Keeping pace with state sales and excise tax requirements can be a significant burden for cannabis operators. The indirect nature of the tax – that it is collected at point of sale as part of a transaction and then must be remitted to the state(s) on their specific timeline – makes it an area of complexity and risk, especially for rapidly expanding operations.
Make no mistake, the tax collection is a high priority to states, and as the industry grows, penalties and fines for late payment are becoming more common. Recreational sales alone amounted to more than $3.7 billion in tax revenue across the 18 states that have legalized adult use sales; this is no small amount, and multistate operators should know that the government is on the lookout for that revenue.
Falling out of compliance has any number of negative implications. The most obvious is the potential for an audit and being exposed to substantial penalties or back taxes. From a strategic perspective, though, the consequences can be even more dire. Operators can put their licenses in jeopardy if they are not in good standing, and those working towards an exit via acquisition face the risk of outstanding tax liabilities coming to light during due diligence.
The complex web of compliance
Tax compliance in cannabis is complicated by the fact that not all items are taxed equally. In Massachusetts, for example, cannabis itself is subject to excise tax, however ancillary products like clothing and equipment are not. Operators therefore need a point of sale system that is sophisticated enough to accurately capture and categorize transactions. When properly bucketed, finance and accounting can readily assess tax payments, rather than trying to reverse engineer thousands of sales each month – a nearly impossible task.
Further clouding the issue is 280E and the regulatory definition of cost of goods sold. In order to arrive at the correct numbers for tax estimates, COGS must be accurately categorized. That necessitates more regular inventory analyses to ensure everything is aligned.
Pitfalls and temptation
Sales tax is paid monthly (in most cases) to each state, and some states require advanced payments. Before the end of the month, operators must estimate the full month’s sales and remit tax based on the trend. The following month is an opportunity to reconcile that estimate, and then of course repeat the process for the current month.
The system is not only cumbersome, it provides the temptation for cash strapped operations to hold out on tax payments as a way to free up cash flow. With traditional financing more challenging in the cannabis industry, the substantial amount of funds set aside for tax remittance is sometimes seen as an easy option for “borrowing” from the government. While intentions to catch up later may be authentic, it is a slippery slope that could cost operators their licenses and their business overall.
Filing requirements pile up
The paperwork associated with state taxes can be more of a challenge than the payments themselves. Some states demand monthly advanced payment, a monthly retail tax return, estimated quarterly taxes, and more; operators can be looking at up to four separate reporting requirements for one dispensary in one state.
When managing multiple locations in multiple states, of course those compliance filings add up quickly. Our work with MSOs often involves creating different entities in each state to avoid comingling issues like tax compliance and licensing requirements. When a range of entities are involved, these filing requirements can further escalate.
Gathering the necessary information and reporting to each of these requirements in the right format is time consuming and labor intensive. Finance departments can be quickly overwhelmed and find themselves pulled away from tasks that are more likely to contribute value to the business on a higher level.
This is one area in which specialized outsourced accounting comes in handy, especially for multistate operators. They want their resources to be deployed in a way that most benefits the business: it can be frustrating to have a Vice President of Finance tied up with compliance tasks and responding to routine tax notices, rather than actively contributing to successful growth.
No company wants to be surprised by a compliance issue. Companies that outsource or automate indirect tax compliance remove the burden from their team and create a more reliable reporting engine. The result is reduced risk, greater efficiency, and a process that supports the continued growth of the business.
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