Blog

Cannabis taxes will drive consumers back to unlicensed channels

Common sense, anecdotal conversations and third party reports tell us that the unlicensed pot industry is growing and will always be larger than the licensed industry. One report in September 2019 estimated that the unlicensed industry in California is three times larger than the licensed industry. In other states the unlicensed industry approaches 100% of the market.

My own rough calculations put the illegal pot industry at 0.1% to 1.5% of a state’s overall economy. In locally depressed areas like where I live, the economic impact could well be larger.

Regulation, taxation and licensing issues are all significant reasons. Taxes are the largest driver of the unlicensed market and will remain so over the long term. Tougher state laws and increased enforcement will have minimal effect on changing the overall market trend.

Motley Fool writes:

“The first concern is the taxation of recreational marijuana sales which, as noted, should represent a clear majority of global revenue in the decade to come. California, the fifth largest economy in the world by gross domestic product, has imposed a 15% excise tax, a cultivation tax on growers of $9.25 per ounce of cannabis flower, or $2.75 per ounce of cannabis leaves, and state and local taxes. Add this up, and some locales could be paying as much as 45% in aggregate tax on adult-use cannabis, which could wind up sending legal consumers back to illicit channels.

Remember, black market marijuana growers don’t have to wait for cultivation and processing licenses or sales permits. They also won’t be paying state income tax, federal income tax, or the cultivation and excise taxes imposed in the state. Illicit weed will easily undercut the Golden State’s legal pot industry on price, and first-year tax revenue collection figures show this to be true. Having originally expected $643 million in full-year 2018 sales following the sale of adult-use weed in dispensaries, actual collection totaled just $345.2 million last year. If U.S. states or foreign markets fail to tax cannabis appropriately, it could seriously reduce the industry’s potential.

California’s problems are of particular concern to Origin House (OTC:ORHOF), which has bet big on being a distribution kingpin in the state. Origin House has been gobbling up some of the smaller pot distributors in California, thereby nabbing the few distribution licenses outstanding. But if consumers aren’t actively staying within legal channels, then rampant oversupply and reduced demand could sap Origin House’s potential, at least over the next couple of years.”

The unlicensed industry is likely already worth billions of dollars. Every participant, even home growers, shares significant tax risk and legal risk. Those risks should to be considered for their impact on other financial planning objectives. Yet most with risk exposure don’t seek help beyond a criminal attorney when the need arises.

The most common questions I am asked on how to tackle this messy issue: Are discussions with an accountant protected in the event of a legal procedure? Can “above the table” activities be protected from risks of “under the table” activities? What’s my “worst case exposure? Can my spouse and family be financially protected?

All of these topics should be carefully addressed in our early and ongoing work.

Tax Court upholds “gross receipts method” to determine tax liability

A recent U.S. Tax Court Case captioned “Raymond Chico and Ruby Chico v. Commissioner”, Respondent upheld the use of a very simple tax accounting tool by the IRS in determining the tax liability of a cannabis-related business.

The IRS used the ‘gross receipts method’ to add up all receipts from all sources and determined that it all was taxable income. The Tax Court determined that the IRS could collect all applicable penalties including the accuracy-related penalties.

Tax Court upholds IRS over legal dispensary

A recent U.S. Tax Court case challenged the ability of the Internal Revenue Service to deny all tax deductions as invalid for a cannabis-related business. The business “Northern California Small Business Assistants Inc.” was a legal dispensary in California.

The Tax Court denied all of the arguments of the business as invalid and upheld the position of the IRS in full. In addition, the case is significant in that it determines that not only are ‘ordinary and necessary business expenses’ (known as Section 162 expenses) invalid, but all deductions and tax credits paid are also invalid.

The case was decided in late October 2019 and the IRS position remains the law today:

“You operated a medical marijuana dispensary. Thus, it is determined
that your business consists of trafficking in marijuana, a controlled
substance within the meaning of schedule I or II of the controlled
substance [sic] Act. Accordingly, you are subject to the limitations of
IRC 280E, which disallows all deductions or credits paid or incurred
during the taxable year in carrying on a trade or business that consists
or [sic] trafficking in controlled substance [sic].”

What you should know about Worker’s Compensation Insurance

Too many hardworking small business owners fall victim to false beliefs and rumors about the law and wind up risking everything.


I have other helpful resources about workers compensation insurance to share once we know what applies in your specific situation. Reach me through the contact information at tonynovak.com.

Big Marijuana Enters South Jersey

20191117_140520000_iOSThis week Acreage Holdings, one of the world’s largest vertically integrated international marijuana companies, said it was buying “100% of the equity interests” in Compassionate Care Foundation in Egg Harbor in anticipation of the New Jersey’s intention to legalize cannabis for adult recreational use. Compassionate Care Foundation’s vertically integrated operations include licenses for cultivation, manufacturing & processing, and three regional retail dispensaries.

