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Cannabis programming in New Jersey

The New Jersey Society of CPAs is moving at a rapid pace following passage of the legalization referendum on November 5, 2020. I’ve been a member of the Cannabis Interest Group at @NJCPA since its inception. My @potCPA business practice is narrowly focused but I am pleased to see that they have adopted the following broad cannabis program scheduling timeline:

November 2020
Ongoing user group updates about anticipated legislation
Article from NJBIA about workplace safeguards
Podcast about cannabis legislation
Blog about cannabis sales tax issues

December 2020
Webinar for CPAs serving the cannabis clients

January 2021
Webinar on legalized cannabis considerations for employers

February 2021
Article about payment processing for cannabis industry
Webinar about tax issues for cannabis industry

March 2021
Article in New Jersey CPA magazine on numerous cannabis-related issues

Tax Change Needed to Level the Playing Field for Small Businesses, Minorities and Women in Cannabis Marketplace  

This statement was released 11/5/2020 by Ralph Albert Thomas, CPA (DC), CGMA, CEO and Executive Director New Jersey Society of Certified Public Accountants.
 
“On Tuesday, New Jersey voters approved a constitutional amendment to legalize cannabis. That was just step one in allowing cannabis sales to proceed in New Jersey. Steps two and three will be the passage of enabling legislation and then the regulatory framework that will be drafted by the Cannabis Regulatory Commission.
 
To ensure New Jersey small businesses, minorities and women can compete in the cannabis market, it’s critical that the state change an obscure section of its tax statute. Otherwise, this new market will be dominated by large and already established players, many of which will come from out of state.
 
Deducting business expenses is a routine and integral part of operating a business and is critical for a company to be profitable. However, cannabis businesses do not have access to this tax benefit even though it is available to all other New Jersey businesses. And that’s because New Jersey “piggybacks” onto Internal Revenue Code Section 280E, which prohibits any company illegally engaged in drug trafficking from deducting business expenses on personal or corporate income tax returns. Since cannabis is still illegal on a federal level, this makes sense for federal taxes, but not here in New Jersey where it’s now legal.
 
That’s why the New Jersey Society of CPAs (NJCPA) is calling on state lawmakers to decouple New Jersey from §280E. While we would prefer decoupling for all cannabis businesses, it is most important for small businesses, many of which are minority- and women-owned. Larger operators generally have enough cash on hand to withstand the drain on profits that §280E will cause in initial years, but smaller businesses often do not. It could literally stifle the ability of small cannabis businesses to get off the ground.
 
Many of the states that have legalized cannabis have decoupled from §280E. Of the 10 states with an adult-use market, two have specifically decoupled completely, one has specifically decoupled corporations, and two have no state tax at the business level thus decoupling by default. The states that have the most robust cannabis industry, Colorado and Oregon, have specifically decoupled.
 
In a survey of NJCPA members, 66 percent of respondents indicated that having a commercial cannabis industry in New Jersey will help the state’s economy. If lawmakers and the public want a prosperous cannabis industry, with small businesses participating and thriving, then New Jersey needs to decouple from §280E. This needs to be done now, before the issue gets buried in the process of passing enabling legislation and drafting regulations for this promising new industry”.

What does New Jersey’s pot vote mean to me right now?

Going forward, cannabis will primarily be a revenue issue and not so much a criminal issue in New Jersey. But what does that mean to the individual user or the spiriting cannabis small business entrepreneur right now?

A logical concerned person needs a way to help guide their immediate actions and decisions in the uncertain and evolving legal climate. Look to these two documents documents coming for guidance.

Criminal issues: The state’ Attorney General issued a statement on transitional policy. In short, nothing has changed yet but an announcement is coming soon.

Tax issues: The NJCPA will release a statement at 8 AM this morning on the work that’s been going on for a long time behind the scenes regarding the legal changes on the tax revenue issues.

Business regulation issues: Nothing is expected for up to a year.

The two upcoming announcements taken together: 1) the AG’s soon to be released directive to police and prosecutors on changes to criminal procedures and 2) the NJCPA’s endorsement of proposed tax law changes, will form the basis of business and personal legal planning for many who expect to be involved in the recreational pot in the immediate future. In reality, it will likely take a long time until we have laws of tough issues like home grow and recreational possession limits.

As a member of the NJCPA’s Cannabis Interest Group, I want to help spread the word that much good work has gone into planning for this eventuality, and that it will move forward in as ‘sane’ a way as is possible within our complex and often ‘whacko’ state government system.

Finally, be aware that nothing compels a police officer, a local prosecutor or state revenue agent to abide by changes in official policy and that we have seen a recent trend, especially in Cape May county and rural southern regions, for some officials to deliberately oppose state policy on ‘hot button’ issues. So, in other words, you could still be arrested and prosecuted here for possessing a joint even if the charge could eventually be overturned.

NJ decriminalization referendum update

New Jersey voters will decide if pot should be decriminalized in the November 3 election. Every indication is that the decriminalization measure will pass.

One of the loudest opponents of the New Jersey decriminalization ballot referendum also happens to be (presumably) one of the largest black market operators. No surprise there. The vote will disrupt his business model.

The largest spender advocating for passage of the measure is a large privately owned lawn fertilizer company, that has established a home-grow division to accommodate the new emerging market.

But the big point here, IMO, is that if you take both points together than you can begin to form an opinion that the new pot industry may not generate as much tax revenue as forecast. But will it generate more tax and licensing prosecutions? Absolutely.

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].”

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/