The legalization and taxation of cannabis remains one of the hottest trends in state taxation. As the New Mexico Supreme Court tax ruling declares that cannabis purchases by medical cannabis patients should not be subject to gross receipts tax, you might be interested to know that medical products from weed are also not taxed in several states. But what states, exactly?
This article will walk you through the legalization and taxation of cannabis in different states in the US.
States that levy tax on cannabis products
Cannabis, also known as marijuana, has been used as a drug for both medical and recreational purposes and in various traditional medicines for centuries. Medical cannabis is legal in 37 states, Washington DC, and the US Virgin Islands.
Most states do not levy a tax on cannabis purchases because they exempt prescription medication purchases from their general sales tax. Each jurisdiction has its own criteria for when cannabis can be prescribed, at what amounts, and the process for issuing medical cannabis licenses to qualified consumers.
On the other hand, other states may tax cannabis at a lower rate than other items sold at retail. Medical cannabis purchase taxes are generally low and equal to the state’s general sales tax rate. Therefore, these taxes are not classified as “marijuana taxes.”
This is mainly because cannabis is still federally classified as a prohibited drug in the US. So, while many states have legalized cannabis for medical purposes, prescribing it remains nearly always illegal at the federal level. Moreover, the FDA has only approved a certain number of cannabis derivatives for prescription medication use.
The table below shows how cannabis tax differs across states.
How is cannabis taxed across states?
In general, state and local governments tax medical cannabis in three main ways.
Price-based. Price-based taxes are similar to general sales taxes in that the consumer pays a tax on the purchase price, which is then remitted to the state by the retailer. Like other excise taxes, the tax rate is usually higher than the state’s general sales tax rate. Most states impose this tax at the point of sale (i.e., the consumer pays the tax together with the price of the goods at checkout). Meanwhile, a few other states apply their percentage of price tax to wholesale transactions. For instance, the cultivator or distributor pays the tax), and this cost is passed on to the consumer in the final purchase price. Some states also allow local governments to impose a percentage of sales tax, but usually with a limit on the maximum rate.
Weight-based. These taxes are similar to cigarette taxes, but the tax is based on the cannabis product’s weight instead of taxing per pack of cigarettes. The wholesale transaction is subject to this tax. It means that the cultivator or distributor pays the tax, then includes it in the final cost of the consumer purchase. States that apply this form of tax usually have varying tax rates for different types of cannabis. For instance, California taxes cannabis flowers at $9.65 per ounce, cannabis leaves at $2.87 per ounce, and fresh plant material at $1.35 per ounce.
Potency-based. Potency-based taxes are similar to alcohol taxes, except that instead of taxing drinks with a higher percentage of alcohol at higher rates (e.g., the tax rate on liquor is higher than beer), the tax is based on the amount of THC in the cannabis product. Currently, Illinois is the only state applying a THC-based tax. It levies a 10% tax on items with a THC concentration of 35% or less, and a 25% tax on those with THC exceeding 35%. All cannabis-infused products are subject to a 20% tax. New York has also established a potency-based tax recently. However, it taxes per milligram of THC, with different amounts applied to different items.
Some states levy more than one of these taxes. Additionally, some states and localities levy their general sales tax on the purchase of cannabis in addition to their excise taxes.
There is still much confusion regarding the supreme court cannabis tax ruling. Still, as more states open legal marketplaces and more research is carried out to understand the externalities of consumption, business owners will better understand this industry’s taxation.
Don’t forget to subscribe to the Shoeboxed blog for more helpful tax and bookkeeping knowledge on various industries!
Shoeboxed is a receipt management application that turns your receipts and business documents into a digital format in just one click by taking a picture straight from your smartphone or scanning a pdf. It automatically extracts, categorizes, and human-verifies important data from your receipts so that you can go over and check your records anytime with ease. Shoeboxed ensures you will always have your receipts securely stored and ready for tax purposes.
Access your Shoeboxed account from your web browser or smartphone app. Stay audit-ready with Shoeboxed for FREE now!
Due to its illegal status at the federal level and as the business is growing fast with a variety of emerging sub-industries, Cannabis companies are facing ever more complex issues that are unique to the industry and require their operators to be extra careful when it comes to keeping their books accurate and organized. Hence, bookkeeping for Cannabis industry best practices is proven to be necessary for businesses in the field.
Let’s go through everything must-knows and best practices about bookkeeping for Cannabis industry in this article!
