Gov. Newsom has issued additional guidance further defining “Essential Critical Infrastructure Workers” that designates CPA services as “essential” and necessary to help ensure the continuity of functions critical to public health and safety, as well as economic security. View the updated list of essential critical infrastructure workers at CA.gov.
This guidance allows a CPA firm to continue to operate and go to their physical offices to perform critical functions that may not be able to be done remotely while the governor’s stay-at-home order is in place. This is an important clarification that allows CPAs to serve their clients and provide advice on critical financial and tax decisions during this crisis.
The guidance states: “Professional services, such as legal or accounting services, when necessary to assist in compliance with legally mandated activities and critical sector services” are considered essential. Additionally, workers in the financial services sector, including “workers who are needed to process and maintain systems for processing financial transactions and services (e.g., payment, clearing, and settlement; wholesale funding; insurance services; and capital markets activities)” are also considered essential.
When the governor issued Executive Order N-33-20 directing all residents to immediately heed state public health directives to stay home, CalCPA was concerned the order may inadvertently prevent CPAs from continuing to provide certain services to business and individuals. Accordingly, we sought guidance from the administration on these orders to clarify “essential businesses and services” and urged that CPA services be included.
Even with the new guidance, CPAs and CPA firms should be judicious about how they operate and take appropriate steps to follow guidance from state public health officials to mitigate the spread of the COVID-19 virus.
The IRS has established a special section focused on steps to help taxpayers, businesses and others affected by the coronavirus. This page will be updated as new information is available. For other information about the COVID-19 virus, people should visit the Centers for Disease Control and Prevention (CDC) (https://www.coronavirus.gov) for health information. Other information about actions being taken by the U.S. government is available at https://www.usa.gov/coronavirus and in Spanish at https://gobierno.usa.gov/coronavirus. The Department of Treasury also has information available at Coronavirus: Resources, Updates, and What You Should Know.
IRS Warning – Incomplete K-1’s – Missing, incomplete, and incorrect Schedules K-1 will limit the IRS’s ability to identify potential noncompliance, resulting in the loss of tax revenue and inequitable treatment of taxpayers, as well as potentially creating unnecessary work and increasing taxpayer burden. We determined that improvements in the receipt and storage of Schedule K-1 data will increase information reliability and availability, which will assist in identifying potential tax noncompliance.
Accurate and complete Schedule K-1 data are not always received. If Schedules K-1 are not provided or contain inaccurate data, the Internal Revenue Code (I.R.C.) provides authority for the IRS to apply a penalty to the flow-through entity submitting the form.
We encourage the software community to put checks in place to ensure:
Required Schedules K-1 are attached to 1041, 1065, the 1120S and 8865.
The number of recipients reported on the flow-through return equal to the number of attached Schedules K-1.
There are correct payee TINs on Schedule K-1. Noticeable errors include impossible Social Security Administration assigned Social Security Numbers (e.g., starting with 000), repeating digits (e.g., 999999999), and consecutive digits (e.g., 123456789).
Ensure the flow-through amounts on the return equal the sum of allocated recipient amounts on attached Schedules K-1.
The impacted Tax Forms include Form 1041, U.S. Income Tax Return for Estates and Trusts, Form 1065, U.S. Return of Partnership Income, Form 1065-B, U.S. Return of Income for Electing Large Partnerships, Form 1120S, U.S. Income Tax Return for an S Corporation and Form 8865, Return of U.S. Persons With Respect to Certain Foreign Partnerships.
Information about Form 4684, Casualties and Thefts, including recent updates, related forms, and instructions on how to file. Attach Form 4684 to your tax return to report gains and losses from casualties and thefts.
Information about Form 6198, At-Risk Limitations, including recent updates, related forms, and instructions on how to file. Form 6198 is used by individuals, estates, trusts, and certain corporations to figure the profit (loss) from an at-risk activity, the amount at risk, and the deductible amount of the loss.
