Year-end planning: focus on budgets and tax for cannabis operators

As we approach the close of a turbulent year, cannabis operators have an opportunity to establish a strong finance and tax strategy heading into 2023. You can enter the year from a position of strength by focusing on tax planning, tax compliance, and budgeting to ensure healthy cash flow.

Year End Tax planning

 Tax planning is always a challenge, and it takes on greater urgency in this environment of regulatory and economic uncertainty. This is the time to evaluate your tax situation and try to minimize tax liabilities while considering your overall financial position. You’ll also benefit from reviewing estimated tax requirements, anticipated cash outlays at the filing deadline, and working to avoid underpayment of estimated tax penalties.

While year-end often brings these activities into focus, a more frequent review of expenses ensures that you are capturing all allowable expenses in cost of goods sold.  Maintaining accurate inventory balances throughout the year provides a clearer picture of your gross profit, leading to more accurate calculations of income taxes and related tax payments. This should include periodic reconciliations between your physical counts and your inventory system.

Some indirect costs are allowable only if accounted for as cost of goods sold in internal books and records.  Any allocation methodologies need to be fully supported and documented, and the key to maximizing the category is consistency and conformity with IRS guidelines for deductible expenses under IRS Code Section 471.

Certain state compliance requirements may also dictate what costs are allowable in cost of goods sold. If you are a multistate operator, you’ll need to be familiar with financial reporting regulations in all your locations.

Tax compliance readiness 

No company wants to be surprised by a compliance issue. Part and parcel with tax planning, then, is ensuring you’re aware of and adhering to compliance needs. Some states demand monthly advanced payments, a monthly retail tax return, estimated quarterly taxes, and more; operators can be looking at up to four separate reporting requirements for one dispensary in one state. Indeed, the paperwork associated with state taxes can be more of a challenge than the payments themselves.

When managing multiple locations in multiple states, of course those compliance filings add up quickly. Our work with MSOs often involves creating different entities in each state to avoid comingling issues like tax compliance and licensing requirements. When a range of entities are involved, these filing requirements can compound even further.

Gathering the necessary information and reporting to each of these requirements in the right format is time consuming and labor intensive. Finance departments can be quickly overwhelmed and find themselves pulled away from tasks that are more likely to contribute value to the business on a higher level.

Maintaining good books and records throughout the year will help ensure you have documentation to support your tax position. Consistent check-ups will create a smoother year-end and filing process, removing an operational headache that no business owner enjoys.

Budgeting and cash flow for 2023

Painting an accurate picture of your operating budget and cash flow projections helps you understand whether the business is on-track and what might cause disruption.

“Zero-based budgeting” is the most effective approach to resource and budget planning, because it forces reevaluation of all assumptions each year. This involves starting annually from a blank budget and analyzing expenses for the current budget cycle, taking into consideration business goals and future plans.

In the beginning of the budget process, you can take a step back to assess your financial position and look at key trends and ratios over the last three to five years (if you’ve been operating that long). You should explore operating results/ profits, operating reserves, and liquidity (current debt-asset ratio, cash trends, and collectability of receivables), among other metrics.

Adding complexity to this budgeting season, energy providers have given fair warning that costs will be significantly higher in the coming year. Energy is one of the single biggest operational expenses for cultivators. It will be critical to assess your power needs and forecast related expenses in the budget.  Cultivators with significant power expenses may also have an avenue to maximize credits under the Inflation Reduction Act. 

In a sector that moves as quickly as cannabis does, there are always questions about what may be around the corner. You can create significant advantages by taking a breath at year end to review your tax situation, be sure your organization is in compliance, and plan ahead for operational and cash needs. The best laid plans may come undone, but no plan at all is sure to leave you at higher risk.