ANJA Presents: Insights from NECANN NJ 2023 - What New Cannabis Operators Should Know

Introduction

The NECANN 2023 conference was a treasure trove of information for cannabis operators, especially those new to the industry. One seminar that stood out focused on the financial aspects of running a cannabis business, covering everything from cash flow projections to compliance and taxes. This blog aims to share the key takeaways from this seminar, offering a roadmap for new operators in the cannabis industry.

Cash Flow and Projections

Understanding your cash flow is crucial for any new operator. Cash flow refers to the money coming in and going out of your business. Most businesses use Excel for cash flow projections, which are estimates of future revenue and expenses. These projections incorporate assumptions and timelines to compare against industry standards. It's advisable to start with 13-week projections—a short-term financial forecast—and scale into quarterly projections as the business becomes more established.

Cost Considerations

Under Section 280E of the IRS tax code, the Cost of Goods Sold (COGS) is the only expense that can be deducted. COGS includes the direct costs of producing the goods sold by a company. For those in cultivation and manufacturing, energy is the most significant cost, followed by labor. Sale-leaseback arrangements, where an asset is sold and then leased back for the long term, are common to improve cash flow.

To illustrate the unique financial challenges faced by cannabis businesses due to Section 280E, let's consider a hypothetical example comparing a cannabis retail business with a standard retail business.

Standard Retail Business:

In a standard retail business, various operating expenses can be deducted from the taxable income. These deductions might include:

• Rent for the retail space

• Employee salaries and benefits

• Utilities (electricity, water, internet)

• Marketing and advertising costs

• Office Supplies

• Business travel

After these deductions, the business would calculate its taxable income, which would be considerably lower than its gross income.

Cannabis Retail Business:

In contrast, a cannabis retail business operating under Section 280E can only deduct the Cost of Goods Sold (COGS) from its taxable income. For a cannabis retail business, COGS would mainly entail the cost of purchasing cannabis inventory for resale.

Notably, energy costs, which are a significant factor for cultivation and manufacturing, are generally not the biggest cost for retail operations in the cannabis industry. Unlike a standard retail business, the cannabis retailer cannot deduct expenses like rent, most employee salaries, utilities, or marketing costs. This limitation results in a much higher taxable income and, consequently, a higher effective tax rate. 

Sale-Leaseback Strategy:

To mitigate the impact of these tax limitations, cannabis businesses often engage in sale-leaseback arrangements. For example, they might sell their retail space to a third party and then lease it back. This strategy improves cash flow but still complies with the restrictions imposed by Section 280E.

By understanding these unique financial constraints, cannabis businesses can better navigate the complex landscape of industry-specific accounting and taxation.

Compliance and Taxes

Navigating the tax landscape is another complex challenge. Section 280E applies to Schedule 1 and 2 substances, limiting the deductions a cannabis business can claim. Schedules 1 and 2 are categories of controlled substances as defined by federal law. If cannabis were to be reclassified to Schedule 3, this would open up access to banking and more favorable tax treatment. Currently, startup costs, which are the initial costs of starting a business, are non-deductible if there's no revenue stream.

New Jersey-Specific Tax Rules

Interestingly, New Jersey has decoupled from the IRS rules concerning 280E, allowing for more deductions at the state level. Operators should be aware of various taxes, including sales and use tax—a tax on the sale, lease, or use of goods and certain services—local cannabis transfer tax, Social Equity Excise Fee (SEEF), income tax, and property tax. The seminar recommended being strategic about the cost separation of assets based on their depreciation rates.

Conclusion

The financial aspects of running a cannabis business are intricate and require careful planning and understanding of both federal and state tax laws. One of the most crucial pieces of advice for new operators is to align with a municipality that is supportive of your business, as changing a town's stance can be an almost insurmountable uphill battle. With the right financial strategies and a deep understanding of compliance requirements, new operators can navigate the complexities and set their businesses up for success.

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