Tax

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Calculating the California Cannabis Excise Tax

 

Because cannabis is a federally labeled class one drug, cannabis retailers must pay several taxes to be able to sell their products. For customers, this can create sticker shock as the price at the register can be 20% to 40% higher than the cost on the sticker. 

In California, there are several types of taxes compounded onto a transaction, so it’s imperative to properly calculate the tax of the purchase. One of the taxes to be aware of is the excise tax. 

Today, we’ll review what the excise tax is and how to calculate it. 

California Cannabis Excise Tax

The excise tax is for cannabis products being sold to customers. Distributors charge cannabis retailers this tax. The excise tax is 15% for retail purchases of cannabis goods. The excise tax is calculated based on the average market price of cannabis in retail. The distribution part of a cannabis business is required to report and pay the cannabis excise tax to the CDTFA on the cannabis tax return. 

How to Calculate Excise Tax 

Any authorized cannabis distributors must collect the 15% cannabis excise tax from retailers when selling cannabis products to the retailers. 

Arm’s Length Transaction 

For an arm’s length transaction, or one between two informed and willing parties, the payment the retailer collects must be equal to the fair market value of cannabis/cannabis products in the open market. Essentially, this means the wholesale price plus a markup. 

The wholesale price is the cost of cannabis plus transportation, before any trade allowances. Cannabis purchased at $125 and shipped for $20 will have a wholesale cost of $145. According to the California Department of Tax and Fee Administration, the mark-up rate is set at 80%

Nonarm’s Length Transaction 

If the cannabis retailer is also the distributor, this is known as a “nonarm’s length transaction.” for nonarm’s length transactions, the average market price of cannabis is calculated with gross receipts. The 15% cannabis excise tax is applied to the gross receipts. 

The “gross receipts” include all charges for the sale of cannabis including:

  • Selling price of cannabis product 
  • Labor
  • Services
  • Transportation/Delivery 
  • Business tax

For example, a delivery charge is included in the gross receipts used to calculate the cannabis excise tax. If you add an amount to cover the cannabis business tax to your customer’s invoice/receipts, then that amount is also included in the gross receipts. 

Staying on top of your excise tax is essential for smooth operations. All cannabis businesses should ensure they comply with the calculations above. 

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How Much Tax Do I Have to Pay with IRC 280e?

Ask any cannabis entrepreneur what the bane of their business is, and they will likely say it’s the IRC 280e Tax Code. Regardless of its irksome nature, cannabis sellers must abide by it or risk losing everything – not to mention possible jail time for money laundering. No one wants that, so here are a few facts to get you started in calculating tax costs. 

 

What is IRC 280e?

 

First, a brief overview of what 280e is. It all started in 1981 with Jeffrey Edmonson v. Commissioner. This was a court case in which a cocaine, amphetamine, and cannabis trafficker (Edmonson) fought to deduct “ordinary business expenses” from his taxable income. The court ruled in his favor – he was allowed to deduct the majority of his expenses, including the cost of goods sold (packaging as well as phone, home, and vehicular expenses).

Less than a year later, though, the decision was overturned, and business owners selling controlled substances were barred from the right to deduct expenses from their illegal businesses. These businesses were originally made illegal under the Controlled Substances Act (CSA), signed by Richard Nixon, and classified as Schedule I and Schedule II controlled substances. Ronald Reagan later expanded this “War on Drugs” by enacting harsher penalties for drug-related crimes, culminating in the passing of IRC 280e.

Section 280e forbids businesses from deducting expenses from their gross income when it involves “trafficking Schedule I and II controlled substances”. This also prevents businesses from taking credits. Federally, marijuana is still considered an illegal (Schedule I) controlled substance. What that means for cannabis sellers is that, despite its medical and recreational legality across the states, they are forced to pay taxes on all of their business income. In addition, they’re prohibited from writing off most business expenses to minimize their taxable income. 

 

How Much Do I Owe?

 

When 280e was passed by Congress, they added an exclusion to prevent future changes to the law. This exclusion allows cannabis entrepreneurs to deduct the cost of goods sold (COGS). This means that even federally illegal products can be claimed for a deduction. The cost of goods sold refers mainly to inventory costs. This means the cost of shipping to the retail location, the cost of the product, and any directly related expenses.

