Cannabis Farmers Need to be Audit-Ready Says Letter Writing CPA
Welcome to our Opinion section. Remember opinions expressed do not necessarily reflect that of Redheaded Blackbelt nor have we checked the letters for accuracy.
How much does it cost to grow a pound of weed? This is not a trick question. I get it, nobody told you there would be a quiz. It’s a pop quiz. Remember those? Know what else is a pop quiz? An IRS audit. It’s the adult version of a pop quiz and it doesn’t suck less than the pop quizzes Mrs. Anderson might have given you in Math class. In fact, an IRS audit sucks exponentially more than any pop quiz you may have booted back in school. That sick twisting feeling in your stomach, racing mind and sweaty fingers that are trying to grip your number two pencil are child’s play compared to what you will endure at the hands of relentless auditors. They have, what will feel like, all the time in the world to scrutinize the shit out of you in order to collect the maximum amount of underpaid tax, penalties and interest. So, the question is, are you prepared?
As a cannabis farmer, if you are to be prepared for an IRS audit, you must be able to correctly answer the opening question. How much does it cost to grow a pound of weed? The answer, as with most tax issues is “it depends”. But there is an answer. This cost per pound issue ultimately becomes a tax matter because it is reported on your tax return. However, as the question implies, the calculation we seek is an issue of cost and therefore of cost accounting. If it’s warm and you are inside go ahead and open a window. Get up, splash some cold water on your face and blink your eyes really hard a few times. No, you may not take a nap in class. Stick with me. You’ll appreciate this when you get older.
Could there be anything more boring than accounting? I have my opinions on the matter. I actually think a lot of things are more boring than accounting. But I have limited interpersonal skills and prefer to be left alone so it kind of works for me. However
, if accounting in general is boring, cost accounting may be slightly more boring than say, tax accounting. If I’ve offended any Cost Accountants I deeply and sincerely apologize. Retaliatory bunch those Cost Accountants. Boring and arcane as you may find the subject of cost accounting, it matters not. Furthermore, cost accounting is one of the few friends you have in this regulatory nightmare that more closely resembles Dante’s Inferno than an agricultural activity.
Under Internal Revenue Code Section 280E the cannabis farmer toils. “No deduction or credit shall be allowed…”. Really? Yes really. No means no. None, zero, nada. Doesn’t everyone want to pay effective tax rates of 70%? I don’t need to tell you, the farmer, that you are kind of screwed. Your only real saving grace that keeps you from being taxed into oblivion is your Cost of Goods Sold (COGS). COGS is not a deduction. It is a reduction in gross receipts or an exclusion and therefore not subject to 280E. That means you, the farmer, rely on it. Heavily.
To correctly calculate COGS you must know what expenses are allowed or disallowed in the valuation of your inventory. The rules related to this issue are found in Code Section 471. The applicable subsections are applied differently for different cannabis industry verticals. A farmer can take advantage of more of the provisions of this code section than can a dispensary. At this point it starts to get a little complicated. So we will leave it here with this introduction to cannabis cost accounting. The takeaway is this; you must be audit, investor and bank ready at all times. If you are ready, you add significant value to your business. The IRS is ramping up enforcement efforts and plan to hire thousands of additional staff. There are numerous court cases on the books and aside from CHAMP the outcomes have not been positive for the cannabis operator. The IRS has been overwhelmingly successful in their audit efforts. If you want peace of mind my advice is to get your accounting in order. Class dismissed.
Loren Harwood, CEO/CPAOrcal Coastal CPA, LLC
How much does it cost to grow a pound of weed? This is not a trick question. I get it, nobody told you there would be a quiz. It’s a pop quiz. Remember those? Know what else is a pop quiz? An IRS audit. It’s the adult version of a pop quiz and it doesn’t suck less than the pop quizzes Mrs. Anderson might have given you in Math class. In fact, an IRS audit sucks exponentially more than any pop quiz you may have booted back in school. That sick twisting feeling in your stomach, racing mind and sweaty fingers that are trying to grip your number two pencil are child’s play compared to what you will endure at the hands of relentless auditors. They have, what will feel like, all the time in the world to scrutinize the shit out of you in order to collect the maximum amount of underpaid tax, penalties and interest. So, the question is, are you prepared?