Acreage Holdings already bought a 135,000-square-foot orchid greenhouse in Sewell last year to convert it into the largest cannabis cultivation facility on the East Coast. The company is formed in Canada, with shares traded on the Canadian stock exchange, and has its headquarters in New York City. The company’s chairman announced “This reorganization will result in increased access to affordable medical cannabis for New Jersey’s existing patients in short order. Moreover, we have long believed that upon adult-use legalization, the New England and Mid-Atlantic regions will be the preeminent cannabis market in the U.S. and Acreage is best positioned of any U.S. cannabis company to benefit.”

Acreage Holdings is one of the most politically connected companies in the U.S. It’s board members include former Speaker of the House John Boehner and former Massachusetts Governor and presidential candidate William Weld. Last year the company retained the services of Philip Norcross’ lobbying firm, Optimus Partners, for consulting services. Norcross is the strongest Democratic power broker in south Jersey politics.

Closing of the new purchase agreement is subject to New Jersey state approval. It is unclear how the deal will work, since Compassionate Care Foundation is a nonprofit. Nonprofit businesses do not have shareholders but typically have a provision that remaining equity interests revert to public benefit.

@potCPA is a brand of Tony Novak CPA that supports smaller independent companies and individuals related to the cannabis industry. While we have no opinion of this specific proposed consolidation deal with Acreage Holdings, we generally believe that it is better to keep local marijuana businesses independent for the benefit of the south Jersey community.

The wrong way to handle small business accounting

Last night I finished the messiest and most stressful small business accounting job ever encountered in a 30+ year career. They will keep their bank financing, but at enormous personal cost to all of us.

I just finished billing a bad stress-filled accounting job that took most of my time for the past two weeks. Preparing the invoice took more than four hours yesterday on a Sunday; I finish halfway through the Eagles game. There were many hours of computer works, dozens of emails, long phone calls, and text messages at all hours.

In the end, nobody was happy. My wife is upset that I charged so little and was unavailable all of this time. The client is upset that I charged so much and acted startled by my summary and invoice despite our many communications on the topic. Other clients are upset that I delayed their work projects for two weeks. My sub-contractor accountants are upset that I dismissed them midway through the project for not having the skills necessary for this difficult job. I’m upset that I violated several of my own business practices in an effort to help a client caught in a difficult situation. I haven’t been to the gym for weeks. My own business marketing plan is decimated this month; my business coach is frustrated and the money already invested there to build momentum is wasted. There are likely to be other “fallout” negative effects including being unprepared for legal cases this coming week. I don’t know yet, but my lack of faster action might have triggered complications in another client’s tax penalty.

I agreed to take the job only to support the company’s treasurer. I like him as a person and empathize with his business goals. He had his back against the wall facing pressure from his board and his bank. I see the loyalty and the “get ‘r done” aptitude that I bring as keys to the success of my practice. In the end, we will meet the primary goal: the business will keep its bank financing. We will both survive to battle another day. But what a tortuous way to accomplish what could have been a routine business process. Now, in the post-analysis, it is easy to identify ways we could have done better.

This was a learning experience for sure. It hammers home one idea: hourly rates are not workable for small business accounting! Short term accounting function by a treasurer are not a substitute for a stable long term controller. I am making changes to my practice to avoid a repeat of this stress ever again.

Another earlier blog post on this topic: https://tonynovak.com/why-hourly-billing-rates-are-a-bad-idea-in-small-business-accounting/

Looking past decriminalization

20191117_140520000_iOSThis coming week our federal legislature will take up a bill to decriminalize cannabis. Most states, including ours, are attempting similar measures. But my form’s focus isn’t on these proceedings. In fact, we have little confidence in the near term outcome. That timeline really doesn’t matter in the big picture.

What we know is that eventually cannabis will be decriminalized. What then? That will be a beginning, not an end to huge numbers of civil prosecutions of growers, sellers and their supporters. Many entrepreneurs will make mistakes that will cost them small fortunes in payments to the government. My firm is specifically focused on representing the tens of thousands of local entrepreneurs who will face civil tax prosecutions and business license penalty cases to follow that will require an adviser to offer tax expertise, representation before authorities and large picture financial coaching for recovery.

Some call the situation “Prohibition 2.0”. Others see it quite differently. See my short video “Eight Inconvenient Truths About the Cannabis Industry (that nobody is talking about)” for discussion on the current situation.

The news coming from California gives us some insight in what will come here on the east coast. Cannabis is already decriminalized in California. Yet government prosecutions are on the rise. Now it’s all about collecting the money. Approximately 85% of the entire industry remains unlicensed and untaxed. The risk of raids on growers’ events like farmers markets, arrests for selling without a license, and tax prosecutions are a part of daily life for more than a million people in that state alone. The cost of those prosecutions will be devastating to many. Yet it isn’t the end of the world*.

