Cannabis: ‘A bit of a bright spot’ for accountants
In a year that has been astonishing for the many and varied ways it can generate bad news, it’s nice to be able to highlight a good-news story — and the extraordinary success of the fledgling cannabis industry is definitely one of those.
“It’s positive almost every way you look at it — the economy, jobs, medicine, ending illegal markets, even social justice,” enthused Andrew Hunzicker, a CPA and CEO and co-founder of Dope CFO, which provides accounting services to cannabis companies, as well as teaching accountants how to serve the burgeoning industry. “I think we will all look back on 2020 and say, ‘What a mess of a year’ — it’s been pretty bleak, but this is a little bit of a bright spot.”
Already growing strongly before 2020, cannabis has continued to thrive even amid the coronavirus pandemic.
“Cannabis really grew during COVID — there was a great product-market fit,” said Derek Davis, CPA, the founder of GreenGrowth CPAs, a California-based firm that serves cannabis clients across the country. “If you’re sitting home all day, cannabis is a great product for that. A lot of cannabis companies are doing really well right now.”
“The industry has really fared well as a result of the pandemic, starting with being deemed an essential business,” agreed Gretchen Schmidt, JD, the faculty program director for criminal justice programs at Excelsior College and one of the leaders behind the online school’s new Cannabis Control Certificate.
Drive-through and curbside pick-up services were “a big win” for the industry, she explained, suggesting that cannabis might prove to be somewhat recession-proof, much like alcohol and tobacco.
But while Schmidt noted that there is speculation that cannabis companies benefited in particular from the $1,200 Economic Impact Payments the federal government distributed to taxpayers early in the pandemic — “You did see a spike in sales as those checks were being passed out,” she said — they were also shut out of federal stimulus funding such as the Paycheck Protection Program because the federal government considers marijuana an illegal drug.
“Newer operators didn’t have an emergency fund, and you should have six to eight months of cash,” she explained. “There’s real estate, licensing fees, and much more to pay for — it’s expensive. It takes a lot just to get up and running, so that’s a big barrier, particularly if you don’t have banks to get loans from.”
That lack of access to normal banking channels (because federally regulated banks don’t want customers who sell a drug that’s illegal on the federal level) is one of the serious problems that has plagued cannabis businesses from the beginning — while simultaneously making them natural candidates for the kinds of compliance and advisory services CPAs and accountants supply.
“Banking’s obviously the most apparent issue because it’s really challenging to run a $15 million company all in cash,” said Davis. “There’s a plethora of issues that come with that — theft, misallocation of funds, misplacement of funds, running payroll in cash — it’s completely absurd.”
Professional advice on how to manage a cash-only business is thus critical to cannabis companies, though as a CPA serving the space, Hunzicker would rather see the banking issue resolved at the federal level.
“We want those companies to have access to banking, so they will be more auditable, so there’s better accounting, and so they’ll be able to pay their taxes better,” he explained. “The IRS has done a study where many, many companies are way underpaying taxes at both the state and the federal level. If you don’t have banking, you simply encourage illegal markets — theft, fraud, skimming. … Why not just add banking in? We’ll get more tax dollars in and we’ll decrease the illegal markets.”
The tangle of state and local laws and licensing rules that govern the space in the absence of federal rules are both a major headache for cannabis companies and a tremendous compliance opportunity for CPAs and accountants.
“We have 50 states with 50 different rules setting up these artificial walls,” explained Hunzicker. “You can’t ship across state lines, even between legal states, so you have these huge price swings, even though this is a commodity — from illegal states like, say, New York, where you get $5,000 a pound, to Oregon, where we’ve actually had a crash and you get $300 a pound.”
For Davis, local licensing rules are a major issue. In California, for example, these have been pushed down to the state’s 482 cities and municipalities, opening operators up to confusion, complexity, and sometimes corruption. He cited a city that required licensees to hire specific “professionals” at inflated salaries for the privilege of operating locally, while many other localities have simply mismanaged the license application process to the point where they get sued by failed applicants and have to hand them licenses anyway.
“How cities go about grading applications is very subjective, and it’s often a ‘Who do you know?’ kind of business,” he said. “You need to look at how the state and the local municipality license operators. That’s really where you’re going to see the bulk of the problems from a business perspective.”
