This post was originally published on this site.
This guest column is from Paula Collins, EA, Esq., a tax attorney dedicated to the cannabis industry, a co-founder of the NY Consortium of Cannabis Accountants, and an adjunct professor at Pace University’s Elisabeth Haub School of Law, where she teaches Cannabis Law and Policy. The views and opinions expressed in this article are those of the author, and do not necessarily reflect the views or positions of NY Cannabis Insider.
Let’s talk tax. Specifically, cannabis tax. Today we will look at booking the losses from your New York cannabis business.
Unfortunately, a lot of people in NY cannabis closed the year 2023 with significant losses. In some cases, the investments are simply waiting for “someday” to turn into revenue streams. In others, the money spent is long gone.
“But what about my write-offs?” clients ask. “How is it that I sunk tens of thousands of dollars into a business and you’re telling me I owe taxes?”
To answer that, let’s look at three different scenarios.
First, the solopreneuer – the guy who is building this NY cannabis business all on his own. He has an LLC. He eventually will bring on investors; just not yet. He has sunk all of his retirement money, personal savings, and most of his current earnings into rent deposits, consultants, software, trips to conferences, and things he knows he will need for the business.
To support himself he is doing several different contract gigs – construction, event planning, Uber, bartending, real estate – you name it. If the 1099s he receives for those gigs are not part of the weed business he has been investing in, that gig income money is taxed in one part of the return, and the investments in the future weed business are reported on a separate Schedule C (Profit or Loss from a Business).
Here’s the rub: we won’t actually realize the losses in a way that helps tax liability until there is income. If you don’t believe me, download some tax software and punch in the numbers. You can have a million dollars in losses but if you are pre-revenue, the losses won’t show up in a way that impacts the tax owed.
Even if we could credit the value of the gift card the guy got for appearing on a podcast as revenue, the income-to-loss ratio will not shave a lot off of the tax bill. And worse, the net operating loss (NOL) from this year’s Schedule C cannot carry forward to future years. So that $50,000-$100,000 that our guy spent is just gone. Poof. No real benefit or offset to the tax bill on the money earned on the 1099s from the contract gigs.
By the way, the 1099 income will be taxed as self-employment income, which means that he very likely will have net losses for the year and still have to pay taxes.
Second scenario:
Our guy has one or two buddies with whom he is launching this NY cannabis business. They formed an LLC, and they saw a TikTok video that said they should file as an S-Corp. (I don’t recommend this in the weed industry, but that’s a subject for another time.) They have each sunk tens of thousands into the weed biz dream.
They call up the tax preparer who gathers their info. (By the way, the tax preparer will need to collect the “real” name, address, and social security number for each of them in order to file.) The partnership return shows the loss and generates a K-1. The K-1 is then used to prepare each of the partners’ individual returns. Caution: do not report the losses on the partnership return AND try to take the direct loss on a Schedule C on the personal return. You can claim the loss on one return only.
The negative income on the K-1 will help to lower the taxable income. For example, if your income is above $100,000 on a W-2 (meaning, there was the correct amount withheld in taxes during the year), the loss from the K-1 will lower the amount the taxpayer will be taxed on, and they will then have a better chance of getting a refund than they had without the losing K-1.
But wait – suppose you have a K-1 with a loss and you are a 1099 contractor. Even if your K-1 loss is greater than the amount you earned as a contractor, you still owe self-employment taxes as a 1099 contractor. So, once again, you could end up with losses AND having to pay taxes. That sucks.
Third scenario: the cannabiz files as a separate corporation. The corporation can declare a net operating loss (“NOL”). Definition of NOL: if a company has allowable deductions that exceed its taxable income within a tax period, they can book an NOL. Cool thing about that: if this year is a loss but last year the cannabiz had a gain and paid tax, they can amend last year’s return, apply this year’s NOL and possibly get a refund on what they paid when they originally filed.
