Suppose you are a business that is lawfully engaged in the cultivation of marijuana. In that case, chances are that you also have a processing side to your business, where you take raw cannabis and process and prepare them in the form that is eventually sold to consumers. This entire process from planting to harvesting and processing may be loosely considered the “manufacturing” side of the cannabis industry.
Or it may be that the operations of your cannabis business are dedicated exclusively towards the processing of raw cannabis products. Either way, figuring out what your costs of sales are, which you can then deduct as Cost of Goods Sold (COGS) can go a long way towards minimizing your taxes.
California tax lawyer Jin Kim helps cannabis businesses resolve Federal and State tax obligations. To learn more about cannabis tax law and your case call her office at (916) 299-9913 for a free consultation.
What Costs Go into the Manufacture of Marijuana?
One of the things that set apart the cannabis produced by state-sanctioned and legally operating cannabis businesses from that produced and circulated in the illegal drug trade is the quality of the product. For a product that begins as a plant that is sowed, nurtured, cultivated, and eventually harvested, such costs can include the seeds that are purchased, the quality of the soil, the water, fertilizers, lighting equipment, the physical environment in which these plants are grown, as well as the man-hours that went into the entire farming process.
Harvesting, on the other hand, requires a bit more specialized handling. While each cannabis manufacturer may have its own techniques, harvesting in general can start from the trimming or cutting of the leaves from the mature plant, drying, de-stemming, sorting, and curing. Done manually can be a pretty labor-intensive and time-consuming process, especially if you have to adhere to strict quality control measures to keep the products pure and uncontaminated. Many cannabis businesses have, in one way or another, found a way to automate all or part of this entire process to speed up production and minimize costs.
Once these stages are done, what follows are the more technical aspects of the processing process: extraction, analytics, and biochemistry.
Such details are probably best left for the discussion of the experts in the field, but for our purposes, it is enough to know that the prepared raw cannabis materials are ultimately processed utilizing methods that are dependent upon the ultimate intended product. The cannabinoids within the raw cannabis material is extracted with a concentration that is dependent upon the requirements of the target product. Such products can range from beverages, chocolates, oils, medicine in the form of capsules, tinctures, vape products, and, interestingly, even dog food. In states where operating a cannabis business is legal, whether, for recreational or medicinal purposes, there is some form of state regulatory agency that checks that the quality of the cannabis products put into the market meets industry standards and are deemed “safe” for public consumption.
This processing stage obviously involves a lot of specialized equipment and expertise among the manufacturers in order to produce a worthwhile product – and it seems a logical conclusion that this entire process is not cheap. All the costs and expenses that went from bringing the cannabis seeds into the form that is eventually sold as a product available to sell, including the testing phase that ensures that the products can pass quality-control tests and inspections, can be considered COGS, and legally allowed to be deducted from the gross receipts prior to arriving at the taxable income.
Importance of determining, itemizing, and documenting your COGS
Like most things in the tax world, any deduction you claim as COGS should be substantiated by some form of paperwork: receipts, payroll, costs of purchase, rent, etcetera. Therefore, it is worthwhile to have a system in place for tracking such expenses and organizing all related documents, paperwork, and other receipts.
Ironically, this kind of administrative efficiency may not come cheap, yet it is not considered included in COGS. And yet, in the long run, investing in such administrative support may prove to be the cheaper and more cost-efficient avenue for cannabis businesses in managing their tax obligations.