Andrew Hunzicker, CPA

Arizona’s Strong Cannabis Sales

The cannabis industry is now in full swing here in Arizona. It is a growing, complex market with many different niches for entrepreneurs, and financial and accounting professionals. In April of this year, Arizona marijuana sales exceeded $68 million, slightly lower than the record $72 million set in March. I expect the robust sales to continue, therefore, Arizona can expect sizable growth in both revenues and tax dollars as its marijuana market matures.  As the Arizona industry grows, businesses and their teams accountants will need to navigate unchartered waters to make sense of compliance and regulations.

What Does This Mean for The Marketplace?

While cannabis remains a Schedule I substance it 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 lower taxable income. Obviously, the more costs allocated to inventory via cost accounting, the less tax the client will pay.

Arizona 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:

  1. Costs that must be included.
  2. Costs that can never be allocated to inventory.
  3. 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 (GAAP).

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 their financial teams will 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 to your clients, you’ll need some very important tools to help them maximize their tax benefits. We recommend clients having:

  • 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 for things like monthly/quarterly counts, weights, estimated yields, and percent 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, I feel these are imperative for all clients to have. I recommend building a “permanent audit trail” every month, starting from transaction/event to source document, general ledger, trial balance tie outs, and financials.

In Arizona, the cannabis industry is still new and multi-faceted, 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 Arizona’s cannabis industry matures, financial professionals must stay ahead of the curve to help business owners navigate this unique, complex niche.

Read the original story on: Phoenix Business Journal