Form 8082 is used by partners, S corporation shareholder, beneficiary of an estate or trust, owner of a foreign trust, or residual interest holder in a real estate mortgage investment conduit (REMIC) to notify the IRS of inconsistencies between the tax treatment of an item on their returns vs. the way the pass-through entity treated and reported the item on its return. Also used to notify the IRS if partners, shareholders, et. al., did not timely receive Schedule K-1, Schedule K-1, Schedule K-1, Schedule K-1, Schedule Q, or a foreign trust statement. Partners, S corporation shareholders, beneficiaries of an estate or trust, owners of a foreign trust, or residual interest holders in a real estate mortgage investment conduit (REMIC) file this form if they wish to report items differently than the way they were reported to them on Schedule K-1, Schedule Q, or a foreign trust statement.
Information about Form 8582, Passive Activity Loss Limitations, including recent updates, related forms, and instructions on how to file. Form 8582 is used by individuals, estates, and trusts with losses from passive activities to figure the amount of any passive activity loss (PAL) allowed for the current tax year.
Information about Form 8582-CR, Passive Activity Credit Limitations, including recent updates, related forms, and instructions on how to file. Form 8582-CR is used by individuals, estates, and trusts with certain credits from passive activities to figure the amount of any passive activity credit allowed for the current tax year.
Information about Form 8810, Corporate Passive Activity Loss and Credit Limitations, including recent updates, related forms, and instructions on how to file. Personal service corporations and closely held corporations use this form to figure the amount of any passive activity loss (PAL) or credit for the current tax year and the number of losses and credits from passive activities allowed on the corporation’s tax return. It is also used to make the election to increase the basis of credit property when the corporation disposes of its interest in an activity for which it has an unused credit.
Information about Form 8960, Net Investment Income Tax Individuals, Estates, and Trusts, including recent updates, related forms, and instructions on how to file. Taxpayers use this form to figure the amount of their net investment income tax (NIIT).
About Publication 541, Partnerships
Donations – Cannabis and Product -Beginning March 1, 2020, cannabis retailers may provide free cannabis or cannabis products to qualified medicinal patients or their primary caregivers. This change is due to the adoption of Senate Bill 34, which also exempts these donated items from excise, sales and use, and cultivation taxes.
Licensed cultivators, manufacturers, distributors, retailers, or micro-businesses may designate cannabis or cannabis products that they hold in their inventory for donation. Items designated for donation may only be provided to a medicinal patient or primary caregiver through a licensed retailer.
Key Requirements for Donations
Special Requirements for Retailers
Designating Packages for Donation in the California Cannabis Track-and-Trace System
All items intended for donation must be marked as such in the California Cannabis Track-and-Trace system. A bulletin with step-by-step instructions for designating new or existing packages of cannabis, cannabis products, and immature plants, and for entering retail donations of these items, has been posted in the California Cannabis Track-and-Trace system. Licensees can log into their Metrc account and find this bulletin under the Messages tab (it appears as an envelope in the top-left corner).
Surviving Legalization! – We were prompted to write this note by the article “Cannabis Regulation: The Struggle of Small Farmers,” written by Lance Griffin and published on February 21, 2020, in Terpenes and Testing Magazine. We were prompted to write this article not for what Lance Griffin’s article says but for what it does not say.
The article starts with The New Yorker’s May 2019 description of the devastating impact of legalization on the Emerald Triangle. This starting point is old news. Mr. Griffin asks, “So, what happened when California voted to legalize adult-use cannabis in 2016? According to The New Yorker, “. . . legalization generated for these farmers ‘not only an economic crisis but also an existential one.'” Mr. Griffin notes that thousands of small Emerald Triangle growers have been forced out of the industry, and then states
“The practical repercussions of shutting out small farmers are catastrophic. As of 2019, it was estimated that 80% of cannabis sales in California were still from the black market, significantly reducing projected market growth and creating an uncertain future for the state’s regulated program.
“Incidentally, roughly 20,000-30,000 cannabis cultivators were estimated to operate in the Emerald Triangle pre-legalization. As of 2019, about 1,000 possessed a license.
“The black market in California is even referred to as the ‘traditional market.’”
We must mention one point in passing that Mr. Griffin and many others seem to miss. The underground market, the “traditional market,” is growing, but the Emerald Triangle is dying. The underground market is thriving in California but in new locations in California.
