Keeping up with changes in the cannabis industry

In 2022, Maryland, Missouri, and Rhode Island legalized recreational marijuana. That means a total of 38 states, plus Washington, D.C., have now legalized cannabis for medical and/or recreational use. With increasing opportunities for cannabis-related businesses, CPAs could have clients investing in or expanding into this industry.

According to Gallup, 68% of Americans support federal legalization of cannabis, a number that is likely to grow since younger generations support legalization at higher rates. With steady growth across the cannabis industry, net sales are projected to boom over the next five years.

Despite movement toward legalization, federal law still classifies marijuana as a Schedule I controlled substance, complicating matters for business owners in the field.

Accounting and finance professionals with cannabis-industry clients may struggle with conflicting marijuana laws. But clients rely on you to keep up with the pace of impending changes. Keep reading for a rundown of cannabis-business-specific best practices and an overview of critical legislation.

The SAFE Banking Act

Cash still inundates the cannabis industry. The Secure and Fair Enforcement Banking Act of 2021, H.R. 1996, known as the SAFE Banking Act, aimed to make it easier and safer for banks to do business with legally run cannabis companies, but the measure failed to make it to the Senate floor last year. The bill was reintroduced in the House of Representatives on April 26, 2023.

Despite widespread support for the SAFE Banking Act, its future remains uncertain. Even without the SAFE Banking Act, however, some financial institutions are already providing banking services for cannabis-related businesses, according to the Financial Crimes Enforcement Network (FinCEN), just without the added protection the SAFE Banking Act would provide. FinCEN released guidance in 2014 for financial institutions providing banking services to cannabis companies on how they can comply with Bank Secrecy Act (BSA) obligations.

Auditing for cannabis-related businesses

When inspecting and auditing the cannabis industry, accountants must first learn each step of the supply chain from seed to sale.

Day-to-day groundwork comes next. Legal compliance rides on being aware of how fundamental accounting activities — bookkeeping, cost accounting, cleanup, payroll, audit trails, and financial reporting — interact with state and federal cannabis laws.

Careful analysis, a healthy dose of skepticism, and awareness of U.S. generally accepted accounting principles (GAAP) when dealing with cannabis activity will pay dividends in the long term.

The basics of cannabis taxation

Cannabis businesses face several unique tax issues. To start with, the cash-intensive nature of the business can increase the temptation to underreport income and can lead to spotty record-keeping.

On top of that, cannabis businesses are not permitted to deduct their business expenses under Internal Revenue Code Sec. 280E. So wages, advertising, and overhead costs that would normally be deductible by a business are not deductible if they relate to activities that are illegal under federal law. The only exception is that marijuana businesses can deduct cost of goods sold (COGS), but in effect cannabis businesses pay federal tax on gross profit instead of net income.

Some cannabis businesses have tried to reduce their taxable income by allocating various indirect costs to inventory and, upon sale, to deductible COGS. The IRS partially allowed this approach in Chief Counsel Advice 201504011, which allows marijuana businesses to determine COGS using the inventory costing regulations (Regs. Sec. 1.471) in effect at the time Sec. 280E was enacted.

In addition to federal tax issues, cannabis businesses will also need to comply with state income and sales tax rules. Some states, such as California, Colorado, and Washington, have issued tax guidance for cannabis businesses.

You can help cannabis-industry clients avoid tax trouble, while reducing taxable income, by maintaining thorough documentation and clear financial records of all business processes and transactions.

Components of successful business operations

Working effectively with newly established cannabis operations sometimes requires knowing how to counsel them on improving business functions. To advise on the creation of pitch decks and financial models aiming to raise funds, you should first understand the components of success specific to the cannabis industry.

Clients with established dispensaries may present a different set of demands. The merger and acquisition reviewing process known as purchase price allocation (PPA), for example, demonstrates the importance of a reliable and consistent system of inventory and asset identification.

Processes like PPA, which require shrewd judgments, are dependent on the formulation of a clear, legally compliant methodology. Maximizing the performance of cannabis-oriented businesses hinges on accurate legal and financial information.

Despite potential complications, working within the cannabis industry offers rewarding challenges and a chance to make your mark in a dynamic and growing field.

Demystify cannabis accounting, network with industry experts, and ensure you are operating effectively and safely by learning best practices at the AICPA & CIMA Cannabis Industry Conference.