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Sounds like everyone should not be legal. Take yer chances on being raided by one agency a decade as opposed to having to deal with a bunch of agencies annually. Plus the threat of more snooping based on federal funding.
Thanks, I won’t be going legal anytime soon. So I do not need to worry bout pesky tax stuff.
Sounds like a CPA pitching their services. More of an unpaid advertisement than a letter to the editor.
I agree…….
Where in the article did I pitch or even mention my services? This is an underserved, nascent industry with very little published guidance. There are no white papers, GAAP guidance or other established cannabis specific guidelines. The large accounting firms have not even entered the market because cannabis is still a Schedule I drug. I do have a business. I don’t apologize for that. I am here to participate and help. Business development, if it occurs, would be a byproduct. Writing articles on accounting subject matter is new to me. I think I have something to offer the industry and the area I grew up.
Thanks for the information. You must understand you are discussing sensitive subjects, feds and tax. You even state it’s a schedule one narcotic which is something we all think is an unjust law. Any written word concerning unjust laws is gonna be scrutinized on this site.
Don’t take the comments too hard. This is how most letters are received. I will say that any legal farmer should already know all the info you provided and even more. The topic is too complicated for most people to interested in honestly. I think you would help more people (those who actually want help) by advertising on this website.
What kind of percentage rate should a farm be paying on gross income if properly accounted for? We grossed 220k last year and have to pay almost 25k in combined state and fed taxes. Does that seem like our CPA is doing a good job maximizing deductions?
About 50k of the 220k went to cultivation tax throughout the year.
I’m sorry but I can’t properly address this question on this forum. There are just too many variables that could affect your specific tax situation, none of which I’m familiar with, for me to come up with what I think your tax liability should be.
Stop crying, you don’t pay any thing in taxes, you pot growers need to grow up and pay your fair share, you paid 10% on revenue, try paying 35% as a pay roll employee with no deductions.
Hey, I appreciate it, but one question: I didn’t get a reference at the end, could you explain? ” …and aside from CHAMP the outcomes have not been positive for the cannabis operator”. Just wondering about “CHAMP”. There was a distribution company with that name in SR…
Californians Helping to Alleviate Medical Problems (CHAMP) v Commissioner
CHAMP is a good case study in successful bifurcation of business activities as they relate to 280e. Other cases such as San Jose Wellness have gone the other way.
Thanks for sharing. Don’t mind those negative suckers. They know nothing and pretend this is “normal”
No, he spelled it out like it is. It’s confusing. I dealt with it helping people set up in another jurisdiction to license, pay taxes and stay legal. CPA is what it’s all about. But I think the whole green rush has pretty well run its course. I haven’t paid for it since . . . Jethro Tull, 1973.
So, what do you think 🤔?? Are you more likely to get busted selling your weed on the black market & not paying taxes or a legal farm selling “biomass” pounds(cola’s) under the table and not reporting/paying the taxes?
Also, who is more likely to get busted not paying their taxes for years? The black market farmer or the “legal” farmer who sold weed on the black market for years??
I think the odds are more on the legal farm getting harassed more so than not being legal.
Sounds like I’ll continue filing as a consultant.
they didn’t get capone on murder or racketeering, it was tax evasion
If the government can avoid audits, so can you
That is exactly while individuals and sole proprietors start limited liability and S Corporations? Are those folks part of the evil corporate hegemony? Or are they just limiting risk and liability? Are they playing the game or selling out? How many of you are ready to go full Amish? I don’t see many hands in the air
Full Amish isn’t for everyone, but people who have grown accustomed to certain Amenities will need to figure out how to make it work. At this point the government needs the credit card taken away, and needs a time out, it’s acting like an entitled spoiled brat.