However, this doesn’t offer the cannabis seller much in terms of a tax break. The IRS ignores any tax changes made after section 280e, which allow more indirect costs to be applied. Essentially, anything expense related to distribution can’t be included under COGS. That includes rent, outbound shipping and some inbound shipping, health insurance premiums, maintenance and repairs, marketing/advertising, employee expenditures, and utilities. In practical terms, business owners can deduct little more than the seeds, soil, water and nutrients essential to plant and cultivate the cannabis.


Because cannabis business owners must pay taxes on gross rather than net income, they end up paying tax rates that are 70% or higher. That’s quite a bit more than the rates paid by non-cannabis business owners, whose rates tend to be closer to 30%. Paints a pretty good picture of how the cannabis industry is affected overall in terms of tax rates.

 

 

How Can I Maximize Deductions?

 

For new business owners, it’s advisable to set up as a C-corporation. This allows the business owner to only pay taxes based on their salaries and dividends. Consider looking into a shared service agreement as well – which splits your business into two entities. The first structure would handle cannabis production and distribution, whereas the other would deal with legal responsibilities. That includes counseling, care, selling related (but not cannabis-infused) merchandise, and management of the retail space. This means only the first structure would be responsible for compliance with the 280e tax code and its definition of COGS. The second entity can then deduct ordinary expenses such as rent and utilities, payroll, sales, administration, marketing/promotion, and some distribution. However, be sure to consult with experts who specialize in cannabis compliance. Doing this before you get started with a shared services agreement will help you avoid any violations. 

 

It’s important to keep impeccable records. The danger of neglecting this area is not just in loss of business, but potential jail time. To stay in the clear, document everything. Audits can come at any time – more often for cannabis businesses since it’s a federally illegal substance. Sales, wages, and vendor payment should be accounted for, and everything should be well organized.

Professional advice is paramount. An expert CPA can provide guidance regarding how to record detailed COGS deductions and what will and won’t qualify. Electronic records for managing documentation for workforce, spend, inventory, etc are crucial. Report all cash transactions, including deposits, payments, and single cash sales over $10,000.

 

For tax purposes, track employees’ tasks and time spent on each. It’s essential to do this to provide accurate reports on employees’ salaries as well. A part-time cultivator and part-time budtender fall under different tax codes. For employees who perform multiple tasks, it’s important to track the time they spend on each task. This helps you determine how many hours are deductible under the 280e tax code. To make this simpler, you can designate specific responsibilities for each employee, or consider investing in employee time and attendance software for cannabis to keep track of everything. 

 

There’s a lot that goes into being a cannabis entrepreneur during tax time, but with expert guidance, cannabis business owners can relax and enjoy the work. That’s one less thing to worry about – happy growing!

Need more guidance?

Be sure to reach out to us today!

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The 3 Biggest USPAP Changes for 2020-21

Every two years, the Uniform Standards for Professional Appraisal Practice, or USPAP, are updated. The latest version of USPAP applies to the 2021-2021 period. 

The major changes to USPAP in this update include changes to reports, certifications, and expectations of competency; most of these changes will have little impact on the appraisal process but are still worth taking note of in order to understand the heart of these standards. 

Here are three of the most major changes to USPAP for 2020-21:

 

1. Changes to Restricted Appraisal Reports

 

The first change to the USPAP to be aware of is perhaps the most significant. Restricted appraisal reports are appraisal reports containing fewer details than a full appraisal report and which were previously only available for use by the client. Now, they can now be used by individuals other than the client. 

These intended additional parties must be identified by name—they cannot be identified by a type, such as “bank”. This change creates new opportunities to utilize restricted appraisal reports where previously they would not have been usable.

 

2. Changes to Supplemental Certifications

 

The requirements for supplemental certifications have also been modified. Under previous versions of USPAP, if an assignment required a certification that did not contain every necessary element of an appraisal certification (such as the URAR and other forms), an additional certification featuring the signatures of the appraiser(s) was required in order to proceed.

These additional certifications are still required, but for the 2020-21 version of the USPAP, the Appraisal Standards Board clarified that the appraiser(s) signatures are not required on the supplemental certifications.

 

3. Changes to the Competency Rule

 

This alteration of the standards seems minor, and it’s true that it won’t have a particularly huge impact on the standard processes of appraisal. However, it’s still something to be aware of.

This change saw a comment from the Standards Rule 1-1 move from the development standards to the Competency Rule. The comment, which reads “Perfection is impossible to attain, and competence does not require perfection”, now applies to all aspects of the appraisal process, beyond development and reporting and on to all other pieces of appraisal practice.

