Jim Marty, managing partner of BridgeWest CPAs and Consultants, knew it was time to roll into the marijuana industry after his clients in Colorado started to inquire about how they could profit from the psychoactive drug.
It all started in 2009, when clients from his former firm, Jim Marty and Associates, wanted to know if they could rent their warehouses to cannabis growers. “Because of the recession, their construction and/or real estate businesses weren’t doing well and they were considering opening a [cannabis] dispensary,” Marty told Accounting Today.
After the constant stream of inquiries, Marty took it upon himself to head to San Francisco to conduct his own due diligence. He met with some of the top lawyers and CPAs in the marijuana industry in California, who shared some vital information. “They said, ‘In the 15 years of medical marijuana in California, a CPA has never been sanctioned for doing tax returns for the industry,’” recalled Marty. “In fact, the IRS wanted people like me to help out with the industry.” This was his cue to jump right in.
Within five years, the cannabis business side of his original firm grew until it exceeded his 30-year-old practice. “January 1 of 2015, I merged all of my non-cannabis business into Brock and Co. To separate the two, I started BridgeWest in 2013 to service my cannabis clients,” said Marty, who now has over 200 clients in his practice, and a staff of 10, including two younger partners.
IRS CODE SEC. 280E
Marty formed a professional bond with the Internal Revenue Service, which he said is quite cordial. However, they do disagree from time to time on some big issues revolving around taxing marijuana.
One of those issues is the Internal Revenue Code Section 280E, which Congress enacted in the early 1980s during the “War on Drugs” campaign. Look between the lines of the code and you’ll see that ordinary and necessary expenses are not tax-deductible at the federal level for marijuana businesses that are legally operating at the state level.
In 1983, Congress fine-tuned 280E after the tax court case, Edmonson v. Commissioner, where Jeffrey Edmondson, a small-time drug dealer from Minneapolis, won his case and was allowed to deduct expenses from his illegal operation. The code now states that marijuana businesses are required to file federal income tax returns, but are not allowed to deduct all of their expenses.
“There are no regulations under 280E, it’s just a simple paragraph,” Marty explained. In very plain language, it disallows any deduction or credit for business expenses related to trafficking in controlled substances.
But the language of 280E is not as cut and dried as it appears. Marty explained that in the state of Colorado, where most of his clients are located, those in the marijuana business operate on an integrated model of both growers and retailers. This is when tax deductions may get a little more intricate. “The cost to grow is deductible, while the cost of retail is not,” he said noting that it’s mandatory for cannabis dealers to grow their own supply.
The IRS Advisory Council 2014 Public Report explained that 280E is not intended to disallow the adjustment to gross receipts with respect to costs of goods sold. The report also took from the 2007 court case, Californians Helping to Alleviate Medical Problems v. Commissioner, which states that if a taxpayer is engaged in trades or businesses in addition to the trade or business of the sale of controlled substances, Section 280E does not disallow the deduction of the expenses of those other trades or businesses.
MO MONEY, MO PROBLEMS
Then there’s the issue of banks turning away marijuana business. Banks are apprehensive about doing business with these cash-run entities because they are worried about violating federal trafficking and federal money-laundering regulations, which can lead to hefty prison sentences. What ends up happening is that marijuana businesses start to hoard their cash, which makes the owners a target for a potential robbery.
Cannabis clients handle a lot of their business in cash. They pay their landlords in cash, they handle their payroll in cash, and they pay their taxes to the IRS and the state of Colorado in cash. “The 20th of the month is a big day in Colorado because the dispensaries all come in with $50,000 to $60,000 in cash to pay their sales tax,” Marty observed.
Surprisingly, most cannabis companies in Colorado do have bank accounts. There are several local banks that accept cannabis accounts. “I have clients who have had uninterrupted accounts for six years,” said Marty. “Now, some of them on the other hand have lost their banking at various national banks that don’t deal with cannabis businesses.”
FinCen and the federal banking agencies keep track of large cash transactions through suspicious activity reports, which monitor banking customers who regularly make large deposits of cash without a valid reason. The regulators and banks are required to file a SAR if they suspect criminal violations.
In February 2014, a special SAR just for cannabis was created. “The federal government realizes that these folks need banking, so there’s a lot of movement going on right now to get them banking. The government knows that it’s a public safety issue to have cash floating around,” said Marty.