Entity selection is important. I’ve never worked with Amish owned businesses but I’d imagine they have CPAs and attorneys as well. Unfortunately until cannabis is federally legal the playing field isn’t level.
i believe there’s a substantial Mennonite workforce operating in the Humboldt County (non-cannabiz) agricultural industry. I’m sure they have accountants and attorneys. It’s how business in America works. Most of the weed industry is still deciding if they want to be legit. Many play the teeter totter game and tell the gubmint that they were robbed (again) and just funnel everything on the traditional market. never a dull moment!
oh and three cheers for using your real name (I’m assuming)!
Entity selection is important especially in cannabusiness. It is just part of the picture. This is a big topic. It’s important to understand that an entity needs to exist for a purpose other than just tax avoidance. Multi entity structuring is not a good strategy if the objective is to “beat the tax code”. It adds complexity and admistrative burden. It can also backfire and result in double taxation in this industry. The IRS will look through a group of entities to the underlying economic activity. So someone could have 15 entities that under examination are disregarded for the purpose of tax assessment.
I don’t see how there isn’t benefit to multiple entities with 280e in play. Cultivation has it the easiest, but even those costs that can’t be included in COGS could be utilized another entity, say a management corp. For vertical integration with different license types, having each one as a disregarded LLC to a parent entity still generally seems best. Feel free to correct me as I’m just some hillbilly.
Sure multiple entities are beneficial if they serve a purpose. No argument there. That holds true in any industry. But setting up numerous entities to hide or obscure the real underlying economic activity isn’t a good idea. I have nothing against hillbillies. We played ball over there when I was a kid. Tough kids over in Hayfork.
“The IRS is ramping up enforcement efforts and plan to hire thousands of additional staff. There are numerous court cases on the books and aside from CHAMP the outcomes have not been positive for the cannabis operator. The IRS has been overwhelmingly successful in their audit efforts.”
If the IRS is finally getting the agents and auditors needed to find tax cheats, it would be so predictable that they would choose (pick on) the cannabis industry disproportionately. Every other agency has. It’s like a fight when everyone just jumps in to clobber the victim. Especially if they have long had jealousy and antagonism for that ‘victim’.
It can happen. And yes. Good to have our accounting in order. But will it? Are we really what / who they will choose to go after, when there are so many people and organizations who have been flouting IRS rules for years, decades? It will be interesting, and maybe sad, to see.
It is happening and will continue to happen. Folks in the industry continue to make it easy for the IRS to target their returns. The majority of them are doing their accounting incorrectly. I’ve read the internal audit reports. It’s easy money for the IRS.
Yes. And those accountants and consultants who have told them they are fine have been bullshitting while collecting paychecks. It will be quite a shock indeed!
No one should cheat on their taxes, it’s un-American
Yes. And politics or social issues should not play a part in the enforcement of tax laws. It is reasonable though to pursue the ‘tax cheats’ who are ducking, to the large$$$t degree, their responsibility to pay their (lawful) fair share!
Fair and square, everyone’s lawful obligation due and payable in a timely manner. Cheats should be punished to the full extent of the law regardless of their position in life because they’ve tried to leave their bill as an unfair burden on others.
Yes. Agreed.
One of the problems is that the wealthy have great influence in the halls of power and are able to sway tax laws to their benefit (loopholes, off-shoring, shelters, etc, etc.). So they can, with the advice of their tax attorneys, beat the system and the IRS are rather inept at trying to defeat them….. and their wall of lawyers.
Very true. Much better to not file at all.
That choice has already been made. I have reviewed several internal IRS documents on the topic. Most cannabis businesses are doing their accounting incorrectly. They are making it easy for the IRS to come after them. This is not theoretical or hyperbole.
Appreciate the reality check and nudge.
So if Im reading this right, a legal, legit cannabis grower isnt allowed any deductions for his cost of production? What about the cannabis processors? This is all new to me and if Im correct here, its surprising anyone goes the legal route. Government is so wonderful!
Most direct and some indirect production costs can be included in COGS. Operating expenses are not deductible unless they can be moved into COGS. This is where solid cost accounting can be beneficial. It’s common for a portion of an expense like rent to be partially allocated to COGS and partially disallowed.
Says COGS deducted, isn’t that all the production cost?