Humboldt County is the epicenter of the Emerald Triangle. Most commentators have attributed 50%-60% of the cannabis production of the Emerald Triangle to Humboldt County. Humboldt County is ground zero for the devastation that legalization wreaked on California’s underground cannabis industry. We concluded in our analysis over two years ago that 40%-50% of the gross annual economy of Humboldt County was based on cannabis cultivation. Of course, this is an economic estimate that is somewhat speculative. Those involved growing cannabis in the Emerald Triangle kept their activities as underground as possible for obvious reasons.
The Humboldt County Sheriff’s Office estimated there were 6,000-10,000 cannabis cultivators in Humboldt County in 2017. If we take the lower number of cultivators, 6,000, and assume each is backyard grower with an annual production 25 pounds of flower, each of these growers would produce approximately $25, 000 of revenue from cultivation in the County. The total revenue is only $150M. However, Humboldt County has less than 150,000 residents.
This revenue comes into the County from elsewhere in California. No one in Humboldt County buys because everyone knows, or is related to, a grower. Not surprisingly, some of the revenue from cannabis cultivation that flows into Humboldt County comes from outside California. A substantial portion of this revenue will be expended each year in Humboldt County. Most of the cannabis revenue spent in the County will turn over multiple times each year before this money leaves the County to be spent on vacations in Hawaii and four-wheel drive vehicles.
For purposes of illustration, we will assume this money turns over four times in a year. The $150M of revenue from cannabis grown in Humboldt County becomes $600M of gross revenue generated in the County in a year. The per capita income of Humboldt County is only a little over $10K. The total annual revenue generated within Humboldt County based on a per capita income of $10K is approximately $1.5B, or $1,500M. If the preceding analysis is reasonably accurate, 40% of the pre-legalization economy of Humboldt County was based on its underground cannabis industry. Anyone who knows anything about the underground cannabis industry in Humboldt County will very likely argue the financial significance of cannabis to the County is greater than 40%.
The population of Humboldt County represents approximately 0.075% of the population of California. Sacramento is not concerned about the residents of Humboldt County as voters. The smallest identifiable minority populations that concern California politicians are larger groups of voters than the residents of Humboldt County. As a financial force in California, Humboldt County is even less significant. By comparison, the City and County of San Francisco have six times as many residents, and each San Francisco resident has over ten times the financial clout of a Humboldt County resident based on per capita income. Sacramento simply does not care what happens to Humboldt County.
Legalization has been a disaster for Humboldt County, but not necessarily for all Humboldt County growers. Some of the biggest cannabis cultivation operations in Central and Southern California are based on the expertise of Humboldt County growers financed in some instances with money from Canada, Texas, or New York. A number of Emerald Triangle cannabis cultivators relocated and expanded their operations in areas better suited to, and more welcoming of, high volume agricultural production.
We decided to write this article because a significant share of the responsibility for the disaster the legalization of cannabis has produced for Humboldt County can be attributed to the Board of Supervisors and the Planning Commission. Few will recall that a very substantial percentage of the first hundred cultivation issued in California were issued to Humboldt County cultivators. A few Humboldt County growers managed to secure State and County licenses before most cannabis cultivators knew the rules.
It is unfair to heap too much blame for this financial disaster on the Board of Supervisors and the Planning Commission. These bodies are elected. The members of these bodies are elected by Humboldt County residents. The entire population of Humboldt County – growers, elected officials, and residents – share in the responsibility for allowing the legalization of cannabis in California to create a financial disaster for the County. Humboldt County was on its own to address the impact of cannabis legalization. It was foolish to think otherwise. The growers, the elected officials and the residents of Humboldt County are wholly responsible for their failure to realize the County was on its own.
If there is one group that should be singled out as having the greatest responsibility for allowing the legalization of cannabis to create a financial disaster for Humboldt County, it is the cadre of consultants, experts and advisors who took so much money for knowing only a little more than their clients, and for not knowing nearly enough to provide the level and quality of advice was required, and still is required, to address the financial chaos cannabis legalization has created for Humboldt County.
