IRC § 162(a) permits the taxpayer to deduct all of the bizarre and needed bills related to the enterprise, and never immediately associated to the creation of the “product” (stock), from gross receipts to reach at taxable revenue. Chief Counsel Advice 201504011 permits marijuana companies to calculate COGS on a money foundation.
IRC § 471 offers the basic rule for figuring out the Cost of Goods Sold (“COGS”) because it pertains to stock. COGS for stock is generally accounted for on an accrual foundation.
IRC § 263A, added to the IRC in 1988, expanded upon IRC § 471 and offers steerage on the prices related to producing a product (“goods or inventory”) which have to be captured and allotted to the product after which deducted from the gross receipts acquired upon the sale of the product to reach at the “profit” obtained from the sale of every merchandise of product. These “captured” prices are referred to as COGS. Prior to the adoption of IRC § 263A the COGS have been calculated solely pursuant to IRC § 471.
The “profit” obtained from the sale of product (Revenue from sale of product – COGS) is then additional decreased by the IRC § 162(a) unusual and mandatory bills to reach at the taxable revenue of the enterprise.
The taxation of a marijuana associated enterprise is totally different from the taxation of different companies. Marijuana is a Schedule 1 Controlled Substance beneath the Controlled Substances Act (21 USC 801 et seq.). In 1982 Congress handed IRC § 280E, which prohibits marijuana companies from deducting their IRC § 162(a) or bizarre and mandatory enterprise bills from gross revenue when figuring out taxable revenue.
As might be mentioned in Part Two, IRC § 280E denies the IRC § 162(a) deduction to these companies that “consist of trafficking in controlled substances.” Arguably which means IRC § 162(a) deductions are obtainable to marijuana companies that aren’t concerned in the “trafficking in controlled substances” of the marijuana business. This may embrace producers and wholesalers.
IRC § 280E does, nevertheless, allow the deduction of COGS when product is bought in arriving at taxable revenue.
In 2015 the IRS issued Chief Counsel Advice 201504011 (“the CCA”), which addressed the accounting guidelines for the marijuana business and how one can arrive at taxable revenue.
Not surprisingly the CCA reiterated that IRC § 162(a) bills are usually not obtainable to the marijuana business. The CCA additionally stated that the COGS calculation beneath IRC § 471 applies and never the COGS calculation beneath IRC § 263A, which in essence changed IRC § 471 however was enacted after IRC § 280E was adopted. The CCA does, nevertheless, allow a COGS deduction for oblique production-related bills. Specifically, production-related bills, in any other case deductible underneath IRC § 471, corresponding to wages, rents, and repairs, are deductible. Marketing and common enterprise bills will not be deductible when calculating the taxable revenue for a marijuana enterprise.
IRC § 471 offers with the want for accounting for inventories. It supplies that inventories at the starting and finish of every taxable yr are vital in each case by which the manufacturing, buy, or sale of merchandise is an revenue producing issue. The stock ought to embrace all completed or partly completed items and, in the case of uncooked supplies and provides, solely these which have been acquired on the market or which can bodily turn out to be an element of merchandise meant on the market, during which class fall containers, … if title thereto will move to the purchaser of the product bought.
COGS, in the case of merchandise produced by the taxpayer consists of (1) the value of uncooked materials and provides getting into into or consumed in reference to the product, (2) expenditures for direct labor, and (Three) oblique manufacturing prices incident to and essential for the manufacturing of the specific article, together with in such oblique manufacturing prices are applicable portion of administration bills, however not together with any value of promoting or return on capital whether or not by approach of curiosity or revenue. 
Indirect prices of manufacturing that could be included in the willpower of COGS embrace:
(a) Repair bills;
(c) Utilities similar to warmth, energy, and lightweight;
(e) Indirect labor and manufacturing supervisory wages together with payroll taxes and unemployment profit funds;
(f) Indirect supplies and provides;
(g) Tools and gear not capitalized; and
(h) Costs of high quality management and inspection.
Indirect prices that could be included in the calculation of COGS relying upon how they’re handled on the taxpayer’s monetary statements embrace:
(a) Taxes in any other case taken as a deduction beneath IRC § 164 (aside from state, native and overseas revenue taxes);
(b) Depreciation reported in monetary studies and price depletion on belongings incident to and crucial for manufacturing or manufacturing operation or course of;
(c) Employee advantages together with these in any other case deductible beneath IRC § 404;
(d) Costs attributable to strikes, rework labor, scrap and spoilage;
(e) Factory administrative bills;
(f) Officers’ salaries attributable to providers carried out incident to and mandatory for manufacturing or manufacturing operations or processes; and
(g) Insurance prices incident to and mandatory for manufacturing or manufacturing.
The COGS evaluation for the retail marijuana enterprise is easier and the deductions are in all probability fewer. The retailer will embrace in COGS the bill worth much less commerce or different reductions. To this internet bill worth must be added transportation or different vital costs incurred in buying possession of the product. Accordingly, freight and repair charges related to the freight charges are added to the COGS calculation. Handling expenses are additionally added. It is unclear whether or not dealing with prices of the product as soon as acquired by the retailer are a element of COGS. They can be underneath IRC § 263A.
One level that must be clear by now’s that the marijuana enterprise individual must spend the effort to correctly account for the gadgets of revenue and expense with a purpose to maximize the alternative to seize all bills that may be attributable to COGS and thereby reduce taxable revenue. The books and data ought to be maintained in accordance with Generally Accepted Accounting Principles (“GAAP”), and whereas this accounting course of is costlier, it ought to, in the long term, end in extra captured COGS bills and save taxes.
The accounting guidelines for the marijuana business are difficult. IRC § 162(a) deductions usually are not permitted. This signifies that the marijuana entrepreneur shall be paying taxes on money expended for in any other case deductible enterprise bills. Income taxes can be paid on greater than the internet revenue from the enterprise. This drastically will increase the efficient tax price for the enterprise.
Accordingly, actual planning and correct accounting for the enterprise operations are each mandatory. Please keep tuned for Part Two of this text as I assessment related case regulation on this space and supply my planning concepts.
General Reference Materials
- “Marijuana Business and Section 280E: Potential Pitfalls for Clients and Activists” by Jeffrey Gramlich, Ph.D. and Kimberly Houser, J.D. The Tax Advisor, June 30, 2015.
- “IRS Further Limits Deductions For State-legal Marijuana Facilities” by Tony Nitti, Forbes January 24, 2015.
Warning Regarding Federal Law: The possession, distribution, and manufacturing of marijuana is prohibited underneath federal regulation, regardless of state regulation which can, in some jurisdictions, decriminalize such exercise beneath sure circumstances. Penalties for violating federal drug legal guidelines are very critical. For instance, a conviction on a cost of conspiracy to promote medicine carries a compulsory minimal jail time period of 5 years for a primary offense and, relying on the amount of marijuana concerned, the fantastic for such a conviction might be as excessive as $10 million. In addition, the federal authorities might seize, and search the civil forfeiture of, the actual or private property used to facilitate the sale of marijuana in addition to the cash or different proceeds from the sale. Although the U.S. Department of Justice has famous that an efficient state regulatory system, and a marijuana operation’s compliance with such a system, must be thought-about in the train of investigative and prosecutorial discretion, its authority to prosecute violations of federal regulation isn’t diminished by the passage of state legal guidelines which can decriminalize such exercise. Indeed, resulting from the federal authorities’s jurisdiction over interstate commerce, when companies present providers to marijuana producers, processors or distributors situated in a number of states, they probably face a better degree of scrutiny from federal authorities than do their clients with native operations.