Webinar Recap: Tax Planning for Cannabis Operators

In this article:

1. Section 280E and Cash Flow
2. Cost Segregation and Depreciation
3. Strategic Tax Planning
4. Rescheduling and Post-280E Strategies
5. Exit Planning for Cannabis Operators
6. How We Help

Navigating the cannabis industry’s complex tax landscape may feel overwhelming, especially given ongoing challenges like Section 280E and potential rescheduling. However, with the right strategies, you can reduce your tax burden, optimize cash flow, and position your brand for growth. AAFCPAs’ 2024 Cannabis Tax Update Webinar, speakers provided valuable insights on overcoming tax obstacles and preparing for regulatory changes.

Below are the key takeaways. You may also watch the full webcast at your convenience.

Section 280E and Cash Flow

Section 280E of the Internal Revenue Code is a persistent challenge for cannabis operators, prohibiting the deduction of most operating expenses. This restriction inflates effective tax rates, which may reach 70 to 90 percent of a company’s profits, and places significant strain on cash flow. Knowing how to best navigate 280E is critical for sustaining profitability and long-term viability in the cannabis industry. 

One key approach to mitigating the impact of 280E is optimizing Cost of Goods Sold (COGS). By carefully categorizing and including all eligible expenses within COGS, businesses can reduce taxable income and their overall tax liability. For example, expenses tied directly to production, such as labor and materials, may qualify for inclusion in COGS. Regularly reviewing and updating these allocations is essential to ensuring compliance with current regulations and maximizing deductions. A misstep in this area may lead to audits, penalties, or missed opportunities for tax savings. 

Beyond COGS, routine tax planning plays a vital role in managing the tax burden under 280E. This includes evaluating changes in business operations or state-level regulations that could affect tax strategies. Additionally, with the potential rescheduling of cannabis to Schedule III, businesses must be prepared to adapt to new rules. Rescheduling could enable operators to deduct standard business expenses, offering significant tax relief. But this will require proactive adjustments to accounting practices and tax filings. 

Strategic planning today not only helps reduce the immediate challenges posed by 280E but also positions cannabis businesses to take full advantage of future tax relief opportunities as the regulatory landscape evolves.

Cost Segregation and Depreciation

Rescheduling cannabis to Schedule III could unlock significant tax advantages, including access to depreciation deductions and tax credits that have previously been out of reach. By leveraging strategies such as cost segregation studies and accelerated depreciation, businesses can reduce taxable income and improve cash flow—all key factors in maintaining competitiveness.

Accelerated depreciation strategies can be especially beneficial, providing immediate tax relief and helping businesses maximize deductions. These strategies include:

• Bonus Depreciation, which allows the deduction of a large portion of qualifying asset purchases in the year they are acquired and thus delivering immediate tax savings.
• Section 179 Deductions, which enable the full expensing of assets like machinery or equipment, providing upfront relief for capital investments.
• A Cost Segregation Study, which reclassifies building components into shorter depreciation categories, maximizing deductions and deferring taxes, ultimately freeing up cash flow without additional spending.

If cannabis is rescheduled, these strategies will become even more valuable. Operators will gain access to deductions and credits that were previously unavailable due to the restrictions of Section 280E, opening new opportunities for tax planning and improved financial performance.

Strategic Tax Planning

To further reduce the tax burden, strategic tax planning is essential. This involves the use of available tax strategies, including:

• The R&D Tax Credit. Cannabis cultivators and manufacturers may qualify for this credit by developing new strains or improving production processes. This credit can help reduce federal and state tax liabilities.
• The Investment Tax Credit (ITC). If you’re investing in renewable energy or energy-efficient facility upgrades, the ITC offers credits for up to 30 percent of the investment, reducing your overall tax burden.