My work focuses on dealing with these post-decriminalization issues that leaves millions exposed to new types of business and financial problems. I’ve always been useful in representing those accused of violating government rules.

20191117_080348512_iOS


*I don’t mean to belittle the several tragic cases starting with cannabis and ending in suicide or police shootings. Rather, I’m focused on the majority of civil prosecution cases that will be life-altering but not insurmountable.

 

November 2019 update on cannabis in NJ

Here’s where we are with the insanity and injustice of cannabis law in our part of New Jersey right now.

The state’s next dispensary will open in about a month here in Vineland. Initially the facility will be open for training; its locally grown cannabis supply won’t be available until next year. The facility is financed and supported by some of the area’s most well-connected community leaders.

The state legislature in Trenton is again trying to decriminalize cannabis this month. The effort seems doomed to fail. Some legislators want to delay the decision until after the question is addressed in the 2020 election. New Jersey voters overwhelmingly support decriminalization but have not yet actually voted on the issue.

Meanwhile someone is arrested on cannabis charges every 14 minutes in New Jersey, according to a new analysis by the American Civil Liberties Union of New Jersey. Most of those arrested are minorities. Local police activity reports show that cannabis possession arrests are still common and Cumberland County Prosecutor’s Office continues to prosecute cannabis cases as crimes. Legislation to end the 30,000 annual cannabis arrests is eventually expected to also expunge the records of those convicted in the past.

Eight Inconvenient Truths About the Cannabis Industry (that nobody is talking about)

CPAs in the cannabis industry are not being candid, honest and straightforward in talking about the cannabis industry. While I’m not suggesting that there are any easy corrections available for current positions, I do think that it makes sense for us to address the facts directly and honestly.1

A headline in a CPA newsletter today caught my attention: “CPA Andrew Hunzicker Creates Course in Cannabis Accounting: ‘This industry is very underserved by accountants.'”2 I strongly disagree; that position is not supported by evidence. In my Delaware Valley region (southeast Pennsylvania, southern New Jersey and northern Delaware market) the industry is already oversaturated. The CPA industry serving legal cannabis is overcrowded here with more well qualified CPAs than there are firms with cannabis licenses.

The cannabis specialty interest group within the New Jersey Society of Certified Public Accountants has over a thousand members. A recent local industry convention had four larger CPA firm exhibitors at a time when there was only six cannabis licenses issued so far in the entire state. CPAs are flocking to the field en masse while regulators are growing the legal cannabis industry at a snail’s pace.

To gain any meaningful insight into the industry trends, we need to consider the illegal cannabis market.

The truth is this:
1) 100% of the cannabis industry is still illegal under federal law. That includes derivatives like CBD used as food additives that are not approved by the Food and Drug Administration.
2) Close to 100% of the cannabis industry is illegal under state laws. Even in California that has the largest legal cannabis industry, almost 90% of the industry is still illegal.
3) Trends in decriminalization are causing the illegal cannabis industry to grow. The largest growth will come in illegal operations, not in licensed legal ones.
4) Despite licensing and decriminalization, the large majority portion of the cannabis industry will remain illegal.
5) The needs of the illegal cannabis industry are underserved. Economic profits are not certain, either for the legal or illegal cannabis industries.
6) The risks of serving the illegal cannabis industry clients are substantial. Legal, financial and professional constraints dominate.
7) CPAs don’t even want to talk about serving the illegal cannabis industry; the entire topic remains wide open.

I’ve decided that my own future professional opportunities lie in representing those with struggles in the illegal cannabis industry, just as I represent illegal clients in the farming, food processing, fisheries and construction industries. 4 All of these industries have high rates of noncompliance with accounting laws. That doesn’t mean that they don’t deserve a good accountant, but it does mean that their future accounting problems are likely to be higher than average. I’ve developed the business structure, tools, temperament and skills to be effective in this environment. I see big demand ahead in this area.

Reforms in the cannabis industry will continue to march forward at an awkward gait. Accountants will not be immune from the angst.


Footnotes
1 I took a similar stance in pointing out and documenting inconsistent positions within the profession in response to CPA statements and actions following enactment of the Affordable Care Act. These discussions are uncomfortable but still useful to ourselves and the industry.

2 Nothing in this post is meant to be disparaging to Mr. Hunzicker, a respected leader in this profession.

3 CPAs are governed by a core principle in the AICPA Code of Professional Conduct requiring us to avoid acts discreditable to the profession. Some interpret that to mean that no public discussion should be made of illegal, off-color or nonconforming opinions. However, that is not an accurate interpretation of the professional standard.

4 I’m not a user, proponent or impassioned by the cannabis industry itself. However, I have a strong track record of representing independent businesses in their struggle with government.