The cannabis industry is now in full swing here in New Jersey. It is a growing, complex market with many different niches for entrepreneurs, and financial and accounting professionals. Currently, 19 states have legalized its recreational use. We’ve seen how this has played out in other states so here’s what business owners need to know about the latest in New Jersey.
In just the first month of sales, New Jersey dispensaries did more than $24 million in sales. A robust beginning to say the least. This trend will continue with more licenses issued and a sizable growth in both revenues and tax dollars as the cannabis market matures. As the New Jersey industry grows, businesses and their accountants will need to navigate unchartered waters to make sense of compliance and regulations.
What does this mean? While cannabis remains a Schedule I substance and is still subject to Internal Revenue Code Section 280e, which states: “No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances (within the meaning of schedule I and II of the Controlled Substances Act) which is prohibited by Federal law or the law of any State in which such trade or business is conducted.”
The bad news: no deductions or credits for cannabis companies. The good news: inventory is a return of capital and not a deduction or credit. So, via IRC Section 471, cannabis companies can put costs into inventory and, when sold, the cost of goods sold is allowed to reduce taxable income. Obviously, the more costs allocated to inventory via cost accounting, the less tax the client will pay.
Cultivators, chemical processors, and product manufacturers (e.g., food, beverage, lotions, tinctures, etc.), get to allocate sizable costs into inventory. IRC Section 471-11 lists direct costs and labor to allocate 100%. For indirect costs, IRC Section 471-11 lists: costs that must be included; costs that can never be allocated to inventory; and costs that can be allocated to inventory if, and only if, the client does cost accounting in their recurring financials (not just at year end) and if that accounting is in accordance with U.S. Generally Accepted Accounting Principles.
Since cannabis companies are essentially penalized due to IRC Section 280e, it’s imperative that they implement IRC Section 471 correctly to minimize their tax burdens.
What do businesses need?
Entrepreneurs and accountants need to know how to allocate the different costs to the various phases in the grow cycles, for example, among other things. To provide effective cost accounting, you’ll need some very important tools to help them maximize their tax benefits, such as:
A very good cannabis chart of accounts. This should be ready for use with QuickBooks, Xero, or another accounting system and be specific to growing, processing, edibles and retail operations.
A client inventory template. This is for accumulating data on things like monthly/quarterly counts, weights, estimated yields, and percentage complete. And you’ll need cost accounting templates to perform these calculations.
Rock solid, audit-proof books and records. With IRS auditors targeting this industry, these are imperative for all clients to have – like building a “permanent audit trail” every month, starting from transaction/event to source document, general ledger, trial balance tie outs and financials.
In New Jersey, the cannabis industry is still new and complex with all its niches, and that’s before we even include accounting and finance issues like cost accounting, lack of accounting tools, lack of regulatory guidance, banking issues, software issues, and more. But with great difficulty comes great opportunity. As New Jersey’s cannabis industry matures, financial professionals must stay ahead of the curve to help business owners navigate this unique, complex niche.