Hunzicker also highlighted two challenges facing cannabis that specifically impact the accountants serving the space. The first is the relative youth of the software systems built for the industry. “Most of the point of sale, accounting and ERP, and merchant services systems are in their first one to five years of being in business, which means software that new is filled with bugs and doesn’t work well,” he said. “If you’re an accountant, you’re facing systems that don’t work well and don’t output reliable data.”
The second challenge relates to problems with staffing. “This niche has been massively underserved by the Big Four and the bigger firms — in most niches, you get GAAP guidance and Big Four industry guides, and they train staff and those people go out into industry,” he said. “We have none of that in cannabis, so most of the people serving the industry are untrained — they don’t have the skills, the knowledge, the tools and the systems to serve these various niches.”
Davis concurred: “The people who are generally drawn to this industry — you probably don’t want to hire them,” he said. “When we post jobs, we get a lot of people who say, ‘I love cannabis, I love how it makes me feel.’ And I want to say, ‘Please don’t ever contact us again.’ You need someone who is detail-oriented, you need someone who’s thorough, and someone who has really good quality assurance, and those people aren’t generally drawn to the cannabis industry. So it’s challenging to find the right person.”
Besides the headline issues like banking, wildly divergent state and local regulatory and licensing regimes, glitchy software, and staffing woes, the industry has confronted many day-to-day accounting and tax challenges from the start. A number of these, like onerous state requirements to track the plant from the grower through to the consumer, represent areas where the knowledge and expertise of a professional accountant can prove especially valuable.
One that has always stood out is the Section 280E problem: That part of the Tax Code says businesses that traffic in illegal substances can’t deduct ordinary business expenses from their taxes. Apart from imposing a major extra tax burden on cannabis companies, it recently gained an even higher profile when the Internal Revenue Service added a marijuana page to its website, and inadvertently led some to a false conclusion.
”Some people read between the lines there that cannabis expenses were now going to fall into 280E, but that doesn’t look to be the case,” said Schmidt. “The IRS was signaling, ‘We are still paying attention to this.’ The FAQ helps those maybe who didn’t hire a professional accountant to get clarity on what they’re allowed to do. What you can deduct varies wildly whether you’re a grower or a dispensary — they helped give clarity on that.”
Hunzicker pointed out another recent area of confusion: a little-noticed provision of the Tax Cuts and Jobs Act of 2017 that some are reading to mean that certain smaller cannabis companies can change their accounting method and save significantly on their taxes.
“I’m highly skeptical if that’s going to work,” he said, adding that the Treasury Inspector General for Tax Administration had asked the IRS for guidance, which the service declined to give, saying only that once its 2020 guidance is resolved, it plans to “ensure coordination between 280E and 471C.”
In general, Hunzicker warned that many of the more dubious ideas that advisors brought to the cannabis industry early on are being unraveled.
“Initially, there were all kinds of tricks that attorneys or accountants were pushing — trying to set up a whole bunch of cannabis and non-cannabis entities so you can move around deductions, so you can essentially fool the IRS and not pay that punitive tax,” he said. “We’re finding out in the courts that the IRS is pretty much winning every time, and those tricks are not working. We tell clients that’s not the way to go, that there are a lot of costs to setting up all those entities, and the IRS will come in and look at the economic entity, not the legally structured entity.”
At the state level, taxation presents another emerging issue, as the economic impact of the pandemic wreaks havoc on tax revenue while expenditures balloon.
“Our counties are going broke, our states are going broke, and our federal government already is broke, so why not tax this industry that’s booming right now?” Hunzicker said. “Any state that’s selling cannabis or CBD is seeing big tax dollars.”
“Cannabis has the potential to help states and the feds recover from the pandemic by creating a new revenue source,” agreed Schmidt. “But you have to look at the tax structure — you don’t want to tax someone out of business, but you want to create the tax structure to offset the oversight. … In areas where there was too much greed, if you will, in the taxes, you’ve seen it be more difficult to operate and to buy in a legal way because it’s too difficult to compete.”
Tax policy has led to some unintended consequences in California, according to Davis: “The black market has never been stronger in California — because the taxes that the state put on are too high. It’s marking up the product from 25 percent to 50 percent, depending on the city you’re in.” That has sent many consumers back to illegal dealers. “I’d look at California in terms of how not to do it.”
