Simon Gumma, CPA, CGMA, Cannabis Legal Group

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Tax & Accounting
CPA ATTESTATIONS FOR PRE-QUALIFICATIONS, ACCOUNTING AND
280E - PRINCIPLES AND MITIGATION STRATEGIES
SIMON GUMMA, CPA, CGMA

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280E Overview
• Cost of goods sold is only deduction available to businesses trafficking in
cannabis for federal tax purposes
• Some states do not apply 280E for state income tax purposes (Oregon)
• Focus on capitalizing as many expenses as possible to COGS; this is actually
the IRS’s preferred position

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280E Defined
• Involves expenditures in connection with the illegal sale of drugs
• No deduction or credit shall be allowed…in carrying on any trade or business if
such trade or business (or the activities which comprise such trade or business)
consists of trafficking in controlled substances.

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The Importance of Corporate Structure
3 main options:
• C corporation
o Pays corporate level tax
o Less tax efficient than a pass-through
• S corporation
o All shareholders must be individuals
o Reasonable salary to owner operators
• Limited liability corporation (LLC)
o Very flexible entity
o Pass-through income could be subject to S.E. tax

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The Importance of Corporate Structure
What entity type makes the most sense by industry segment?
• Retailer
• Wholesaler/distributor
• Producer/processor
How ownership structure influences entity choices
• What functional role does the ownership group play in the operation of the business?
Does entity type even matter? (YES!)

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CorporateStructure: Retailers
C Corp is preferred vehicle to operate dispensary or recreational cannabis store
• Tax liability is contained inside the corporation
o Some retailers are not profitable after taxes
• Shareholders not liable for taxes of the business individually
o Protects shareholders’ other assets from potential liens and levies

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Corp. Structure: Retailers
• Not as tax efficient as pass-through entity
◦ Downside protection could be more important in EARLY years
•Low salary, high dividend strategy
o Ability to control timing of dividends
o Can also take loans from corporation tax free. Must eventually be repaid.

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Corp. Structure: Retailers
• S Corp can hold a tax trap for the
unwary
• Non-deductible or partially non-
deductible salary gets taxed again at
individual level via W-2

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Corp. Structure: Retailers
• “Reasonable salary” can potentially cause double taxation
o IRS could demand higher “reasonable salary”
• Highly profitable retailer could make switch to S corp after business is established,
profitability metrics determined
• Compare C vs. S corps side-by-side
o Assume salary is non-deductible & dividends are
o Maxed to make determination

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Corp. Structure: Retailers
LLC
• Also a pass-through entity, so tax liability determined at individual level
• Income is subject to self employment tax + income tax
o Can be a substantial amount
• Same downside issues as S corp:
o Tax liability is individual liability
o Exposes owners to potential tax liens and levy

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Revenue $1,000,000
COGS (500,000)
Gross Margin 500,000
SG&A (non-deductible) (400,000)
Pretax income 100,000
Tax (corp. rate) (170,000)
After tax loss $ ( 70,000)
Corp.Structure:Downsideprotection(C Corp)
• Example of why it makes sense to
use a C corp. when non-deductibles
are relatively high
• Company is experiencing an
economic loss after taxes
• Wise to contain the tax liability
inside the corporate entity rather
than passing it through to the
individual shareholders

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Corp. Structure:Wholesaler/Distributor
• Tax impact similar to retailers
• C corp is preferred entity
• Delivery and sales expenses are
significant and are generally NOT
deductible for tax purposes
• Expenses of receiving goods ARE
deductible

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CorporateStructure:Producers& Processors
• 280E impact not as significant
• Traditional net income is closer to taxable income as compared to retailers
• C corporation protections are less urgent

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Corp.Structure:Producers& Processors
• S corp or LLC is best option
o Depends on ownership structure,
operational functions of owners
• Pass-through entities are more tax
efficient
• One level of tax vs. C corp

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Producers/Processors:Ownership Example
• Three owners
oTwo in charge of production
oOne in charge of admin, distribution and marketing
• Best option would likely be LLC
• Requirement to pay “reasonable salary” to admin partner would create a double
tax to extent of his or her non-deductible wages
• LLC not required to pay a “salary”
• Weigh cost against self-employment tax