Ka-ching? In NY cannabis, probably not. So far, very few NY cannabis companies have actually edged out of the red and into the black on the financial statements. A few have strong revenues, but that does not equate to showing profits.
The corporation can carry the NOL forward, which will help offset future tax liabilities. It just won’t help for this year.
The cannabis business filed as a C-Corp is a separate entity from your personal return. If you had no dividends (earnings) that you received from the business, then there is not much to report on the personal tax return. No gain, no loss. But again – if you claimed the loss on the corporate return, your tax preparer cannot double-dip and claim the same losses on your personal return.
Since I can’t seem to speak about cannabis tax without mentioning IRC 280e, I need to emphasize that phrase “allowable deductions that exceed taxable income” in a discussion about NOLs. The money you have spent trying to launch your retail dispensary will not actually have very much in NOL, since 280e says that “no deduction or credit shall be allowed…”.You are only permitted to claim cost of goods sold; if you had no goods sold, you can’t claim those costs (and you probably did not incur them since you can’t buy licensed product until you have approval to open). The people on the other side of the supply chain (farmers, manufacturers, processors) can take more deductions through IRC 471.
There is a thin beam of light through the language there. If you have not yet been plant-touching, you might be able to claim some of the deductions as if it were a regular business. However, that doesn’t help much, since we still have to have some amount of income in order to offset the losses.
Compare a NOL with a capital gains loss. I hear from a lot of people in the NY cannabis industry who liquidated life savings – stock accounts, CDs, 401ks. For some people, their timing was unfortunate. They needed to put down a $45,000 deposit on a lease and it settled on a day that their portfolio was down and they took a loss. This is a capital gains loss, and is subject to a $3,000 per year limit applied only to ordinary income. Did you catch that? $3,000 per year – even if you lost millions in crypto or stock, even if you had other losses on the return. A loss on your stock account is handled very differently than a loss on a business in which you were an active participant.
Bottom line: if you really were unlucky and took a $10,000 capital gains loss, you can’t apply it to business income and you can’t take the entire $10,000 capital gains loss in a single year. Also, if you are younger than 59 ½, you will pay a penalty for funds you liquidated from a retirement account.
A few closing remarks: remember that deductions (“write-offs”, as some people call them) are not dollar-for-dollar. They are credited against your income as a percentage against taxable income. From the IRS: “For each dollar of tax deduction, the reduction in tax liability is less than a dollar. Assume that the tax rate is 15 percent and the tax deduction is $200. At a 15 percent tax rate, a $200 tax deduction results in a $30 reduction in the tax.”
Charitable donations are also tough to understand. If I donate a car to a charity and get a $5,000 receipt, the tax preparer enters it into the return. But if I don’t have other deductions, such as medical expenses, mortgage interest, and other losses that actually show up on the return (see the information above about how a loss could just be listed on the Schedule C and not flow through to the return) I may not exceed the standard deduction of $13,850 for single people (double that for married people). In that case, the $5,000 will be buried in the worksheets for the return, but not actually flow through to offer any tax savings. Or I could pass up the government’s offer of the $13,850 standard deduction, and take the $5,000 deduction instead. But why would I do that?
About refunds: as a business owner, don’t think of the annual filing of your tax return as a sort of ATM that sends money to you once a year. A refund (or a refundable credit) happens when someone has paid more into the system during the year and the government is sending back the excess. For example, a salaried, W-2 employee who has withholdings for each paycheck may get a refund. The small business owner who sends in quarterly tax payments (subject of another column) might also get a refund, though the smart thing to do there is to roll it forward to next year’s tax liability. In general, a 1099 employee owes taxes at the end of the year. Please don’t complain – the W-2 employees were paying taxes out of each and every paycheck. The 1099 employee pays it in a lump sum at the end of the year.
In closing, please reach out to your tax professional sooner, rather than later. Partnership and S-Corp returns are due March 15. Other returns are due April 15. For most of us, if you email after the 10th of March or April, we are going to file an extension so that we can have time to prepare the return with utmost care.