Those involved in cannabis businesses are probably already familiar with the much-debated and much-maligned application of the federal government’s IRC 280E on state-sanctioned and legally operating cannabis businesses. As a brief summary, legally operating cannabis businesses are not allowed to claim any credit or deduction to their taxable income even if they are legally operating, like any other regular business, under state law.
At present, there seems to be some movement in the policy approach to 280E, due, in large part, to the very real financial drain that 280E poses to legally operating cannabis businesses. But until and unless there is a definitive change implemented by Congress relieving this burden, cannabis businesses have no choice but to work with what they have. And that includes making use of Cost of Goods Sold (COGS) adjustments to their gross receipts.
Jin Kim is a California tax attorney helping cannabis businesses resolve outstanding federal and state tax debt. Through her tax law firm, she represents cannabis dispensaries in audits, offers in compromise, payroll tax arrears, and installment agreement applications. To learn more about your tax resolution options, call her firm at (916) 299-9913 to schedule a free consultation.
A Brief Overview of COGS
Cost of Goods Sold, or COGS, for short, refers to all the costs and expenses that went directly into the production or manufacture of the product that is eventually sold. So literally, the costs that went into the product that is sold.
COGS does not, however, include costs that are not directly related to the production or manufacture of the products. So costs that went into, for instance, marketing and overhead costs, would not be considered COGS.
Why is this important for cannabis businesses to know? It is important because, at present, COGS seems to be the only way for cannabis businesses to minimize or reduce the taxes they owe on their income. Since they are not allowed to make any deduction or take any credit on their taxable income, they would essentially have to pay tax on their entire taxable income. This makes for a very expensive way to run a business. COGS, however, can help to alleviate this tax-centric dilemma. To put it simply, cannabis businesses can deduct COGS from their gross receipts, thereby lowering their taxable income, and as a direct result, the tax they owe to the federal government on their income.
COGS for Marijuana Cultivators
Unfortunately, there is yet no definitive guide on what costs are considered to be part of COGS. What we have, really, is simply a general definition of COGS as the total cost associated with the production or acquisition of any goods that are sold during the reporting period. Obviously, the COGS for a cannabis retailer is completely different from a cannabis manufacturer.
For those whose primary business is the cultivation of marijuana, their COGS would typically include all the costs that they had to expend in growing the marijuana plant. These would therefore include the following costs:
- the labor that went into the cultivation, care, and harvesting of the plant
- The physical infrastructure used to house the cultivated plants
- Inventory equipment or software
- Other types of equipment used directly in the cultivation of the plant
- Other similar costs and expenses
COGS for those businesses that function exclusively as cannabis cultivators, however, do not include other businesses’ costs that are not directly related to the cultivation of the cannabis that is eventually sold. So, for instance, marketing and advertising costs, accounting costs, or the rent of physical space that is devoted to office management and administrative tasks would not be considered as included in COGS. The “inventory,” in this instance, would be the marijuana product that is ultimately sold. So COGS for a cannabis cultivator would be the actual costs that went into their inventory.
*Disclaimer – The content on this page does not contain legal information. The information on this site is for general informational purposes only. Consult a tax attorney for legal advice and a licensed CPA for accounting guidance.