Many cannabis business owners draw a salary from the profit of their cannabis venture. Unless you are running a nonprofit, certain business entities allow you to take a reasonable salary from your cannabis operation. You may be required to earn directly from your cannabis interest.
Our experts frequently get asked about the best way to withdraw a salary from a cannabis business. Aside from what’s required, what are the ways you can take money out of your cannabis business? How will your salary impact your business and personal taxes? We’ll break it down for you in this quick guide organized by type of business structure.
When you set up your cannabis venture as a C-Corp, your business is owned by individual shareholders who have equity in the company. These shareholders vote on decisions related to growing and running the company, while a Board of Directors has the power to make final decisions.
As a C-Corp, your cannabis venture pays taxes on any income. The entity itself is considered the taxpayer. Compare this to an LLC or S-Corp, where income gets allocated to the owners who then pay taxes on their personal tax returns. The risk in withdrawing from a C-Corp is that you may face double taxation.
Double taxation occurs when a corporation has accumulated profits: the IRS considers payments to shareholders to be taxable dividends unless the recipient can prove the payment was for compensation for services rendered or loan payments. Dividends may not be the best option for you, but luckily, there are four other ways in which you can withdraw money from a C-Corp. Here are your options.
- Dividends: profitable C-Corps can pay their shareholders dividends at the discretion of the Board of Directors. This is one way to withdraw money if you are a shareholder with no direct role in the operations of a cannabis C-Corp (and therefore not a salaried employee). Shareholders do not have a right to dividends, and you may face double taxation – more on this in a minute.
- Shareholder salaries: if you are a shareholder in a cannabis C-Corp, the easiest way to withdraw money is to list yourself as a W-2 employee. You avoid the double taxation issue of LLCs and S-Corps in that the entity withholds and pays federal, state, and local taxes on your salaried wages. When you set a salary, make sure it’s reasonable amount for the job’s role and responsibilities. Do your research for positions and compensation levels at comparable companies and industries if you’re not sure how much a shareholder salary should be.
- Benefits and expenses reimbursement: you can have certain costs reimbursed by the C-Corp, provided they are at least partially related to the business. For instance, benefits such as health insurance, life insurance, car rentals, smartphone and laptop costs, and other business-related travel and utilities can be reimbursed by the C-Corp. Avoid non-business related expenses (such as movie tickets or school fees) as the IRS will likely flag these costs as non-reimbursable.
- Non-dividend distributions: also known as the return of capital distributions, this method of withdrawing money happens when the corporation refunds a portion of capital contributions shareholders have made to the company. For instance, if you paid a portion of start-up expenses to the cannabis company, you may be able to receive a non-dividend distribution repaying you for those expenses. This type of withdrawal is non-taxable.
- Shareholder loan: it is possible to receive a loan from your cannabis C-Corp. The terms of the loan must be approved by shareholders holding a majority stake in the company. The tax liability is a little tricky: the loan terms must appear in the loan agreement and include a “promissory note” signed by the corporation and shareholder receiving the loan. As one legal expert adds, “The repayment terms and interest rate should reflect arms-length negotiation between the borrower shareholder and the corporation (represented by a non-borrower shareholder or director).”
How does the double-taxation of dividends work? Basically, the cannabis C-Corp gets taxed on the income it made from performing well and earning a profit. Then, you get taxed on your personal tax return on the dividend you received as a result of that profit. Not ideal.
There are a few ways to work around the double taxation issue. The first is to become a salaried employee – instead of earning dividends, you can earn a bonus. Or you could include a third party to lend money to the cannabis venture, taking loan repayments instead of dividends. Read more about the various ways to avoid double taxation in this guide.
If you’re interested in withdrawing money from a cannabis C-Corp, there are plenty of good ways to do so. We suggest speaking to a tax expert about your specific situation to determine which option is right for you.
There are many ways to take money out of a cannabis S-Corp. Some of these methods aren’t very different than withdrawal from a cannabis C-Corp; however, S-Corp entities don’t contend with the double-taxation issue.
Remember, the S-Corporation is a tax election. This means that a corporation, LLC, or LLP is created at the state level and then elects to be taxed under the S-Corp heading. These businesses can have no more than 100 shareholders and only one class of stock.
Here are some ways to take out money from your cannabis S-Corp.
- S-Corp salary: like a C-Corp, you can take wages from an S-Corp. Earn a reasonable salary for work performed and take a paycheck with employment taxes withheld.
- Earnings distributions: distributions are not the same as dividends. S Corporations are able to make tax-free, non-dividend distributions on the provision that the distribution does not exceed the shareholder’s stock basis. Note that if you take a distribution in excess of your stock basis, this amount is taxable as a long-term capital gain.
- Loan: most of the same rules apply to taking a loan from an S-Corp as C-Corp loans. If you wish to take a loan out, you must have a promissory note and normal lending terms that include a fair market interest rate and schedule for repayment. Failing to do so will result in tax penalties.
- Reimbursement of expenses: S-Corp shareholders can also have business-related expenses reimbursed.
If you’re interested in avoiding double-taxation, it may be worth exploring an S-Corp designation. Our experts can help you assess your options and learn more about the pros and cons of this specific entity.
Finally, an LLC (limited liability corporation) is a business entity in which individual members are protected from liability within the business – as long as the business is registered with the state and obeys state regulations. There are two main types of LLCs: single-member LLC and an LLC with multiple members. The tax repercussions for these two types (and how you can withdraw money) vary slightly.
First, when you take money from your cannabis LLC, you draw money from a capital account. This is not the same as taking a paycheck: there are no federal or state income taxes or FICA taxes withheld from your draw. That doesn’t mean you avoid taxes, however.
A single-member LLC will pay taxes with a Schedule C report. This report calculates the net income of the cannabis business. Net income reported on the Schedule C form is then added to the person’s other income on their individual tax return. Basically, what this means in practice is that you don’t need to file a separate federal tax return for the LLC. As the sole owner, the LLC income gets listed on your personal return.
A multiple-member LLC pays its taxes like a partnership. “The total net income for the partnership is calculated on Form 1065. Then, the individual partners receive a statement called a Schedule K-1 that shows their share of the income or loss for the year. The Schedule K-1 information is added to the person's other income on their tax return to figure their total income and tax liability for the year,” reports one expert.
If you have further questions about any of these cannabis business entities, then please get in touch with our cannabis tax experts who can give you industry-specific advice about withdrawing money from your cannabis venture.