It’s only costs that go directly into the product. Clones, fertilizer, labor, packaging, etc. Marketing for you farm would not be included for instance. Farms do get to count more expenses that distro (which mainly can count just the cost to buy the product, storage and inventory maintenance), but retail gets hammered since they don’t produce anything. That’s why most of the headline grabbing cannabis tax cases have been against retail shops. A lot of these issues go away if you your supply chain is vertically integrated.
I’d agree with a lot of that but there are other costs at the production/farm level that can be included if proper cost accounting and GAAP reporting are performed regularly. Overhead allocations based on percentage of square footage dedicated to farm use etc.
Production costs are generally includable in COGS. This gets into direct and indirect costs and more detailed cost accounting. Retail and processing activities are treated a little differently than farming. Deductions are another story. Some deductions can be reclassified to COGS. Some cannot. Many ordinary and necessary expenses are disallowed. This is especially true at the retail level.
This guy is a clown, what a joke. Some scare tactic “letter to the editor”. We have CPA’s. We pay them well, This guy is whipping up fear probably so he can gain more clients. What a joke.
Sorry you feel that way. I try to fill the role of an objective third party. I’ve done this for a long time. My goal is to participate and help not scare people. By all means please feel free to challenge any assertion I have made. If I’m incorrect and it’s brought to my attention then I’ve learned something. For those of you who have competent advisors with industry specific knowledge good job. Many folks don’t.
Oh you know it.
So unless you owe the IRS 1 million dollars its not worth their time, the average IRS investigation costs them anywhere between 60-100k to complete. They arent coming after you unless they think they can get alot of money from you.
That is inaccurate.
I’ll agree. Usually best to file as a c corp for cannabis. Partnerships have the lowest audit rates.
You do know that they can demand Kym’s records and use the internet tracking to find out who you are right? Because it just sounded a lot like you gave advice on how to commit fraud against the IRS and the federal government…Have a nice day!
Very unlikely for a lot of reasons. Mostly because the government would have a hard time prosecuting someone for something they said anonymously on the internet. Secondly because IP addresses are a lot harder to trace than you think.
Haha, you’re really stretching it. Just because I understand audit rates? Or taxes in general (I’m no EA or CPA)? Tax avoidance is allowable and using the tax code to reduce tax liability is what it is for. It’s a boring topic and you sound as grumpy and bitter as always.
Any business owner should understand taxes as it is generally the largest expense they face. It’s well understood that partnership have the perceived lowest audit rates due to the small size of staff assigned to this tax classification. Having your farm taxed as a partnership is a poor idea in my mind.
C Corps have some real benefits especially upon sale if they qualify for Section 1202 treatment. Also they are self-contained so there is a reduced audit risk at the personal level for shareholders.
They are projecting their fear onto you. Seems very clear to me.
Wow! Nice advertising for your business….scare the shit out of them into calling you…did you kick down Kym for the advertisement??
Thanks. Yes I paid her in cryptocurrency so it wouldn’t be traceable. Don’t tell anyone. Good grief I’m just trying to participate and help. If someone wants to call me they can. I’m pretty good about trying to provide assistance.
The people are too paranoid for great advice.
A tax mess can be a nightmare from hell Thank you CPA
If you intend to build a legal-side cannabis business for the long term, it would pay high dividends for those who are doubting this information or accusing someone of spreading fear to do the research.
Its real. Very, very real.
JB
No doubt it’s a serious issue and one that almost all accountants don’t understand properly. I did plenty of research in 2016. I just figured it would be more ethical to have bought an advertisement, but hey we are all talking about it and the author is even defending themself so the saying of all publicity is good publicity might just apply here.
//” one that almost all accountants don’t understand properly”//
Correct.
//” I just figured it would be more ethical to have bought an advertisement”//
The world turns on money of course and in the case of Kym — that means the world turns on content. She’s gotta eat. If she wants to put in the effort to include content by professionals that both inform and yes … advertise, I personally don’t find that unethical. That’s just me of course.
Most of what I see folks doing here in this case is ‘demonizing’ someone who is stating things that are absolutely 100% truth.
