As a cannabis operator, you’re probably sick of having to contend with the many, frequent taxes due to the state and local government. Cannabis distributors, cultivators, and manufacturers are all responsible for different taxes, in addition to federal taxes required of all business owners.
What many operators don’t realize, however, is that they are critically under-collecting taxes from their customers. This causes the cannabis business to shoulder more costs than necessary. How and why does this happen? There are two main reasons why cannabis operators don’t collect sufficient tax revenue from their customers. This guide can help cannabis operators remedy their tax collection strategy to benefit their bottom line.
Problem #1: Improper Cannabis Tax Calculations
One reason why cannabis operators don’t collect enough taxes from their customers is because they’re not calculating their tax responsibility correctly.
Let’s start with a basic understanding of how taxes are classified in California.
A local tax is considered a business tax, not a consumer tax.
For example, sales tax is a consumer tax: it’s tax that you collect from a customer and remit to the state. Sales tax is typically the percentage amount your customers pay when they purchase cannabis from your business. Then, as the cannabis business owner, you must pass the tax collected to the state or local tax authority. In this instance, you are simply the middleman.
A business tax, conversely, is something you can’t (FULLY) collect from the customer. An example of business tax for a small business would be income tax. Your income tax is the amount you pay on your total income from your cannabis business to federal and state governments. For cannabis business owners, business tax is 5% of your gross receipts – something we’ll discuss later in this post.
The problem of miscalculation occurs when a cannabis operator collects a business tax from the consumer. When that happens, the governing tax agency will tax you on the amount you collected from your consumer as well because it is part of your gross receipts.
Business Tax Example
For example, imagine you sell a cannabis product for $10. Let's also assume that your business tax is 10% of gross receipts.
So in scenario one, if you were to only collect that $10 of product cost from the customer ($10 in gross receipts), then $1 is due for local business tax.
But, in scenario two, if you charge (or pass on) that $1 business tax to the consumer, then you are taxed on the $10 and the $1 of the business tax you collected from the customer. In this case, your gross receipts is $11. The calculation here would then be $11 x 10% = $1.10 in business tax.
This doesn’t seem like a lot – $1.10 isn’t a lot of money in this second scenario. But, this can add up quickly, especially when you have loyal, repeat customers with high income per customer. The difference between paying the FULL $1.00 yourself in scenario one or paying just the $0.10 (since you already collected $1 from the consumer) can have significant impact on your bottom line over time.
While it’s a good strategy to pass some of your business tax on to your customers, be aware that you must file your taxes properly when it comes time to declare your receipts.
Many customers are willing to accept part of the responsibility of paying your business tax in your sales price, as long as you break out the cost on their receipt. It’s a good strategy to be transparent about passing along some of the costs of running the business.
In MANY of our onboarding and audits of new clients, our tax experts see operators are opting to pass some of that business tax onto consumers, but they are just remitting the $1 they collect. That means that operators are underpaying their liability by 10%, or whatever your local business tax rate is.
Sales Tax Example
We also see this very commonly in clients’ sales tax calculations. Remember, cannabis operators pay sales tax to the CDTFA.
In scenario two as shown above, let’s see how mis-calculating sales tax can impact your budget. Sales tax is 10% of gross receipts. But, in scenario two, you calculate your sales tax from $11, not $10.
Scenario 1: If you don’t collect that business tax from the consumer, then it would look like
- $10 for product
- $10 gross receipts
- Sales tax is $1 x 10% = $1.00
- Full amount collected from customer = $11.00
Scenario 2: If you DO collect some business tax from your customer, and then you break all the taxes out on a receipt, it will appear to the customer as:
- $10 for product
- $1 for business tax
- $11 gross receipts
- Sales tax is $11 x 10% = $1.10
- Full amount collected from customer = $12.10
But remember, in Scenario 1, you still need to pay the business tax on gross receipts. That means you’re spending more money on taxes than if you were to collect it from the customer as in Scenario 2.
Our experts have seen that most uninformed operators calculate sales tax off the product amount only, and do not also use the local cannabis business tax (if collected) as part of gross receipts.
If you calculate this wrong, and the CDTFA finds out, they will hit you with penalties, fees and interest that compounds.
Problem #2: Incorrectly Defining the Term “Gross Receipts”
It’s not uncommon for cannabis operators to define gross receipts incorrectly. In 90% of jurisdictions, operators are getting this allocation wrong.
“Gross receipts” is defined as cash collected, less consumer taxes.
Returning to Scenario 2 as outlined above, remember that local business tax is NOT a consumer tax. Your gross receipts is $11. However, if you look at Scenario 1, you collected $11, $1 of which is sales tax, which is a consumer tax. Therefore, in Scenario 1, gross receipts is $10.
Another consumer tax that we see most often is state cannabis excise tax. The state defines excise tax and the amount that you are to pay, while your jurisdiction defines gross receipts and whether you can deduct consumer taxes or not.
As a reminder, excise tax is a consumer tax that dispensaries pay upfront to distributors (see more in our guide to cannabis taxes for distributors).
When charging excise tax, dispensaries have the option to either directly charge 15% to the consumer, or say it’s included in the cost of the product. Since sales tax is a consumer tax and is deductible, so excise tax should be deductible as well.
But, most businesses are not deducting this from their gross receipts. Make sure you are not overpaying this portion of your taxes!
Key Considerations for Charging Taxes to Your Customers
So, what are the key takeaways cannabis operators need to know about paying their cannabis taxes?
First, we believe you should still collect local tax from your customers. This is not a consumer tax, and therefore you can’t fully pass it onto the customer. But, passing on some of it will still greatly reduce your tax burden.
The majority of cannabis businesses are under-collecting sales taxes. This is not good, as you may be charged penalties, fees and compounding interest on this underpayment.
Likewise, if you have not been deducting excise tax from gross receipts, then you're likely overpaying local tax, but this is only true if excise tax is deductible. This is spelled out jurisdiction by jurisdiction, but nearly all places are deductible.
Reach out to us to conduct a high-level audit and make sure you are not under or overpaying your taxes at any of the levels. Our team can help keep you compliant and pave a brighter future for your cannabis company for years to come.