Not many federal-regulated financial institutions welcome those who run their business in cannabis as it is still classified as an illegal drug in many states, thus making its risky and problematic reputation. Apparently, the lack of banking options from the beginning subjects cannabis businesses to multiple issues, including internal and external theft, misallocation of funds, payroll, and insurance paid in cash.
It is not totally hopeless to find a bank that can work with your cannabis business though if you are willing to go through complicated application procedures in which regular financial statements must be handed in for reviews. The banks often do this quarterly, but monthly financial records should be ready at any time for submission since it is likely that they will be investigated to support what is reported. The banks will also pay attention to fluctuations in your report, and you don’t want your account to be shut down because you can’t account for such inconsistencies!
Cash flow control
Needless to say, it is challenging to manage cash-only businesses, and those trading in cannabis are no exception. Without a proper tracking system in place, tracking cash transactions by transaction can become a mess. In this case of cannabis – a federally controlled substance, every piece of inventory matters, so any suspected activity may cost the companies their precious licenses or even lead to criminal charges against concerned individuals.
To prevent money laundering, marijuana companies must meet strict requirements regarding accounting and keeping records of every activity and transaction during the course of business, “from seed to sales”, and from suppliers, distributors, retailers to customers. Moreover, for any transaction or a series of transactions that total $10,000 or more in cash, cannabis businesses have to prepare Form 8300 for tax purposes, the filing of which can be confusing with errors resulting in serious fines and audits.
According to Internal Revenue Code Section 280E, “No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances (within the meaning of schedule I and II of the Controlled Substances Act) which is prohibited by federal law or the law of any state in which such trade or business is conducted.” In compliance with this, cannabis-related businesses follow strict limitations when reporting taxable income, with the cost of goods sold being the only deductible expense. Accounting processes, as a result, must implement complete record-keeping to ensure a compliant inventory environment.
Cannabis business and accountants working in the industry do not often talk about seed-to-sale tracking with much enthusiasm. Every state has its own seed-to-sale system to monitor the production and distribution of Cannabis plants, causing a great deal of confusion for growers, distributors, and other stakeholders involved who need to adhere to changing rules of each local government.
Specifically, depending on its preference, each state may require a different software system to trace and monitor the plants and finished products from inventory to the point of sale. The three popular seed-to-sale software, Biotrack, MJ Freeway, and METRC, however, tend to have unreliable reporting and it is also difficult to integrate them with existing accounting systems.
Bookkeeping for Cannabis Industry
Bookkeeping is fundamental to accounting, and with all the federal and state regulations that make accounting for cannabis extremely complex, anyone who deals with keeping the books must do it right.
In particular, bookkeepers should know the ins and outs of Section 280E in the tax code because of its major implications on the business’s actual income and profit. Unlike those working for most small-to-medium-sized businesses, accountants and bookkeepers in Cannabis companies must get used to concepts such as cost accounting, accrual accounting, generally accepted accounting principles (GAAP), and absorption accounting.
Since many of these principles are not required for everyday small business accounting, a generalist accountant may not be familiar with them. Finding a person with the necessary skill set to keep good records for your cannabis business, therefore, is important in several ways.
Whether outsourcing professional bookkeeping services or hiring an internal bookkeeper, cannabis businesses benefit greatly from having their books handled by people who have experience in the industry. It will be too late to get your accounting system set up and begin organizing your expenses months after the business starts operations. Money is spent on a daily basis, and without proper tracking of day-to-day expenditure and transactions, catch-ups of bookkeeping will turn into a nightmare with a higher tendency of errors. Even for pre-revenue companies, having a comprehensive bookkeeping system in place is essential at the beginning of their journey, when they need to know how much is spent on what before making the first profits.
The key to keep a cash-intensive business like Cannabis companies up and running is said to lie in fundraising. Not to mention the difficulty of finding investors who understand the possible pitfalls of the industry, there are a host of components that accountants and bookkeepers can’t overlook if they would like to attract investors to their business. However, it all comes down to the basics such as providing organized books and accurate financial reports that show effective internal controls and accounting policies. There is no one who wants to entrust their money in incompetent hands, and for marijuana businesses that wish to access capital, it is expected that they can express their efficiency in financial management through good bookkeeping practices.