JB
I’ve posted a piece from a local insurance agent on insurance rules. I’m going to be posting an opinion piece from the local Hotel and Lodging group on Measure J soon…I post opinion pieces from numerous folks–lately almost every day. These are not articles but editorials or letters to the editor. There’s nothing unethical about either writing them nor posting them unless I get paid for them and don’t disclose that. I did not get paid.
Ok, maybe unethical is too much. But it was solely directed towards the author and not Kym. I would simply hope to encourage paid advertising on this website.
I think this topic is about the biggest issue not generally dealt with by most cannabis businesses. It also seems supremely unfair (specifically 280e and the lack of bank access) and is a leading factor as to the problems smaller farms must still overcome.
You are assuming that my primary intention in writing this article is to gain clients and is therefore some form of advertising. I like to write and wrote this article for the sake of writing an article. I would like to write more articles. I’d also like to do speaking engagements. It’s all part of developing expertise in the field. I’m trying to participate. I like the sun grown craft cannabis movement that is going on. I’m building a business, learning, participating, helping and getting involved. I also have a love for Humboldt County. Questoning my ethics is a little harsh man.
Good luck build your business and getting out there publicly. Also, it’s important to not have thin skin when doing so.
Fair enough. Thanks and best wishes.
lol, I hope some day we get to socialize in a public setting. Trinity county fair in July maybe, it be a hoot and some hollerin. Blessings.
Agreed, thankfully the fair in July might miss all the smokey days of the past. It’s a rare treat for the kids and I hate to see it when the fair is canceled. Plus the fair board could really, really use the revenue. Doesn’t get much better than the demolition derby!
Taxation is theft.
Tell it to the judge.
There IS a federal courthouse in Humboldt County. It’s been pretty underused but it exists. They moved it from Eureka to a new building McKinleyville near the airport a few years back. In anticipation of…”legalization”? I think so. They want anything that is left over after the county and state have reamed you. Enjoy that “legalization” and your pansy permit! I hope you are feeling safe and free by now!! So glad you decided to be a “good player” LOL
Oh ya, they moved to McKinleyville because of legalization? Haha your hatred of permit holders has clearly cloud your judgement.
No hate. Just calling it like it is. And I will keep doing so whenever you want to make some comment regarding me. The federal courthouse in Eureka was in an old building and it had cramped space. Their projection for future cases was such that they acquired expanded space up in McKinleyville next to the airport. Made sense since some personnel would be flying in and out of ACV. Federal cases will be where the conspiracies to commit frauds, money laundry cases, IRS fraud cases, etc will be prosecuted. It will happen. Timeline got pushed back due to covid but it’s still in the works. Did you think the feds will sit by idly while millions of dollars get refunneled into other pockets?! Do you have some inside information about how maybe the feds suddenly secretly love weed growers who bought permits and so they will refuse to audit or prosecute their crimes?! Now …tell me…who is cloudy?
Farce is right on this one…also the H st courthouse was not designed with all the modern security twists and turns the new federal buildings have. Lots of automatic locking doors and surveillance in the new buildings. Plus it’s way the fuck out there so Very difficult for any meaningful protests to happen there and Extremely Easy to manage any protestors who do show up to attempt to picket or blockade the place…it’s a fucking cul de sac!!!!
The point is the letter writer is correct. The IRS is already got everything and everyone in their sights it’s just a matter of time. It doesn’t matter about the cost/ benefit or any other BS because it’s about OPPRESSION of all non Corporate players. And llc’s don’t mean shit when the fed steamroller gets headed your way!! Fuck the “legality”bestowed by a corrupt state and keep yer head down!👍
I guess I’m just calling it as it is too. Your obsession with permit holders is certainly entertaining. It’s gotta be tough to see the world change when nostalgia is so alluring.
I have no special info and maybe there is a huge series of federal cases coming down the pipeline. Probably not though as they could have been doing this for decades. Most likely it will be like enforcement where they have a few cases they work on and the vast majority go on untouched.
She’s right.
Plus local Cannabis cpa’s are hard to come across. Mine stopped taking clients a few years ago.. Happy to see some local talent.. there are way too many worthless “consultants” and not enough people with a degree that can actually help.