Tax - CDTFA

Formation – Set-Up Cannabis Industry Business

Formation – Set-Up of Cannabis Industry Business – We have spent the past couple of articles reviewing the differences between “bookkeepers”, “generic accountants”, and “professional accountants”, the final phrase being limited to certified public accountants [‘CPAs” in the United States[1]. We add mention of Enrolled Agents [“EAs”][2] noting that they are “Circular 230 Practitioners” many of whom, are or have been employed by the Internal Revenue Service, and may be skilled at “Tax Resolution[3]”.

We have summarized the resources available to licensed firms of CPAs that are members of the American Institute of CPAs, the Private Companies Practice Section [“PCPS”], the Tax Section, and various state societies[4]. We apologize for the way we build rigorous background in our articles, however, we believe that is part of their value as references for our readers[5].

We have defined the roles and skills of the participants in the financial and tax space for the legal commercial cannabis industry. Let’s see if we can provide an example of how we approach a group of promoters that have decided that they want to form, capitalize, license and operate a cultivation operation and a companion cannabis extraction operation in California. While there are certain items that are unique to California,  the basic pattern is the same in many other state [6].

As we dive into the formation and operation of a cannabis business, we need to make a shameless plug for an article that is about how we think our clients can make the best use off our services. [See Effective Use Professional Services]

The core team of advisors should be selected, the composition of which will vary according to the size, nature and operations of the business. [We are going to assume that our entity does not have any intention of entering the public capital markets at this time. However, it may decide to seek money from accredited investors under the California Dept. of Business Oversight.[“CDBO”] Small Securities Exemptions provided in Sec. 25102(f)[7].

The core team must include law firm with cannabis industry experience[8] , a firm of certified public accountants, a firm or individual freelance “generic accountants” and “bookkeepers” that are under the direction and supervision of senior company executives and the outside CPA firm. If the size of the business warrants it, an outside fractional CFO may also be appropriate [who should be under the same supervision], a business banker for day to day banking, cash management and credit card processing, an insurance broker to manage multiple needs, a payroll processor[9] and other consultants as necessary [Once again, please note that the focus in this article is on accounting, tax, regulatory compliance and indirectly licensing.

Once the structure of the entity or entities has been decided, they need to be:

Formation – Set-Up Cannabis

Formed in the appropriate jurisdictions and qualified in any necessarily related jurisdictions with the Secretary of State [ California SOS – Delaware Division of Corporations].

The entity needs an Employer Identification Number from the Internal Revenue Service [“IRS”][10]. Then registration for indirect cannabis taxes[11] [CCT and CET] and a Seller’s Permit is done with CDTFA, and employment taxes are done with EDD.

There are situations where somewhat more specialized documents may be required.

A primer on Non-Disclosure Agreements can be found here.

Article on the How To Fund A Start Up [includes “Venture Funding”] and a Fundraising Survival Guide.

Y Combinator – Simple Agreement Future Equity – they can be used to make “bridge notes” is needed.

The items above should permit the business to form a legal structure, and get to the point where they can set up accounting software[12]. We recommend Sal Cucinella and Lilypad for Fishbowl as the “bridge” to METRC.

Formation – Set-Up Cannabis

Where necessary, bank accounts should be opened, detailed procedures for internal accounting controls over cash developed and documented, and coordinated with both business operations and security.

If the business is going to have a customer-facing front end, they need to select a Point-of-Sale system and insure that it can interface with the back-end general ledger.

We don’t place much value in pre-constructed charts of accounts for cannabis businesses in California. There are just too many distinct sets of rules for numerous purposes. We tend to develop the Chart of Accounts from checklists we have developed which originate from an article – Which Set off Books?

Just as we can be certain that we will set up an entity structure, someone is going to want a change, and there are traps and issues associated with that[13].

Formation – Set-Up Cannabis

We remind everyone that we have all of this in a climate of provisional licenses and annual licenses that are renewable after a year.

While we are at it, we might as well mention some good news…we will say with certainty that fifty percent or more of the cannabis industry licensees in California won’t be around in a year. One of the big reasons is going to be enforcement action by CDTFA with respect to Cannabis Tax Audits. We have yet to see a business that is maintaining records that meet recordkeeping requirements.

We note that we have note even scratched the surface on the next level of issues which include

Application of IRC Sec. 280E and YES the provisions apply differently for the various types of licensees.

We haven’t touched on expense allocations, state withholding.

Consequences of alternative choices in a capital structure and investor returns.

While important, for the moment, we are not going to dwell on the fine details associated with what we call the “local portion” of the “dual control” features contained in the California cannabis statute[14].  A resource is provided at California Cannabis Portal.

Formation – Set-Up Cannabis

Appendix – Outline for Accounting Best Practices

“Use your primary accounting system as the general ledger only for sales, cost of sales and inventory. 

Use your primary accounting system’s department classification functionality within a single accounting file and use separate files for each legal entity. DO NOT commingle a management company or other entities with your dispensary.

Use the same chart of accounts in each company’s accounting file. This will make it easier to prepare and confirm financial information.

