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Biggest Accounting Mistakes Start-Up Cannabis Entrepreneurs Make

The Green Rush is upon us, but the path to a successful cannabis business is not a smooth and easy one to navigate. AAFCPAs has been deeply immersed in serving cannabis businesses since 2012 with Advisory, Tax, Accounting & Assurance Solutions. We were the first full-service CPA and Consulting firm to represent Massachusetts cannabis companies, and we have outlined some of the most common pitfalls witnessed in advising this entrepreneurial community.

Underestimating the Regulations

Cannabis is one of the most highly regulated industries today, and the laws, rules, and regulations are incredibly complex. Cannabis remains illegal at the federal level, even in states that have legalized it. In addition to the complexities related to federal prohibition, there are many layers of compliance and regulations at the city, county, and state level. Further, vertically integrated cannabis businesses must comply with the myriad of regulations related to cultivation, extraction, retail, wholesale and food manufacture, including those enforced by the IRS, FDA, OSHA, EPA, and more. Staying in compliance and maintaining a license in good standing is a full-time job.

Poor Structure

The choice for corporate structure is nuanced and should account for your unique business strategy, complexity, exit strategy, and tax implications. Many small start-up entities will default to a limited liability company (LLC) taxed as a partnership. Choosing between a C Corporation, S Corporation, or LLC should be done on a case-by-case basis as the ramifications of entity choice should be tailored to your business.

Cannabis has the additional constraint of Internal Revenue Code § 280E which requires that cannabis businesses may only deduct their costs of goods sold (COGS).  This means that only those expenses associated with the production of the product are deductible for tax purposes. There are opportunities to minimize the tax impact of 280E if proper attention is given to choice of entity.

Bootstrapping for Accounting Talent

Cannabis is one of the fastest growing industries in the U.S. today and suffers a dearth of quality accounting talent. The complexity of cannabis accounting requires specialized expertise not available in most accounting talent pools, especially start-up markets. Little training is available in a very young and inexperienced market and the IRS has targeted Cannabis as highly lucrative for audits.

280E notwithstanding, various IRS and state-by-state rules can be daunting. Cannabis accounting requires a deep understanding of the accounting rules related to inventory, accrual, GAAP, and cost accounting required by IRC §§ 280E and 471. In addition, vertically integrated cannabis businesses have accounting requirements related to agriculture, chemical manufacturing, food, and retail.

Further, agreements among founders and potential investors can have significant long-lasting tax ramifications if not properly documented and accounted for at the beginning. Potential exit strategies, such as the $10 million Qualified Small Business Stock exclusion, may be lost if not properly considered at onset.

Working with a well-qualified accountant and proven advisors that understand the business and are prepared to scale with the company is invaluable. An experienced CFO at your fingertips can ensure you have proper accounting procedures and information available to management to help you avoid common pitfalls and realize returns in this nascent industry.

There is a precariousness to the Cannabis enterprise, and AAFCPAs advises entrepreneurs to vet carefully people who claim to have experience in the industry.

How may we help?

AAFCPAs’ multi-disciplinary team includes CPAs, Consulting CFOs, Consulting Tax Attorneys, wealth advisors, as well as business valuation and IT & cyber security professionals. Our specialists will help you thrive while navigating the increased complexity of running a sustainable, high-performing cannabis company.

If you have questions, please contact Joshua England, JD, LLM at 774.512.4109, jengland@nullaafcpa.com; or your AAFCPAs Partner.

About the Author

Joshua England, Tax Attorney
Josh is a tax strategist with extensive expertise advising high-net-worth individuals, nonprofits, and business owners and investors on effective strategies to ensure tax efficiency, asset protection, well-executed succession plans, and wealth preservation. He has been practicing law since 2000 and focuses his practice on the areas of wealth transfer planning, fiduciary and individual taxation, business structuring to maximize tax efficiency, and advising tax-exempt organizations, foundations and charitable donors.