Cost of Goods Sold (COGS) Adjustments for Medical Marijuana Related Companies
As a cannabis producer or reseller, you may have the option to deduct COGS for particular expenses related to the operation of your business. These deductions can offer substantial savings for your business, as the deduction options for cannabis-related businesses are limited to COGS due to § 280E of the Internal Revenue Code (IRC).
In 2015 the Chief Counsel Advice (CCA) 201504011 was issued by the IRS Office of Chief Counsel, this memo was designed to clarify the COGS deductions that are available to cannabis businesses. The IRS determined that the specific IRC sections that govern the items that can be included as COGS for cannabis businesses are §1.471-3(b), in the case of a cannabis reseller, and §1.471-3(c) and 1.471-11 , in the case of a cannabis producer.
Although these regulations outline the general categories of deductions permitted for cannabis businesses, they do not detail specific items cannabis-related businesses can deduct. Here are some examples of the costs that you should include in your COGS basis for your cannabusiness so that you know which items are acceptable to deduct.
COGS for Cannabis Resellers
The IRS has interpreted the §1.471-3(b) section of the IRC to mean that cannabis-related business are permitted to deduct expenses relate to inventory as COGS only. As a result, cannabis resellers can claim deductions for:
As long as these charges are strictly related to cannabis for resale and the storage of inventory, cannabis resellers are permitted to take these deductions. The most effective way to ensure that the IRS will not challenge these deductions is by creating an inventory space that is closed off from the sales area of your cannabis business.
COGS for Cannabis Cultivators
§1.471-3(c) and § 1.471-11 of the IRC define how cannabis cultivators should treat production cost and define which expenses are permitted to deduct as COGS. The IRC advises the use of the "full absorption" method of computing COGS which takes into account both indirect and direct production costs.
Direct production costs are considered those costs which are necessary for the production of cannabis and the materials that are consumed as a part of the production process.
According to the IRC, the direct production costs that cannabis producers can deduct are the costs of:
Examples of indirect production costs that can be deducted as COGS include:
These production costs are only deductible if they can be related to the production of cannabis. Also, if cannabis production business prepares financial statements in accordance with GAAP, a few additional expenses can be deducted.
Californians Helping to Alleviate Medical Problems (CHAMP)
The Tax Court determined that CHAMP could take business deductions for the patient care portions of the non-profit’s medical marijuana dispensary operations, since the 2007 case, Caregiving Californians Helping to Alleviate Med. Problems, Inc. v. C.I.R., 128 T.C. 173 . In accordance of the laws of the state of California, CHAMP was a caregiving program that was designed to provide members with medical cannabis. The organization also provided medical supplies, one-on-one counseling, healthy meals, yoga instruction and internet access.
The Tax Court agreed that CHAMP was actually two separate businesses, as a not-for-profit entity per California law. The ruling concluded that CHAMP’s primary business was actually caregiving services, which would permit the deduction of business expenses that were precluded by §280E.
The CHAMP case creates the possibility for cannabis business to operate multiple businesses under one roof. You can take advantage of as many of these COGS deductions by adding additional services to your cannabis business.
By expanding your business to include non-cannabis related services, one can improve profits and increase the number of COGS deductions your business can claim. For example, you can add patient services, such as advocacy or counseling, and make sure that all other businesses have real purposes and separate financial records to back up their operations.