The marijuana business is not the only industry that conducts its business in cash. Take a look at the gaming industry. “A lot of the internal controls of casinos have been adopted by [the cannabis industry] with cash transactions,” Marty explained. “Just like the casino industry, the marijuana business makes sure that there are at least two people in the room when cash is counted. ... There are several really good software point-of-sale systems that track the sales and the inventory. Colorado has a system that updates every evening as the shops close up where the entire inventory in the dispensaries is reconciled with the state’s system. The state monitors that inventory very closely.”
“In my audits, unreported net income is almost never an issue. These people really want to be compliant and want to stay in business,” Marty continued. “If they sell out the backdoor they are going to lose their license. What you really have to watch out for are the employees. A lot of the shrinkage and theft are inside jobs. And this is where the general control procedures come into play.”
KEEPING TABS
Marijuana has been on the scene for decades, but when it comes to the legal side of the business, it’s still relatively new. Marty said that he is able to stay abreast of the many layers of the business by following the tax court cases that have come out over the years, such as the CHAMP case, the Olive case, Feinberg v. Commissioner, and others.
For now, these court cases are Marty’s main sources of information: “It’s such a new area and there are no textbooks other than the ones I’ve written.” He also co-wrote a paper with Marc Rubin, a partner at BridgeWest CPAs, in which the two broke down the multifaceted layers of marijuana sales and income taxes in Colorado that was published by Bloomberg BNA. Marty is also in the process of writing a book on the topic.
In addition to following court cases and authoring books, Marty has formed the BridgeWest Network, which consists of CPAs and attorneys who work in the cannabis business throughout the United States. “We have a conference call once a month to go over issues that are happening in each state,” said Marty. He also has weekly calls with the IRS to discuss various audits taking place around the state of Colorado.
CLIENTS
The marijuana industry is more than just planting seeds, harvesting and dealing. There are more than 100 dispensaries throughout Colorado, and Marty provides services to a number of cannabis-related clients. There are the growers and sellers who have retail and manufacturing facilities. Then there are the edible companies, as well as the concentrate operations for the hash oil that is used for edible products. “This is really big,” said Marty. “It’s about 40 percent of our sales here in Colorado.”
There are also clients who buy and lease equipment to handle the extraction process. And let’s not forget the real estate side, where clients invest in land to grow and harvest marijuana.
Marty’s clients turn to BridgeWest CPAs for just about everything. “They need help with their accounting, their internal controls, inventory and cash control. They need help with their tax return preparation,” he shared.
“It’s a fairly litigious industry because there were a lot of shotgun marriages a number of years ago,” he said. “In 2010, when Colorado [required a vertical integrated model], farmers had to become retailers and retailers had to become farmers overnight.” The integrated model basically forced retailers and growers to partner up quickly. And before long the quickie business marriages started to fail, which gave him another stream of clients. “I do a lot of litigation support. I’m involved in three cannabis cases in Arizona.”
How big is the business of selling Mary Jane exactly? Marty said that it doesn’t take very much to get to $1 million a month in sales. “Colorado is projected to do $1 billion this year in sales. The state collects about 12 percent of that, which is close to $120 million in taxes.”
Marty also has CPAs on his client roster. “I help other CPAs around the state with their IRS audits. A lot of businesses are consulting with CPAs in this industry, in Colorado and around the country,” he said. “I have a very full schedule. I get calls every day ranging from Maryland, Illinois to Minnesota.”
WORKING TOGETHER
Just because there’s a conflict between federal and state law right now doesn’t mean that CPAs and lawyers can’t work in this industry. Marty said that it’s the lawyers and CPAs who will help resolve this conflict: “If you really studied the CPA code of ethics, it talks about conflicts between stakeholders and that CPAs have a role to play on these conflicts. Our middle name is ‘public,’ and we are here to serve the public. In many states the public has decided sick people need access to cannabis.”
However, Marty admits that the marijuana business is no walk in the park: “What keeps me up at night is my workload of IRS audits, tax returns and the constant phone calls from all over the country.”
Andhe also warns that it’s important for accounting firms to look at the overall picture: “If you’re into this just to make money and you don’t believe that marijuana should be legal, it’s probably not going to work so well.”
AT A GLANCE
Firm: BridgeWest
Headquarters: Denver
Managing partner: Jim Marty
No. of staff: 10
Year founded: 2013
Services: Tax, bookkeeping, accounting, technology, training, litigation support and advisory services for the marijuana industry