Taxes and deductibles
As mentioned above, under the regulation of IRC 280E, Cannabis companies cannot take deductions from business expenses such as rent, vehicle, and marketing like other companies because their business is related to a controlled substance. Despite this tax limitation, professional accountants can help to legally reduce taxable income by allocating costs to inventory and the cost of goods sold, which is mandated by IRC 471.
Besides the reputable IRC 280E, there are other tax requirements that accurate bookkeeping can help cannabis businesses fulfill, thus maintaining their license while staying out of trouble with the IRS.
GST/HST and Provincial Sales Tax
Once a proper accounting system is set up with organized bookkeeping practices guaranteed, Cannabis companies can be at ease that they are paying the correct amount of sales tax they are supposed to. What’s more, based on the tax collected it will be easier for them to plan ahead, using the expected tax refunds for business operations.
Exercise duties, applied at the time the cannabis product is delivered to a buyer, are compulsory for any cannabis licensee. Duties of each transaction must be kept track of, and the higher duty payable must also be reported. Those who own a business in the industry had better have a good grasp of what rules and regulations that the excise duty framework entails to know how to calculate duties or have a reliable accounting team to do this meticulous task for them. Plus, they should do it from early on too before all the transaction receipts pile up or go missing!
Bookkeeping for cannabis industry best practices
Knowing the rules
Whether it is for medical use or adult purchases, businesses associated with marijuana are restricted by countless written and unwritten rules, the sheer number of which may shun anyone wishing to be engaged in this space. Those who overcome the hurdles to take on the role of bookkeepers in Cannabis companies must be well aware that there is no room for ignorance here. Before things can be done “by the book”, first and foremost, bookkeepers must find out what “book” to read. Both federal and state laws have their own specifications regarding cannabis businesses, and it goes without saying that bookkeepers need to know them like the back of their hands to stay compliant. Legality, undoubtedly, is a top concern when it comes to the future growth of the cannabis industry.
As the foundation of good accounting and financial management, bookkeeping is all about being organized. You may have heard about digitized receipt services such as Shoeboxed that help to keep your documents safe, both online and offline, but there are more advantages of applying technology in bookkeeping than you would imagine.
With brilliant features including verified data that is audit-ready and easily located, customized expense reports, and integrations with a variety of accounting systems, Shoeboxed offers an actionable data tool. Just like any other business, accurate records and transparent accounting procedures are what a cannabis business needs to track its finance and enhance its credibility with the bank and other financial institutions, as well as potential investors.
A cannabis company is a complicated entity that involves several sub-industries (farming, chemical manufacturing, food production, and retail), and each requires all kinds of reporting pursuant to the many legislations at the state and federal levels. Another big headache for cannabis bookkeepers and accountants is the buggy seed-to-sale software requested by local regulations. Unfortunately, software that are specifically designed to assist this complicated process are still lacking and don’t work well with widely used accounting systems.
While looking for more plausible solutions, specialists in the field suggest we make use of current software, combining their functions to serve our needs. For accounting, Quickbooks and Xero are popular choices although some attempts must be called for to create charts of accounts for each business stage. The good old Excel is also a basic tool for cost accounting, reconciliations, consolidations, and so on. If one realizes its versatility and puts decent effort into utilizing its functions, preparing monthly reports or creating accounting templates can become much easier. Finally, the unsolved issues of seed-to-sale software must be acknowledged so that predicted errors can be avoided. Making do with what we have seems to be the right strategy, at least for now.
Checks and balances
Problems with bookkeeping in cannabis businesses are mostly due to the huge amount of cash being collected, which may lead to undesirable consequences ranging from careless mistakes to fraud. There are so many things that can go wrong and result in inaccuracies found in the books when a lot of business activities occur every day. Many of them, however, can be prevented by implementing checks and balances consistently during operations.
For example, cash counts on a daily and weekly basis can help to identify discrepancies between actual cash on hand and the records in the books. Likewise, sale receipts must be kept carefully and compared to the receipts listed regularly. It is also a good idea to have two people do the cash collection and reconciliation separately to lower the chance of a financial thief. In this way, professional bookkeepers and accountants make a perfect couple who compliments a reliable internal control system.
We have yet to know when the federal legalization of cannabis is coming and how it will change the bookkeeping practices in Cannabis companies. Whatever may happen, there is truth in keeping accurate and organized books for business smooth operations.
What do you think about the future of the cannabis industry from now on? Do you have more tips on good bookkeeping for cannabis industry to add?
Don’t hesitate to share with us your opinions in the comment section below!