By Todd Arkley
As a cannabis business owner, there are three important financial challenges you face — two unique to the industry and one shared by every small business in America. The unique challenges — access to banking and the impact of IRS Code Section 280E on your federal tax return — have received the lion’s share of the press coverage.
However, banking and federal taxes pale in comparison to the major challenge you face every day, every month, every year — running a profitable business. To run a profitable business, you need to build and maintain strong and secure accounting systems in order to accurately capture all of your company’s revenues and expenses.
Building and maintaining a financial system might not sound exciting, but if you do it correctly, you can neatly address profit, federal taxes and banking all at the same time. With an investment of time up front, and regular investment of time throughout the year, you will not only understand your company better, but you will be better positioned to grow and thrive.
My recommendations below are simple, basic financial steps that will provide you with a solid framework from which to address more complex financial issues, such as Section 280E and banking.
Recordkeeping: In order to have a basic grasp on your profitability, your first step should be to implement an accounting program, such as Quickbooks or Xero, in order to have a robust database in which to record your revenues and expenses. Quickbooks and Xero are both very user-friendly for non-accountants and are widely used by accountants, bookkeepers and CPAs. Other options are available as well, but for simple solutions, these are hard to beat.
The simplest advice I can give you for how to effectively utilize accounting software is this: record everything. The concern here is less about how you record the information and more that you actually record it. When you are dealing in cash, carry around a sales and expense pad, either physical or electronic, and record your transactions as they occur. With cash, you are both the banker and the customer, so you must be disciplined. If you are making purchases or sales through your bank account, save every receipt.
Federal taxes: You will need to partner with a CPA who is familiar with the intricacies of 280E and how that impacts a cannabis business. Section 280E disallows the deduction of “ordinary and necessary” business expenses on a federal tax return for those who traffic in a Schedule I or Schedule II controlled substance.
Cannabis is considered a Schedule I controlled substance. Thus, expenses have to be very carefully classified on the federal tax return.
On a daily, operational level, how do you address 280E? First, meet with your CPA early in the year and have them review the expense accounts in your accounting software. They can help you understand which expense accounts will be deductible and which will not be deductible. This will save you time and money when tax filing season begins.
However, there is a much more important reason to have “280E-compliant” accounts setup in your accounting software. If you know you are going to face an inordinately high federal tax bill each year due to 280E, wouldn’t you want to be able to estimate that tax liability throughout the year and then set aside money throughout the year to pay the bill?
This is where your accounting software and processes play a crucial role. If you are disciplined about recording your revenues and expenses in the proper accounts, it will be relatively straightforward to estimate your federal tax liability on a monthly basis. Your goal is to not be surprised, or bankrupted, when the federal tax bill comes due.
The main challenge is to run a profitable business on a daily basis. To do that, you need to focus on the simple, daily financial transactions in order to address the big challenges, such as Section 280E, banking and profitability. Don’t make the mistake of approaching these big challenges before taking care of your simple accounting functions.
You would be surprised how much more manageable major financial issues become when you have been effectively collecting quality revenue and expense data throughout the year.
Todd Arkley, CPA, is the owner of Arkley Accounting Group, which provides financial management for small businesses and the cannabis industry. He also serves on the board of the Coalition for Cannabis Standards & Ethics.