A bright future
A booming industry with an apparently endless list of challenges that only a professional accountant can solve may sound like an ideal client base, but Davis offered some caveats.
“They’re always having cash-flow problems and they never pay their bills on time,” he said with a laugh. “So when I see firms getting into the space, I’m always thinking, ‘Are you sure you want cannabis clients?’ They’re always a headache, and their records are second only to a fifth-graders.”
“In the early years — 2016, 2017, 2018 — we were getting a lot of unlicensed clients, but we’re now at a point where they’re usually more sophisticated,” he continued. “When we were first starting out, one of the hardest things for me to do as a practitioner was to have to convince people that paying taxes was in their best interest. They thought that because they were a nonprofit mutual benefit company, they didn’t need to pay tax, and that just isn’t true. Since 2018, a lot of institutional money has gone into the space, and an institutional investor will often make you hire a CPA firm, and that’s helped a lot.”
Hunzicker agreed that cannabis companies are becoming better clients — and better businesses. “Business owners are catching up,” he said. “Three years ago, they’d ask, ‘How do I beat the IRS?’ They’re starting to get that that’s not their best strategy; their best strategy is to build a good company and to build a strong brand.”
Clients aside, Schmidt noted that there is still some stigma around the plant in general, and its continued federal illegality makes it difficult to break that stigma down. That said, she expects to see more states opening up to cannabis.
“Legalization is going to continue — it’s not a matter of if, it’s a matter of when,” she said. “Already, more than half of the states have some form of legalization, and that isn’t a trend we see slowing down or stopping. It’s too big of an industry to close down or for that to stop.”
With five states voting on cannabis this Election Day, almost four-fifths of the country could be legalized on Nov. 3. Industry watchers don’t expect the presidential election to have much effect on cannabis, though, with neither candidate showing any inclination to remove the plant from Schedule 1, the federal government’s list of illegal drugs.
Even without federal legalization, having more states on board will help with the welter of confusing regulations around cannabis. “It means a more straightforward set of laws and policies — right now, it’s wildly different from one state to the next, and even from one city to the next,” Schmidt explained. “The more states that adopt legalization in one form or another, the more it is going to help. … Right now we don’t have a great model out there — as more states legalize, they’re learning from earlier mistakes, and with every state that legalizes, we seem to be getting more of it right.”
On another front, Hunzicker is looking forward to new efforts to study and prove the medical benefits of cannabis. “We finally have real science catching up — we have universities, hospitals and governments all over the globe doing real research and testing on this around pain, inflammation, sleep, autism, epilepsy, cancer and on and on — even COVID. Even our federal government has studies going on,” he said.
He is also seeing the industry growing. “The niches are expanding a bit, too — you’ve got traditional farming and chemical processing to make the oils for the various products, and retailers, but now we’re seeing distribution companies that move the flower from wholesalers to retailers, and delivery companies from the retailer to the consumer, and that brings up a whole other set of accounting issues, and are they subject to 280E? So we’re getting more subindustries under these niches, each with their own accounting and tax issues.”
Even in the current tough environment, cannabis is a growing industry with bright prospects and a built-in demand for high-value accounting and tax services.
That doesn’t make it an easy niche to serve, however, or one that accounting firms can just pick up in their spare time.
To start, since cannabis is very local, they’ll need to investigate their local market, or be prepared to go broad.
“As a CPA, how you operate — and how your state licenses — will largely determine whether you can build a profitable practice,” said Davis. “If you’re an accountant in Ohio, say, with under 10 licensed operators, cannabis probably isn’t the best niche for you, unless you go virtual. But if your state has a lot of licenses, cannabis can be a great niche for you.”
More important, though, is the need to really gain expertise in the industry and in cannabis itself. CPAs and other professionals who serve the space routinely cite cannabis-specific expertise and a deep knowledge of all facets of the industry as absolutely crucial.
“The key takeaway is education,” said Schmidt. “The more education any professional can get around the rules, the laws, the regulation, and policy — it’s only going to benefit you.”
“You have to understand the plant, the history of legalization, the complexities of the regulatory landscape, and more,” she continued. “It’s the people who didn’t understand the plant and its history that don’t make it in this industry.”