Should your cannabis company consider the cash-basis method of accounting for tax reporting purposes?
The best place to start trying to answer this question may be a quick review of the basics of tax accounting methods.
An accounting method is a set of rules used to determine when and how income and expenses are reported. There are two different methods of accounting for tax purposes, cash-basis and accrual. Generally speaking, cash-basis accounting recognizes revenue and expenses only when money changes hands (cash-in and cash-out), but accrual basis accounting recognizes revenue when it’s earned and expenses when they are provided or used.
The method of accounting does not change the amount of expense or revenue that will ultimately be reported on tax returns, but it does impact the timing of when they will be reported. Furthermore, the use of either basis of accounting will not change the amount of taxable income a business subject to 280E will have to report but may result in the deferral or acceleration of the income reported into different years.
An abbreviated description of the complicated rules used to determine if a cannabis business may be eligible to use the cash basis of accounting would be as follows. License holders with three-year average gross receipts of less than $26 million, for 2019, and/or license holders with grows that may be considered farming activities could elect to report taxable income using the cash basis for all or a part of their operations.
Tax-payers eligible to use cash-basis because their average gross receipts are less than $26 million are still required to either:
(1) treat inventory as non-incidental materials and supplies (i.e., materials and supplies that are tracked in the tax-payer’s books and records, either through records of consumption or by periodic physical inventory)
(2) conform their inventory method to the one used in their applicable financial statement (AFS), or if they do not have an AFS, the technique used in the books and records prepared under their accounting procedures [IRC Sec. 471(c)(1)(B)].
The requirement to treat inventory as non-incidental materials and supplies or to treat it consistent with relevant financial statements may not be relevant to grow activities. License holders with these activities may be eligible to use special rules of accounting for inventory available to farmers.
Now that we have endured the above technical tax discussion, we can proceed to try to answer the question as to whether a cannabis business should elect to report taxable income on the cash-basis. Before we start, it would seem necessary to mention that this article is merely meant to provide business owners and executives ideas to consider and discuss further with tax counsel. All of the specific facts and circumstances that are relevant to each and every license holder would not be practical to address
Now that we have endured the above technical tax discussion, we can proceed to try to answer the question as to whether a cannabis business should elect to report taxable income on the cash-basis. Before we start, it would seem necessary to mention that this article is merely meant to provide business owners and executives ideas to consider and discuss further with tax counsel. All of the specific facts and circumstances that are relevant to each and every license holder would not be practical to address.
Are you a business with a grow activity? If so, then using the cash-basis may accelerate the timing of when you deduct production related expenditures which would otherwise need to be capitalized into inventory and not deducted until the related inventory is sold. Additionally, if you have accounts receivable you may be able to defer the recognition of the revenue associated with the accounts receivable until they are collected.
Are you a business with a processing or retail activity? You may have similar potential advantages associated with using the cash-basis of accounting as a grow activity. However, you may have some limitations on being able to deduct some inventory costs depending on the financial reporting and record keeping of your organization.
It would also be important to keep in mind that using the cash-basis method could accelerate the recognition of taxable income if the activity has significant accounts payable.
The tax professionals at Bridge West LLC are committed to understanding the intricate tax complexities facing license holders. If you have any questions, and if you would like assistance with your cannabis income taxes, please contact Calvin Shannon, Principal of Bridge West LLC, at email@example.com or Nate Panning, Tax Manager of Bridge West LLC, at firstname.lastname@example.org.