5 myths about marijuana and the accounting industry

May 25, 2023 11:14 AM

The legal cannabis and CBD/hemp industry is expected to be a $100 billion market in the next few years, with hundreds of thousands of new companies needing accounting and tax help. Many states start slowly, but as the effects of more jobs and tax dollars for cities and counties start to grow (as well as the demand), we will start to see pressure move things along more quickly. Not to mention, we have a real possibility for federal legalization very soon. We saw this happen in 2018 when CBD and hemp were fully legalized in the farm bill.

With cannabis legalization in limbo on a federal level, and individual states allowing the sale and production of cannabis, this leaves professionals like CPAs in a rather precarious position. On one hand, cannabis companies need accounting support to remain compliant and keep their licenses. But because cannabis is still considered a Schedule 1 substance by the U.S. Drug Enforcement Administration, there is some hesitancy for professionals like CPAs to provide services to this industry.

The truth of the matter is that there are thousands of businesses springing up all over the place, and there are not enough experienced accounting professionals to go around.

The following are the top five myths surrounding providing accounting services to the cannabis and CBD/hemp niches:

Myth No. 1: Accounting for cannabis companies is just like any other niche

We are experiencing the birth of an entire industry, including many "subniches" like farming, chemical processing, manufacturing of foods and products, distribution, testing labs, retail, and delivery companies. You might even find all of these "verticals" in a single company or organization.

There are major accounting and tax issues in these niches. For instance, many vendors will not service companies that operate within the cannabis industry. There is also a lack of accounting tools available. New software in the market is full of bugs, which causes significant periods of downtime, features that don't work and poor customer service. Likewise, state mandated "seed to sale" tracking software is difficult to use and doesn't integrate well with cannabis or accounting software, making it incredibly difficult to reconcile and ensure that state tracking is in line with internal counts.

Monthly, quarterly and yearly reporting requirements are different, depending on which state you're in and where you bank. Bookkeeping and recordkeeping are not an option and must be done regularly for cannabis companies to be compliant. Cannabis companies also cannot take any tax deductions on the federal return due to the substance's Schedule 1 status. There are legal ways to reduce tax liability, but you must understand the tax codes, including what is allowed and what isn't for each vertical.

The first place you'll want to start when working with cannabis companies is to review and thoroughly understand the tax codes and how they relate to each vertical in the industry.

Because cannabis is a Schedule 1 drug, Section 280E of the U.S. Internal Revenue Code says a cannabis company cannot take any deductions or credits on their tax return. They are, however, allowed cost of goods sold, as COGS is a return of capital and not a deduction or credit. That brings in Section 471, which also involves complex cost accounting that must be done at least quarterly to maximize the allowable COGS on the tax return using 471-11.

Myth No. 2: CPAs will lose their licenses if they serve a cannabis company

As of right now, there are thousands of CPAs serving cannabis companies in almost every state, and not one has lost a license simply for serving a state legal cannabis company. The same goes for attorneys, plumbers, electricians and thousands of other service providers. Almost all the big national firms are also serving the legal cannabis niche.

The American Institute of CPAs has recognized the need for accountants to serve cannabis companies and is on board. Over the past three years, the AICPA has hosted a two-day conference of handpicked experts in the cannabis niche to present key information to better educate accounting professionals about this grossly underserved segment. If you have any other doubts whatsoever, contact your state board of accountancy to learn more about serving cannabis companies as a CPA.

Myth No. 3: This is an “all-cash” industry

Actually, credit unions and banks serve cannabis companies in many different states. For example, in my home state of Oregon, Maps Credit Union (with more than 10 branches) serves any licensed cannabis company.

That said, there is a lot of cash in the industry, so there is a big need for cash controls and procedures to prevent fraud and theft. Additionally, you will find many cannabis business owners have anywhere from two to 10 noncannabis entities, such as a real estate or equipment company, and these can have easier access to banking.

The SAFE Banking Act is currently under federal review, and hopefully we will have easier access to banking and merchant services very soon for cannabis companies.

Myth No. 4: Cannabis companies are a “goldmine” in terms of net income

Since there are massive taxes on this industry at the national level via Section 280E — as well as heavy state and local taxes — it's actually very hard for these companies to have a net income (if they are correctly doing accounting and tax).

Like the tech boom, many of these companies will lose money for years. The name of the game for founders and investors is focusing on building brands, growing revenues rapidly, vertically integrating, and staying well capitalized. Exit valuations are now based on growth and brand — not net income — and will likely be for some time.

I've seen farms go through $10 million in cash and still go under, so companies that try to enter the niche without sizable investors will have difficulty.

There is massive capital coming into the niche, and this is expected to grow rapidly as more funds, private equity, family offices and angel investors look to get into this space.

Myth No. 5: Cannabis must be a horrible “niche” for CPAs

Because there are so few CPAs in the niche right now, it's a massive opportunity. Many surveys have shown that solo CPAs struggle most with finding great clients, and if that is the case for you, this might be your chance to easily find high-paying clients. Many will pay into the six figures for world class accounting, tax and CFO services.

When you consider that a small mom-and-pop cannabis business (whether a farm, dispensary or vertical integration) will often quickly become a $10-$20 million company, these clients will pay sizable fees for rock solid accounting and tax. The cost accounting is not simple, and it's important to the founders and investors for this to be done correctly.

Cannabis accounting is one of the most rewarding industries for those of us who love the challenge of navigating complex accounting and tax issues, implementing systems and controls, and helping our clients manage the financial health of their business, while maximizing cash flow.