis offenses.
  • The bill creates a prescribed excise tax on cannabis and cannabis products. The funds collected from the taxes would be channeled into opportunity and reinvestment programs.
  • A Community Reinvestment Grant Program would be established aimed at the provision of services for “individuals most adversely impacted by the War on Drugs,” such as job training, education, literacy programs, mentoring, and substance use treatment programs;
  • A Cannabis Opportunity Program would be established providing state funds for small business loans in the cannabis industry targeted at social equity candidates; and
  • An Equitable Licensing Grant Program providing funds for states to implement equitable cannabis licensing programs aimed at minimizing “barriers to cannabis licensing and employment for individuals most adversely impacted by the War on Drugs.”
  • The bill would require all cannabis producers to obtain a federal permit. Cannabis businesses would need to be licensed at the state, local, and federal levels to operate.

This MORE Act is a substantial step in cannabis legislation. Reactions to the proposed legislation have been mixed. While the bill does include some measures aimed at social equity, critics of the bill claim it does not go far enough. Similarly, while the bill includes a federal permitting provision, this would be the beginning of a nascent federal regulatory scheme.

What does this mean for your business? 

While this bill passed in the US House of Representatives, it would still need to pass in the U.S. Senate this term, which by most accounts does not seem likely. However, the passage of this bill signifies the progress that has been made and provides insight on what further legislation may look like.

2021 Trends: Nine Developments in California’s Cannabis Market

By Amy Steinfeld, Jack Ucciferri
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While we’re pleased to report that 2020 is almost over, 2021 will be a mixed bag. New jurisdictions will open their doors to cannabis and consumption will continue to rise, but competition from new operators and illicit supplies will increase. As California’s cannabis industry matures and turns the page on a bizarre year, market uncertainty will linger as the pandemic drags on and overtaxation and regulation strangle profits. But let’s remember, cannabis has been cultivated for over 6,000 years and has withstood far worse—this market isn’t going anywhere and will continue to grow and become more impactful.

Access to Traditional Finance Services

The U.S. Senate will likely pass legislation providing cannabis businesses access to traditional banking and financing services. This will be a game changer for the industry. Valuations will go up. Increased liquidity will smooth transactions. Companies will look to affordable debt to expand their footprints and capacity to compete on a new scale. Full federal legalization could be a game changer if 280E tax restrictions are lifted and interstate and international cannabis trade open up, but the timing of this is hard to predict.

Continued Quarantine-Induced Consumption

Cannabis consumption will continue to increase as Californians seek to ease pandemic-related stress, temper quarantine conditions, and sample an eye-popping array of new products. Sophisticated consumers will be open to spending more on unique and niche products. But hemp-derived cannabinoids may present a new source of competition, especially if CBD remains unregulated. By the end of 2021, cannabis beverages will begin to compete with mainstream alcohol categories. Pharmaceuticals will increasingly take notice of this industry and the increasing share of consumers turning to plant-based remedies.

Ever More Cultivation Opportunities 

In pursuit of revenue, agricultural counties will liberalize their policies on cannabis cultivation by permitting more acreage and streamlining permit processes. Neighborhood groups will push back, but policymaker concerns will be assuaged when they see cannabis farms operating innocuously (and sustainably) around the state. Advances in seed breeding, pest-and-disease control, outdoor growing techniques and odor abatement technology will help too.

New Retail

Cities and counties will revisit opening their borders to cannabis retail storefront and delivery as they attempt to fill budget gaps. Many cities will allow cannabis retail for the first time and/or expand the number of licenses available. These new dispensaries will provide a much-needed outlet for the influx of licensed flower and will continue to spur innovation and consumer education. But a “second wave” of retail speculators seems poised to let optimism override judgement, setting themselves up for failure or acquisition by incumbents.

Getting Social Equity Right

2021 will be a pivotal year for social equity, which will establish a foundation for a just cannabis economy. The industry will have to grapple with how to ensure that those most impacted by the criminalization of cannabis and most often excluded from traditional financing exposure are provided with equitable access to meaningful opportunities. As California’s regulated cannabis market grows, getting social equity right will be important if the industry is to firmly establish itself as an inclusive industry that addresses impacts on marginalized communities and responds to customer demands.

Formalizing Appellations  

California’s new CalCannabis Appellations Program will provide cultivators and brands a way to credibly market the value of their unique growing regions and cultivation methods. These distinctions only apply to cannabis planted in the ground, excluding greenhouse and warehouse grows. The expectation is that high-end consumers, trained to recognize place-based designations and quality certifications in other products, will reward products that boast these designations. How many consumers will be willing to pay the premium and how long full implementation of the program will take, remains to be seen.

Prices May Begin to Drop

2020 was a great year for the few fully licensed cultivators in California permitted to sell to the regulated market. 2021 may be different. Numerous licensed cultivation projects will complete the permitting processes and come online next year. While growing demand may outpace supply at first, by Q3 supplies could swamp the market. Premium flower is perhaps an exception. Adding to the pricing pain, as always, is California’s illicit market, which will continue to undercut prices, as legal growers toil to comply with a labyrinth of state and local regulations. Nonetheless, cannabis will remain the most profitable crop on a per acre basis for some time.

Business Turmoil

The drop in prices coupled with continued high taxes and regulatory burdens will result in turnover of assets and businesses. Less efficient and inexperienced cultivators will struggle, many unable to ultimately withstand pricing pressure. Others will be hit by enforcement actions for failing to comply with California’s myriad regulations. Retailers, already burdened by punitive tax structures, real estate finance commitments and onerous local regulations, will need to be disciplined and have a clear strategy to address new competition.

Consolidation

Driven by business failures and renewed investor interest, California’s regulated cannabis industry may consolidate rapidly in the second half of 2021. Institutional finance will enter the space with a much more disciplined approach than prior capital sources. Traditional agricultural interests will invest in cannabis cultivation projects. Well-run retail chains will begin to outcompete, and then acquire, mom-and-pop competitors. Big brands will continue to expand their shelf space, relegating smaller competitors to niche and novelty status.

In short, the cannabis industry will continue to be highly dynamic, exciting, enticing and risky.