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.

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.

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.

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*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.

 

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.

The role of the CFO in the marijuana business

The role of the small business Chief Financial Officer (CFO) is typically described in four distinct functions. I describe my own CFO role as filling five functions in the emerging marijuana industry.

#1

Recordkeeping

The CFO has primary responsibility to assemble, safeguard, manage and store the financial records of the company. This basic but necessary service is best handled by a person focused and experienced on business records. This may sound straightforward, but I find that almost every business faces challenges keeping and managing necessary records.

#2

Internal controls

CFOs add value by designing, monitoring internal controls. This happens to be the area where management tends to have the least experience and so this important function might be otherwise overlooked, leading to financial losses that could have been avoided. Management often underestimates the risk of fraud and misappropriation; the CFO must keep that risk control front and center.

#3

Communication and reporting

The CFO communicates internally to management and to external stakeholders.

A business needs accurate timely data to make good management decisions. The always-changing type of data, the format, timing and the method of delivery are all important components to consider as part of this function. Management may also need to know how the company is doing compared to the competition or benchmarks established by investors. Managers typically want to know the business is doing now compared to earlier periods.

CFOs also oversee duties related to owners, investors and shareholders and are the primary control of risks related to management fraud and disclosing financial information.

Sometimes the CFO must develop forecasts of future performance and utilize industry benchmarking data.

#4

Compliance

Every company has compliance issues to address with government, and the CFO oversees many of them. Filing and paying taxes is obviously one major burden, but not the only compliance requirement. Marijuana businesses face strict non-financial recordkeeping burdons.

#5

Advocate for management and the industry

The modern CFO is often active as an advocate, negotiator and representative of the company in dealing with new potential customers, government regulators, and investors. I often find myself active through industry associations that leverage the power of small independent businesses.

I am pleased to discuss how an experienced part-time CFO can help your business. Please use the chat box below to send a message or the scheduling link on the right to set a time to talk.

Sara’s advice for entrepreneurs

My business relationship with Sara Rosenberg, the Connector-in-Chief, is one of my greatest blessings. This excerpt is taken from one of her recent social media post as a sample of why I say this:

“When you’re first starting out, and money is tight (or let’s be real, non-existent), you can do the following things for free, or damn near close to it, if you’re willing to learn:

1. Build a website (Wix and Godaddy are super easy and cheap.)
2. Create marketing collateral. (Canva and MS Publisher!)
3. Build a network and work it. (LinkedIn and Brynne Tillman’s book.
4. Learn a sales process (Book Yourself Solid)
5. Learn how to do social media the right way. (Gary V’s $1.80 Method)
6. Keep everything straight (ASANA or Trello)1
7. Keep track of your money (Freshbooks or Quickbooks)2
8. Everything else…. Google and Youtube are an entrepreneur’s BFFs!!”

Simple, right? In reality there is so much more and Sara stresses constant learning. Aligning with the best people can make a huge difference. All of the people and resources mentioned are top-notch.  

If you are planning a business or trying to ramp up your existing business these tools can be invaluable. I’d love to hear what’s working for you and where you see a need for improvement. Use the chat button below to send a message or use the scheduling link at the right to plan a free, no obligation introductory call.

Notes:

1 As a small business accountant I spend a lot of time on this topic. It’s the single most important ingredient to business success. In a Microsoft Office 365 environment (mine and most other professional firms) I rely heavily on OneDrive and OneNote to keep information available, safe and organized. Pipedrive and Lastpass are also essential information organizers for me. I’ve written about and offer consults on each of these crucial starting block tools.

2 Yes, I’m Freshbooks and QuickBooks certified. I also offer simpler tools for start-ups. But, bottom line, if you aren’t devoting 1% to 2% of your time and money into financial management then you are headed toward disaster.

All accountants are not created equal

It’s all important, of course, and I’m grateful for these online communities that allow us to collaborate daily.

All accountants are not created equal. That should be obvious.

Some are great at bookkeeping (I’m not. I automate or outsource as much as possible). Some crank out huge numbers of tax returns (I don’t. I do a few, maybe 50 mostly complex ones, and take my time on each one especially the messy or complicated ones). Others are great CFOs, focused on management procedure and internal controls. (I’m good at this but few of my small business clients are big enough to justify hiring for CFO services so I usually offer this service piecemeal incidental to another engagements).

But I notice that I’m stronger in one specific area than most others: business planning. That’s partly a result of formal education. That’s typical core MBA stuff. Then I had the benefit of some great business and tax planners in the Masters of Taxation program. My focus of study at law school was “Compensation Planning”. After that I was drilled in the financial planning strategy mindset through the many training programs on Wall Street and then in the first decade of my solo career. Now decades later, It is so ‘routine’ that I actually had to be reminded of this market position distinction by my marketing advisor.

Nowadays when I’m with other accountants, often in online webinars and group chats, I’m leading the discussion on strategy – focused on asking what is possible – while others focus on tax code requirements and better ways to get things done within the firm. It’s all important, of course, and I’m grateful for these online communities that allow us to collaborate daily.

So where does all this lead? It points to a consensus that I’m a good person to talk with when you are planning a business launch or change in strategy or a major financial move. At this early stage of marijuana industry development, many are seeking early input into financial aspects of their business plan. That’s the reason that offer free 30 minute consults. It gives me a chance to shine as a first impression doing what I do best.

So I encourage you to get a second opinion on your most important small business financial strategies by scheduling a 30 minute call. There’s no obligation and I welcome the chance to learn about your unique business situation. Use the link at the right or the chat box below to plan a time for us to introduce this discussion.