How Cultivators Can Maximize Profits: 280E Tax ConsiderationsWhen it comes to paying taxes to the state and the IRS, all cannabis operators must deal with the limitations of the Internal Revenue Code (IRC) Section 280E.
Cannabis cultivators, like other license types, experience high costs of operations and demanding expertise. They’re not simply farmers, they are compliance officers, wholesalers, financial managers, salespeople, influencers, brand managers and so on.
Profitability is every cannabis business owner’s number one priority. But the daily business demands make it difficult to focus on optimizing profitability in each segment of the business.
When it comes to paying taxes to the state and the IRS, all cannabis operators must deal with the limitations of the Internal Revenue Code (IRC) Section 280E. Cannabis businesses are not allowed to make the same federal tax deductions as other industries.
However, by properly implementing inventoriable cost accounting, cannabis cultivators can maximize their profits by minimizing their tax liability.
The best strategy for decreasing tax liability is using an accounting methodology called absorption costing. An inventory valuation is placed on the balance sheet, in which direct and indirect costs are attributed as production costs. These Costs of Goods Sold (COGS) ‘absorb’ the expenses to top of the balance sheet and allow them to be deducted under 280E tax code guidelines.
All expenses and costs that are tied to cultivation and the finished cannabis product are assigned to inventory. They are not recognized as expenses in the month the business paid for them. However, they remain in inventory as an asset until the product is sold. At that time, they’re finally charged to COGS.
Direct vs Indirect Costs
Before we dive into the granular chart of accounts, it’s important to define direct and indirect costs.
Direct production costs are those that are necessary for production of the saleable good. Material and labor make up the direct costs of a cultivation operation. Direct material costs are the materials that are expended and utilized during production. Direct labor costs are similar to the labor and time that contributes directly to cultivating and producing the final product.
Indirect production costs are similarly capitalized to ending inventory. Often referred to as overhead, cannabis cultivators consider themselves lucky to be able to absorb more overhead than any other license type.
The more COGS assigned to inventory, the lower the income tax owed. Those cultivators who solely grow and sell wholesale are able to absorb the most expenses. However, when an operation starts to venture into ‘vertical integration’, either in the form of distribution, manufacturing, or retail, a lower portion of costs can be attributable to production.
Certain employee time can be attributed to production, but not all. Similarly, rent and utilities might not be 100% inventoriable. Consulting with a CPA to audit your facility, team hours and production processes will ensure you’re reporting accurately to the IRS.
Chart of Accounts
The best way to set yourself up for success is with a strong chart of accounts that your bookkeeper, accountant, and CPA are all signed off on. That way, maintaining records will be a breeze because you’ve already established your direct, indirect, and non-deductible buckets.
Review your chart of accounts and compare the way you are currently attributing costs to the inventoriable cost accounts. This cheat sheet is a good reference point to identify areas of opportunity.