Nonprofit, C-Corp, LLC: what business structure offers the best tax benefits for new cannabis companies?
- A multi-entity structure limits your liability and can protect your interest – but also create a logistical nightmare.
- C-Corp is one of the most popular options, but beware the double taxation issue.
- Keep investors in mind as you create a structure that looks appealing to those risking their own money on investments.
Speak to one of our experts to learn more about setting up a cannabis business.
So, you want to start a business in California’s booming cannabis industry. Now seems like the perfect time to get in on the ground floor: the market estimates that cannabis will bring an additional $5 billion to California each year. It would be nice to get a slice of that pie, no?
Before you dive in, take some time to learn about the different ways to structure your business in a way that will give you the biggest slice of the pie -- not the leftover sliver that’s all crust (unless crust is your thing). The way you set up your company can mean the difference between growth and success and burning out after a year in business. Ask these five tax questions when setting out to structure your cannabis business.
1. What kind of legal entity do you want to be?
Historically, before California decided to have a fully regulated state system for medical marijuana, cannabis companies were set up as non-profits. Now, there are other options for structuring your business. Figuring out which model is right for you depends on many factors, including your role in the cannabis industry (i.e. grower, distributor, or partner); county and local regulations; and your projected growth. Here are some options available:
Nonprofit (allowed pre-2018):
- The California Cooperative Corporation: in this scenario, cooperatives will be able to operate both as for-profit and non-profit entities.
For profit (allowed in 2018):
- The B-Corporation: B-Corporations are now authorized at the state level in California. A B corporation is a benefit corporation, a for-profit with a certain score for social and environmental performance.
- C-Corporation: a C-Corporation refers to a for-profit corporation that is taxed separately from its owners. In this scenario, your business will be taxed on its income at a corporate level, and then as the owner, you will be taxed on your personal return for any income received from your canna-business. If this double-taxation seems unfair, you’re not wrong; however, having C-Corporation status creates a firewall against any personal tax liability, lowering your personal risk.
- S-Corporation: an S-Corporation is another for-profit model, like the C-Corporation. The difference here is that the business doesn’t pay income taxes. Your cannabis business’s income or loss is divided among your shareholders. Then, each shareholder must report the income or loss on their individual tax return. This puts the liability on each individual -- and can have big repercussions depending on how well your business succeeds.
There’s no one model fits all for your cannabis business. Consult with a tax professional to learn about these options – and others – before incorporating.
2. What are your growth goals?
Do you plan to have multiple locations and holdings? Depending on how your business operates, you can structure to account for different levels of liability. If you have multiple corporate entities, for example, you can limit your liability within each one. Then if one of your locations is sued or forced to shut down, your other locations can continue to operate independently. Conversely, managing multiple corporate entities can be a logistical nightmare – especially if you intend to grow big or go home. It is much more efficient to run all your branches under one corporate entity if you’re smart about handling your risk.
3. What are your investors looking for?
Investors will be interested in your company’s assets, inventory, cash receivables, and profit potential. They will want to see your business model in all its parts: trademarks, intellectual property, physical locations, and more. When you want to raise some serious capital -- going beyond your personal investment and a Kickstarter campaign -- the way you structure your company can impact an investor’s interest. For example, in a multi-entity structure with different locations and sub-companies, an investor can pick and choose which parts of your business they want to fund. Having a multi-entity structure can be very attractive if you’re shopping your canna-business around to people with low-risk tolerance (and it widens your potential pool of funders). However, different ownership stakes can start to lead to conflicting interests for you as a manager. Having a seat at many tables with multiple influential voices can cause some real cross-company conflicts for you as a leader.
4. How should you structure compensation and benefits?
Cannabis tax regulations have two special rules. First: cannabis companies can deduct the cost of goods sold on their tax return. Second: cannabis companies cannot deduct any sales and marketing expenses. Ouch.
What this means is that many traditional expenses can’t be claimed as decreed by tax law section 280E. Know the ins and outs of the payroll tax, executive compensation, and healthcare benefits you’ll be accountable for as a business owner in the California cannabis industry. The best way to do that is to consult with a tax professional in your community.
5. What do you need to do to be compliant?
This is a big question – and pretty broad at that. If you’ve made it this far, this step is the most crucial. Knowing what forms you need to fill out, what licenses you need, and how to best account for your expenses is what will make or break your business in the long run. California Cannabis CPA will be releasing more guides and checklists in the coming weeks to help you keep track of everything, but know that compliance varies by district, county, and between the federal and state levels. If you’re going to have locations in different parts of California, do the research for each area you’re operating in. When in doubt – pay your taxes!