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RetailTax Strategies
• Split cannabis sales away from paraphernalia, branded merchandise and other items
or services
• Best method is to physically divide premises and put respective operations in
separate entities
• Separate books and records

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RetailTax Strategies
• Separate employees
• Must be a real and substantial business; should be able to stand on its own
• Opportunity for deductible brand marketing

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Producer/ProcessorTax Strategies
Segregate Your Operations
• Producers and processors should hold any land, building and equipment in an
entity separate from the one that is considered to be trafficking.
• Lease back to operating entity
• This entity will not be subject to 280E and therefore not subject to deduction
restrictions

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Producer/ProcessorTax Strategies
• Opportunity to take more aggressive tax depreciation deduction
oSection 179
oBonus depreciation
• Those methods not availablein cannabis COGS due to clear reflection of income
issues
• Changes the character of the income or loss to rental

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Effectof SeparateEntitieson Depreciation
Assets placed in service
Land 200,000
Building 500,000
Improvements 130,000
Equipment - 7 year 400,000
Equipment - 5 year 50,000
To t a l 1,280,000
Comparison of First Year Depreciation
Leasing Company (not subject to 280E) 270,013
Grow Operation (Entity subject to 280E) 81,442
Additional Depreciation allowed 188,571
Potential Tax Savings @ 35% $ 66,000
Note: If the overall income of the Leasing Company
allows for the § 179 deduction, the first year
depreciation would total $461,442 producing a
potential tax savings of $133,044!

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Producer/Processor Tax Strategies
• Creates potential opportunity to offset operating income
• Be sure to charge commercially reasonable rents. Don’t get cute!
• Lease agreement should be in writing
• Creates different opportunities for investors that don’t want direct
connection to cannabis
oWork-around for out-of-state investors if your state prohibits

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Producer/Processor Tax Strategies
Intellectual property
• Another segregation strategy
• Hold all brands, recipes and production or processing methods outside of
operating entity
• Should have a business purpose for doing so

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Producer/Processor Tax Strategies
License to operating entity for a fee, which can be deductible
• Should be written agreement
Opportunity to license to “partners” in other states
Operation of entity is not subject to 280E because
• Licensing is not trafficking

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Setting Up – Corporate Structure is
Your First Defense
Why Do You Need Two LLC’s & A C Corp?
1. Once entity is the actual cannabis enterprise holding the license.
2. The other entity is the management company providing goods and services
to the cannabis enterprise
3. Management company marks up the goods & services, creating a higher
COGS
4. The third is to hold the share of the management company
5. Utilize Sec. 1202 Small Business Stock Capital Gains Exclusion

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Qualified SmallBusinessStock (QSBS)
Considerations for 100% Gain Exclusion
Five criteria must be met to qualify:
1. The stock must have been directly acquired via an original issuance from US C
corporation (Sec. 1202(c)(1))
2. Both before and immediately after stock issuance, the C corporation’s tax basis is gross
assets < $50 million (Sec. 1202(d)(1))
3. The C corporation and shareholders must consent to supply documentation regarding
QSBS (Sec. 1202(d)(1)(C))
4. The C corporation conducts certain qualified active trades or businesses (Sec. 1202(e))
5. The stock must have been held for at least 5 years (Sec. 1202(b)(2))

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Beginning in 2015, for the first time since its enactment in 1993, Sec. 1202 allows
noncorporate taxpayers to exclude from federal income tax 100% of the gain on the sale of
certain qualified small business stock (QSBS), limited to the greater of $10 million or 10 times
the adjusted basis of the investment.

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Michigan Taxation of MedicalMarihuana
3% Excise Tax – NEW
• The Medical Marihuana Facilities Licensing Act
• File and remit quarterly; 30 days after the end of the calendar quarter
6% Sales or Use Tax
• The General Sales Tax Act / The Use Tax Act

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Tax Tips: Do…
Keep good accounting records
Have a written operating agreement, written leases, written royalty agreements
Hire a good attorney and CPA

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Tax Tips: Don’t…
Cut corners
Listen to advice that seems too good to be true
Procrastinate

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Thank You