Keep the details of sales, cost of sales and inventory in the tracking and point-of-sale systems and archived monthly.

Document the services and transactions between all your dispensary-related entities.

Follow all intercompany contracts and pay/record the intercompany bills monthly.

Ensure all inventory is on your balance sheet at the end of each reporting period.

Create a separate cash general ledger account for each safe. 

Develop and document a process to determine the total cost of goods sold and follow it strictly.”

Formation – Set-Up Cannabis

[1] See Rules Apply to Everyone and Cannabis Work – Division

[2] We have mentioned our respect for the skills of some of the EA’s we have encountered in practice. We have also expressed our disgust with the outrageous claims contained in much of the advertising and marketing material which has been produced by the National Association of Enrolled Agents [“NAEA”], notably their “America’s Tax Experts” campaign. They should realize that the “Experts” claim is probably a violation of Circ. 230 Sec. 10.30(a)(1). We created “America’s Tax Experts – A Cruel Hoax” as part of our effort to provide correct information, and wrote proposed legislative amendment to the statue that underlies Circular 230 you can read here.

[3] We have always been impressed by the quality of both the material and presenters at NAEA’s National Tax Practice Institute [“NTPI”]. We have had significant issues with Tax Marketing HQ, and we highlight a significant collection of inappropriate, crude and otherwise inappropriate comments at Smelly Stinky EA

[4] Our firm and I are members of the state CPA societies in every state where we are licensed – California, Florida, Illinois, New York, Oregon [Applied] and Texas. The state society committee network is invaluable. Since it will come up, feel free to verify my licenses here.

[5] We have compiled a number of collections of Whitepapers, Tools and Guides for the commercial cannabis industry, particularly California. We note that unlike some of our peers, we didn’t package them up and seek to sell a $5K course under the “Cannabis Genius” moniker, nor have we implied that there is any secret to this process. We share for the benefit of the cannabis industry, specifically the CPA profession that services it. The following are some of the next “generation” of professional accountants working in the cannabis industry – Diana Halenz, CPA, John Cornwell, CPA, Shane Eloe, CPA, Mel Sams, CPA , Jeff Calloway, CPA and Zephrina Cazaubon CPA, EA.

See Cannabis Business Start Up – a series of Whitepapers for new California cannabis industry businesses, aBIZinaBOX CPG – Resources For CPA Firms serving the cannabis industry, aBIZinaBOX CPG – Doing Cannabis Business in Cash, and our Manufacturing SOP’s [by invitation]

Formation – Set-Up Cannabis

[6] A brief history of legal cannabis in California can be traced through Background – California Cannabis Regulation, California Cannabis Cultivation – Qualification as Farming, Keeping the Promise of Proposition 215, Implementing Proposition 64 – Marijuana Policy in California

[7] Corporations Code Title 4, Division 1, Part 2, Chapter 1, Sections 25100-25105

[8] The skills required of cannabis industry attorneys has increased substantially. At a minimum for a small business, the firm needs to have skills as business transactional, corporate. land-use and zoning, environmental, taxation [though the tax and regulatory compliance responsibilities can and in many cases should be divided between counsel, and an CPA firm with a senior contact that has an MS in Taxation, possibility business litigation and criminal procedure,

[9] Gusto.com is our recommended payroll processor.

[10] The entity may need to make a “Check the Box Election – Form 8832, S Corporation Election – Form 2553,  or QSSS Election Form 8869, or Form W-9 for vendors. We may also need S Corporation Stock & Debt Tracking

[11] See Guide for Cannabis Businesses

[12] In the interest of simplicity, we are going to select QuickBooks Online – Essentials Edition for the businesses’ general ledger, boxstorm.com by Fishbowl Inventory for Distribution, and Fishbowl Manufacturing for Extraction and Manufacturing [which we will “containerize” in a Virtual Machine either on AWS or MS azure.com].

Formation – Set-Up Cannabis

Our individual desktop productivity and ECM will be a combination of Office 365 E3, Google Cloud G Suite Business or Dropbox Business. If HIPAA or similar “hardening is required, we lay sookasa.com on top.

[13] See Transactions Involving Changes in Ownership, Financial Interests and Entities,  BCC – Commercial Activities

[14] The California statutes provide that the cannabis industry is to be regulated by three entities, the lead agency is the Bureau of Cannabis Control [“BCC”]which is responsible for licensing Dispensaries [On-Premise], Dispensaries [Off-Site], Distributors, and Distributors [Transportation Only]. Cultivation licenses are overseen by the CalCannabis division of the California Dept. of Food and Agriculture [“CDFA”], and Extraction, Manufacturing, and Testing Laboratory license are managed by the Manufactured Cannabis Safety Branch [“MCSB”] division of the California Dept. of Public Health [“CDPH”]. Finally, Cannabis Cultivation Tax [“CCT”], Cannabis Excise Tax [“CET”] and Sales Tax are the responsibility of the California Dept. of Tax and Fee Administration [“CDTFA”] See “Blowing Smoke

Formation – Set-Up of Cannabis