Green Frontier: What CPAs Should Know about Cannabis Clients.

• Author: Martin, Matthew
• Position: Emerging industries

Cannabis is a more than 35 billion industry in California and is expected to grow to as much as S23.3 billion in the first five years, post-recreational legalization. Nationally, some sources say this could easily be a $I trillion industry in the near future. There are 33 states that have legalized the use of cannabis in some form, and the Food and Drug Administration recently approved Epidiolex to be the first pharmaceutical drug composed of an active ingredient derived from the cannabis plant.

Practitioners considering working with this industry have many specific items to consider when offering services.

Brief History

On Nov. 8, 2016, California passed Proposition 64, known as the California Marijuana Legalization Initiative, or the Adult Use of Marijuana Act, which allowed for cannabis use by adults (21 and older) without the need for a medical recommendation. The law was designed to give, local jurisdictions a large amount of control by requiring a local license before a state license could be applied for. Each locality has developed its own licensure policy and basis for determining local taxes.

Federal Regulation, Case Law & IRS Guidance

Cannabis is a Schedule I drug as defined by the Federal Controlled Substances Act. As such, any trade or business connected to the sale of cannabis is subject to IRC See. 280K, which states: "No deduction or credit shall lie 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."

IRC Sec. 280E essentially eliminates the deduction for all ordinary and necessary deductions incurred by businesses deemed to be trafficking a Schedule I narcotic:. The recovery of capital doctrine protects cost of goods sold from being subject to this code section. Therefore, inventory accounting and determination of the correct cost of goods sold is extremely important for tax purposes in the cannabis industry. It's important to note that the IRC does not include any definition of trafficking and that the courts have looked to the dictionary definition for clarity.

There are five major court cases that practitioners must look to for guidance:

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