To effectively leverage tax credits, businesses should start by consulting with a tax advisor to identify any research and development activities within their operations that may qualify for the R&D Tax Credit. In addition, it is important to review facilities for potential energy-efficient upgrades that could qualify for the Investment Tax Credit (ITC). Proactively tracking qualified expenses throughout the year will help ensure no credits are overlooked, allowing businesses to maximize available tax savings. This approach not only reduces tax liabilities but also positions businesses for long-term financial efficiency.

Rescheduling and Post-280E Strategies

If cannabis is rescheduled, businesses will finally be able to deduct ordinary operating expenses, aligning them with other industries. This shift could provide immediate tax relief and make the market more competitive. However, until rescheduling occurs, businesses must make careful decisions about their tax strategies. 

A critical choice is whether to continue complying with Section 280E or adopt a non-280E approach. While some companies have chosen to bypass 280E, this carries significant risks because it conflicts with current tax laws. To prepare for a potential rescheduling, operators should consider filing protective claims, which safeguard the ability to claim refunds once rescheduling happens. These claims ensure businesses are ready to take advantage of future changes without jeopardizing compliance. 

Proactive planning is essential. Businesses should work with their tax advisors to determine whether a non-280E strategy fits their circumstances. Keeping past tax years open through protective claims allows for amendments if needed. Additionally, updating accounting systems and tax processes now can help businesses smoothly adapt to any new rules when rescheduling takes effect.

Exit Planning for Cannabis Operators

Whether considering a sale or simply preparing for long-term sustainability, exit planning should be a key part of your tax strategy. With rescheduling on the horizon, operators should consider asset vs. stock sales, Employee Stock Ownership Plans (ESOPs), and Qualified Small Business Stock (QSBS) options to minimize taxes and maximize the value of their business.

An asset sale typically results in double taxation but can be advantageous for the buyer. On the other hand, stock sales may qualify for QSBS benefits, allowing up to $10 million of gains to be excluded from tax if the stock meets specific criteria. Additionally, ESOPs offer a tax-free exit strategy, providing a way for owners to transition out while retaining control over the company.

Key Actions for Exit Planning:

• Evaluate whether an asset or stock sale is more advantageous based on your business structure and long-term goals.
• Consider establishing an ESOP to defer taxes and provide a tax-free transition.
• Explore QSBS opportunities to eliminate up to $10 million in capital gains tax, depending on your stock’s eligibility.

How We Help

AAFCPAs partners with cannabis businesses to navigate complex tax, finance, and regulatory challenges. With more than a decade of experience, our team provides tailored solutions to help you optimize financial strategies and comply with evolving federal and state regulations.

Given the current state of rescheduling and the recent uncertain tax positions taken by leading MSOs, AAFCPAs is well-positioned to advise clients on the pros and cons of a non-IRC 280E approach. We support clients in making informed decisions based on their financial situation, risk profile, and other relevant factors. Our services include analyzing and disclosing specific tax positions, navigating IRS scrutiny, and considering timing implications.

CannCount, a wholly owned subsidiary of AAFCPAs, brings extensive industry expertise to help cannabis operators boost efficiency, profitability, and competitiveness. With years of experience in cannabis finance, operations, and cultivation, we provide data-driven insights that streamline processes, reduce costs, and support growth. Our consulting services help operators optimize everything from cultivation practices to retail operations, ensuring clients can navigate the industry’s challenges and drive lasting success.

If you have questions, please contact David J. Gravel, CPA, MPAc, Tax Director at 774.512.4008 or dgravel@nullaafcpa.com, David McManus, CPA, CGMA, Tax Partner & National Cannabis Practice Leader at 774.512.4014 or dmcmanus@nullaafcpa.com, Joshua S. England, LLM, Esq., Partner & Tax Attorney at 774.512.4109 or jengland@nullaafcpa.com, Janice M. O’Reilly, CPA, CGMA, Partner at 774.512.9046 or joreilly@nullaafcpa.com, Tomás A. Pueyo, Jr., CPA, MSA, Tax Manager at 774.512.9081 or tpueyo@nullaafcpa.com—or your AAFCPAs Partner.