It is not too late to salvage a significant portion of California’s cannabis industry for Humboldt County. The County must not look to Sacramento for help. The County must salvage what it can of its cannabis industry through its resources. There are far more resources available than most realize. These resources are not utilized.
In this regard, Cannabis Cooperative Associations (“CCAs’), which the Legislature enabled in SB 94, gave small cannabis cultivators a competitive advantage over large cultivators. Unfortunately for Humboldt County and similar enclaves of small cannabis cultivators, CCAs are not properly utilized.
We will explain in subsequent posts how CCAs can provide substantial financial advantages for small cannabis cultivators.
WAKE UP CALIFORNIA!, On February 14th the Los Angeles Times published an article by Joe Mozingo entitled “Cannabis Farm Was a Model for California’s Legal Industry”. Then Came a Sheriff’s Raid.” The article suggests the law enforcement officers who executed the search warrant were surprised by the extent of the criminal activity at this “model” cannabis farm. Wake up California! Wake up Santa Barbara County!
The article provides interesting background relating to the explosion of Santa Barbara County’s cannabis industry as well as the development of this particular farm. The article describes how Santa Barbara County jumped into the “Rush for the Green” with both feet and great enthusiasm. The article also suggests it is a surprise to some – perhaps many – that this “model” cannabis farm is a multi-million-dollar criminal conspiracy.
Wake up! No Californian should be surprised in the slightest! Every individual involved in plant-touching activities in California’s cannabis industry is a criminal. Every individual involved in plant-touching cannabis business activities in California is engaged in the distribution of a controlled substance – a criminal violation of federal law. Those individuals who are involved in a business in this industry but do not touch the plants could be charged as criminal co-conspirators.
Eight years ago, the information published by Joe Mozingo last Friday would have been promptly followed by an announcement from the Office of the U.S. Attorney that it already has pending a criminal investigation of the cannabis industry in Santa Barbara County. The announcement would have explained the pending criminal investigation relates to public corruption, tax evasion and money laundering. The announcement would have been made whether or not it was true.
It has been less than eight years since the DEA, the Criminal Investigation Division of IRS and the Office of the U.S. Marshal executed search warrants secured by the U.S. Attorney for the Northern District of California on eight different locations in Oakland that were associated with Oaksterdam University and its founder, Richard Lee. In the raid on Oaksterdam on April 2, 2012, the federal government simultaneously seized every cannabis plant; every item of electronic equipment; every business record; and every safe along with contents from each of eight locations located in Oakland that were associated with Richard Lee and Oaksterdam.
How times have changed. The U.S. Attorney General now has bigger fish to fry, or to protect, depending on your political persuasion. Washington, D.C. will allow California to wallow in the mess it has made of its cannabis industry. Any association with the mess California has made of cannabis legalization has an immense political downside and little, if any, political upside.
A substantial majority of Californians agree that the roll-out of cannabis regulation cannabis is an unmitigated disaster. It is virtually impossible to find a rational person who does not agree that California made many errors in implementing regulation. There is a diversity of opinion on the reasons for the disaster but almost unanimous agreement on the disaster. The Santa Barbara situation described in the article is merely one of the thousands of such symptoms that exist throughout California.
We were surprised by Joe Mozingo’s article, but for different reasons than those expressed in the article. We were surprised it took the execution of a search warrant by the Santa Barbara County Sheriff to “discover” this “model” operation is a multi-million-dollar criminal conspiracy. Anyone who knows anything about California’s cannabis industry knows that criminal conduct permeates every level and every facet of the industry.
Santa Barbara County very likely produces more cannabis at this date than any other county. What did Santa Barbara County think the cultivators would do with this production capacity? Santa Barbara County has licensed 275 acres of canopy according to Joe Mozingo’s article. The bulk of this acreage can produce multiple crops each year. The article indicates these growers are doing precisely what Santa Barbara expected them to do – produce tons of cannabis.
Santa Barbara growers are producing tens of millions of dollars worth of cannabis. They are reporting and paying taxes on a significant portion. The same article, however, indicates a far larger portion of this production is not being reported. Of greater significance, it appears likely a substantial number of cannabis growers in Santa Barbara are engaged in tax evasion – conduct that may even rise to the level of criminal tax evasion.
