Getting to the root of cannabis accounting
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Getting to the root of cannabis accounting

7 months ago · 3 min read · AICPA Insights Blog

As of 2022, medical marijuana use is legal in 38 U.S. states, and 17 states plus the District of Columbia also allow recreational use for adults.

According to Gallup,two-thirds of Americans support the country-wide legalization of cannabis, a product that garnered over $25 billion in revenue in 2021. With steady growth across the cannabis industry, net sales are projected to boom over the next five years.

Federal law, on the other hand, still identifies marijuana as a Schedule I substance, contradicting the legal status of cannabis at the state level.

Accountants and finance professionals with cannabis industry clients may struggle to know which guidance takes precedence. But clients rely on you to keep track of case outcomes, the latest in the regulatory landscape and the pace of impending changes. Keep reading for a run-down of cannabusiness-specific best practices and an overview of critical legislation items.

Getting to the root of the issue

Cash still inundates the cannabis industry. The Safe and Fair Enforcement Act of 2021, known as the SAFE Banking Act, looks to change that. Where banks were once hesitant to offer full financial services to cannabis dispensaries for fear of sanctions, the 2021 act now protects banking institutions offering services to lawful cannabis-related businesses.

Despite an improved banking framework, you still have a lot to consider when inspecting and auditing an enterprise active in the cannabis industry. Among an accountant's first ports of call could be to gain an overview of operations by fully comprehending 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, clean-up, payroll, audit trails and financial reporting — interact with state and federal cannabis laws.

Careful analysis, a healthy dose of scepticism and remaining mindful of U.S. GAAP when dealing with cannabis activity will pay dividends in the long-term.

The basics of cannabis taxation

Businesses handling cannabis face varied federal tax rates and special taxations, like the cultivation tax. Federal policy continues to prevent cannabis business owners from fully accessing their organization’s powers. These financial restrictions are likely motivated by the residual though waning stigma still surrounding cannabis.

For this reason, small business owners tend to accept tax inefficiency and lean toward C-corp entity structures designed for larger businesses. While smaller entities would traditionally pursue the pass-through format, they increasingly prefer to incur higher taxation to maintain financial freedom and keep their personal income free from the perceived reputation of cannabis.

Tax code alterations

You should also be aware of the cannabis tax code system and potential upcoming alterations. The stringent Section 280E remains imposed on larger-scale cannabis commerce to financially deter businesses from entering expansive trafficking operations.

With many dispensaries looking to expand their operations, the presence of 280E confines businesses and prevents them from scaling upward.

Harborside, formally known as Harborside Health Center, an Oakland, CA-based marijuana dispensary, was notably overruled in its appeal against 280E in a landmark case. Setting the bar for cannabis-related businesses across the country, the ruling upheld against Harborside rendered it liable for several million dollars in back taxes.

In the face of the Harborside case, political efforts look to tip the scales further toward the widely desired and more lenient 471(c) code. Leading this effort is the STATES Act, legislation pushed by Sen. Elizabeth Warren working in tandem with the SAFE Act to facilitate the full exercising of state law.

Despite steps taken to untangle and streamline cannabis accounting, such as the SAFE ACT, finance professionals amid or looking to enter the cannabis industry still operate within a legal limbo between state and federal law. To clarify and align legal frameworks, prominent political figures including Senate Majority Leader Chuck Schumer continue to aim toward a nationwide legalization effort.

Issues with business processes

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

Clients with established dispensaries will likely 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.

Frameworks such as PPA requiring 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, a topic you can learn more about at the AICPA & CIMA Cannabis Industry Conference in August.

Ethical considerations

While navigating state and federal law is challenging enough, another complexity you may face is personal objections to cannabis. Once seen as a potential gateway drug, cannabis usage has now been associated with positive medical effects. The National Institute of Health states that those beset with chronic pain, neurological diseases and mental health disorders successfully turn to medicinal marijuana for relief.

Effective regulation and auditing of cannabusinesses contributes to a better social climate too, with one study finding that medical marijuana laws directly reduced violent drug-related crimes.

Working within the cannabis sector 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 shining a spotlight on best practices at the 2022 AICPA & CIMA Cannabis Industry Conference, August 8–10, on-site in Denver, CO, or live online.

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