Understanding the USPAP is critical to maintaining USPAP compliance. These three changes are not the only differences between this version of USPAP and previous versions, but they are the most major and important to understand for any appraiser.

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Business Valuation in Divorce Cases

One of the more potentially complex processes of a divorce case is that of dividing assets between the two parties. Some assets are simple to equitably divide. A joint bank account, for example, can sometimes be split as easily as just splitting the account balance at the time of separation.

However, not all assets are so easy to divide. This is especially true when it comes to business ownership. If a party owns a business, it is considered an asset to split equitably between the parties; but the value of the business can be difficult to determine. In this article, we will explore what business valuation in divorce cases entails.

How Does It Work?

 

Typically, a business is valued by Fair Market Value (FMV). This, in its simplest definition, refers to something’s value if it were to be sold on the open market. But not every jurisdiction defines or calculates FMV in the same fashion, and as such, attorneys, accountants, and other parties involved in a divorce case must be diligent and knowledgeable as they attempt to value a business.

Another factor is the fact that, in most cases, the assets of a business are not liquid. With that in mind, the question arises of how to value and divide non-liquid assets. Would the business be able to continue operations if these assets were to be liquidated? And what parts of the business belong to which party?

This brings us to the questions of separate versus marital property in the context of a business. If the business was started by one party before the marriage began, it is generally to be considered separate property and treated as such. Many small businesses, though, are started by married couples. In these cases the business may be considered marital property. Either situation can present complications.

One method of valuing a business is by comparing it to the prices at which similar businesses in similar markets have been sold. Another somewhat more common process is to assess the historical income created by the business and work from there. The method chosen will depend largely on the type of business you have and your goals going forward.

The accounts at Miod have the experience and understanding necessary

Bottom Line: Business Valuation is a Complex Issue

 

Regardless of the situation of a business (whether it is separate or marital property, whether it has primarily liquid or primarily non-liquid assets, in what jurisdiction it exists, etc.), the process of valuation of a business is complex and requires a strong understanding of tax codes and local laws. 

The accountants at Miod have the experience and understanding necessary to handle the valuation process of any business in any divorce case. If you or a client needs this complicated process handled with care and expertise, look no further than Miod for all of your divorce accounting needs.

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How Financial Experts Help With Family Law Cases

In the event of a divorce, both parties will be impacted financially by the results of their cases. Financial experts can help make sure that each party has a favorable financial outcome during property division, alimony establishment, and any other stage of the divorce process that involves the finances of the involved parties.

Here are five ways that financial experts can help with family law cases:

1. Identifying assets

Financial experts are able to use their expertise and resources to determine whether or no particular assets should be considered marital or nonmarital assets.

This will help ensure that parties are not forced to divide and lose money on assets that are nonmarital.

2. Determining alimony and child support

While ultimately a judge will create any alimony or child support orders, financial experts can assist by determining the true income of both parties. Sometimes calculating income requires more than just tax returns or financial statements. 

Financial experts can gather the information necessary to calculate each party’s income and each party’s current standard of living so that a fair spousal or child support order can be established.

3. Valuing and dividing property and assets

There are some marital assets that are challenging to value and divide, like pensions and retirement or business goodwill.

In a divorce, involved parties are not always able to value and divide businesses as if the business is already dissolved or to determine how pensions should be calculated into future alimony payments. It can be complicated for people to make sure that the existing and future income from businesses is calculated correctly so that there is a fair division of assets and no double-dipping on either party’s end.

4. Assisting with trial

Financial matters within a divorce can be complicated. If a judge or members of a jury are not able to fully understand the financial information they are presented with while in court, it might not bode well for both parties in a divorce.  Financial experts can help structure and explain this financial information and any finance-related exhibits in a way that makes it clear for the attorneys, jury members, and the judge presiding over a family law case. They can also use their expertise to help attornies develop depositions and useful cross-examination questions when challenging their opponent’s financial expert.

5. Handling taxes

Financial experts like CPAs who are well versed in property tax laws can help make sure both parties are able to divide assets according to their best interests come tax season. These individuals can make sure that their party avoids tax-traps and negative tax-related consequences during property division.

If you need help with a family law case, do not underestimate just how valuable a financial expert can be for your case. From offering advice about retirement plans and taxes to helping determine fair alimony and child support payments, a financial expert can make a world of difference when it comes to the financial impact of your divorce.

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