One should not be harsh in one’s criticism of Santa Barbara County’s complicity. Carpenteria may smell like skunk, but the County collected $9.6M in taxes on cannabis that it did not have before it created this economic boom. The County very likely picked up a comparable amount of additional revenue in increases in real property taxes. The County receives approximately $1,500 of revenue for each Carpenteria resident who is suffering from the smell. The County also benefits from the increase in commercial activity.
Santa Barbara County differs from many other areas in California solely because it took a bigger and faster leap into California’s cannabis industry. Throughout California cities and counties have sought to take advantage of the economic opportunity that many perceived was created by Proposition 64. In the long-term Santa Barbara County may prove to be the County that most benefits from the “Rush for the Green.” It will be a number of years before the final results will be known.
California is entering its 3rd year of a regulated and taxed legal market. Presumably, most of the 275 acres that Santa Barbara has licensed are also licensed by CalCannabis? CalCannabis and BCC should know how much cannabis can be produced by this acreage, although it is far more important that CDTFA knows how much is being produced. CDTFA is the agency that collects Cannabis Cultivation Tax (“CCT”), Cannabis Excise Tax (“CET”), as well as Sales Tax and California income tax.
IRC §280E is not the problem for the California cannabis industry that has been so extensively described in various articles. The vast majority of the taxes imposed on California’s cannabis industry are local taxes or California taxes. Federal income taxes on California’s cannabis industry likely would make up less than 10% of the total tax load on the industry if the IRS was successful in collecting all such income taxes. The IRS does not collect a substantial portion of the income taxes that are owed to the federal government by participants in the industry.
The principal reason for this article is our surprise at the questions that Joe Mozingo did not ask. Where is CalCannabis? Where is the Bureau of Cannabis Control (“BCC”)? Where is the California Department of Tax and Fee Administration (“CDTFA”)? Where is Governor Newsom? Where is Xavier Becerra, California’s Attorney General? Why did California’s roll-out of regulation prove to be such a disaster? Could this disaster have been avoided? What can be done after 2+ years of bureaucratic ineptitude?
This disaster could not have been wholly avoided. Proposition 64 was ill-conceived and poorly drafted. We have previously written on this topic. [See Reboot in 2020!, and Implementing Proposition 64: Marijuana Policy in California ] The California Legislature and the administrative agencies it tasked with the regulation of this industry bear the principal responsibility for the disastrous roll-out of regulation. We have earlier commented on many of these issues. [See Greed and Cannabis, Major Cannabis Tremors! and IRC Sec. 280E Insanity].
Many points to unfair taxes on cannabis as a cause of problems for the industry. Complaints regarding taxes that are too high or that are unfair is a red herring. Consumers pay all taxes imposed on the movement of cannabis from cultivators to consumers. Even the income taxes imposed on the businesses involved in the movement of cannabis from the cultivator to a retail sale are collected from the consumer in the purchase price. It is the management of taxes that presents the challenge for a cannabis business not the rate of tax or the unfairness of its imposition.
The management of taxes in California’s cannabis industry is difficult. This difficulty is wholly the fault of the California Legislature, BCC, CalCannabis, and CDTFA. California made it difficult and costly for businesses to enter the regulated commercial cannabis market. California made it costly and difficult for a business to make money in its regulated commercial cannabis marketplace. California also made it far more attractive for a cannabis business to be only partially compliant with the law. California has achieved a wholly predictable result. The vast majority of California cannabis businesses are only partially compliant with the law whether or not they have some license.
Governor Newsom already knows some of the changes that must be made in order to bring California’s commercial cannabis industry under regulatory control. He has included the first steps in his proposed budget. However, there will always be many not-wholly-compliant commercial cannabis businesses until the profitability from a lack of complete compliance with the law does not outweigh the risks associated with non-compliance.
Money can be made in California’s cannabis industry by wholly compliant cannabis businesses that are well-advised. California’s cannabis industry is unfortunately filled with “experts” that know only a small portion of what they should know as a precondition to providing advice.
This is the first of a series of articles we intend to publish relating to the management of taxes in California’s cannabis industry which is the key to making money in wholly compliant cannabis businesses in California.