Archaic laws and regulations plague booming new industry.
By Liz Gold
The two biggest challenges facing businesses following the green rush in Colorado today?
Taxes and banking.
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When operators first get into the industry, everybody is looking at the top line and are not too concerned with taxes, says Jordan Cornelius, owner of Cornelius CPAs in Denver, Colorado.
“It’s a problem, taxes are a huge deal,” he says.
Cornelius, who works solely with cannabusinesses, points to an antiquated sentence in the tax code (since 1982) that says if you are trafficking in a Schedule 1 or 2 substance you are no longer allowed to take normal business deductions.
“When you’ve generated $50 million on the top line sales, and it’s taken $25 million in cost of goods sold, and then $15 million in operating expenses, the IRS comes in and says everything that falls below gross profit is disallowed,” he explained.
“So, instead of having a business taxed at $10 million, the business is taxed at $25 million. The tax owed can wipe out all profit and in some cases, exceed profit generated. At the end of the day, they will end up with a tax liability that will be shocking, and these are things that happen on a regular basis. I’ve seen operators get angry, cry, put their businesses up for sale. Until the IRS changes, it’s something practitioners will need to deal with.”
An other headache many of his clients face is access to banking. Back in late 2012 and 2013, cannabusiness owners in Colorado had bank accounts. At that point, banks didn’t have any regulations.
But then, in the first quarter of 2014, the Department of Treasury issued guidance to banks that were in states with legal marijuana jurisdictions to prepare for adult use.
“It was fairly conservative and asked the banks to do a lot of things they never had to do,” says Cornelius. “The banks said, ‘no, we could lose our charter if we fall out of these conservative federal requirements.’ So almost overnight most of our clients lost their bank accounts, and people found out that they would need to deal with cash.”
That created a loss of efficiency in operations and made it more of a challenge to create internal controls, but also opened a Pandora’s box of other issues – a big one being cash management. It’s harder to track theft. Dispensaries were now building armed rooms and installing vaults to hold this cash. Then there’s the challenge of how to count and keep track of thousands of dollars that get carried to, for example, a wholesale transaction at a grow warehouse.
“People need help developing cash handling techniques that are conducive to their business environment, and that can be painful,” he says. “They call us twice a day, ‘We did a count, we’re $1K off, can you help us?’”
Today, there are fewer than a handful of banks who have agreed to work with cannabis businesses – and they cover about half of the industry in Colorado. They had to set up a protocol and adhere to federal treasury requirements. Those cannabusinesses that have been grandfathered in are paying $30-40K a year in fees to have a checking account.
The other half are out of luck.
It’s problematic when one business wants to pay by check, but another business doesn’t have the means to cash the check.
“The banks here are not taking on any other clients because of the administrative view at the federal level, and they got uncomfortable with the amount of business coming through the doors,” Cornelius says.
Cornelius was working with multi-million-dollar gaming clients first in California and then in Colorado back in 2011 when he was asked to take on some accounting work for mom and pop medical dispensaries.
At first, Cornelius didn’t think they had a lot in common. After all, he didn’t have any background in the cannabis industry, specifically. But there was one mom and pop shop that didn’t have anywhere to turn for their accounting issues, so Cornelius and his partner agreed to take them on. They ended up doing their accounting and tax reporting and from that everything changed.
“It’s a pretty tight-knit industry,” Cornelius says. “Somebody else called us to do more accounting work, and then we started marketing towards 200 above ground marijuana shops in Colorado.”
Then in 2012, Amendment 64: Use and Regulation of Marijuana, in Colorado passed, allowing recreational use of marijuana. It took about nine months to implement. At the time, medical marijuana shops were looking for financial assistance, day-to-day bookkeeping and getting their back taxes done so they could have all the necessary documents in place to meet the specific requirements for licensing. There was a tremendous amount of need and interest in what Cornelius was providing.
“At the time, there was only one CPA firm doing this, and we were picking up quite a large amount of work,” he says. “I approached my partner about doing it full time, but he decided he didn’t want to do it. It was a direction I wanted to go.”
So, the Denver-based firm went through a re-branding, marketing itself as a cannabis CPA firm, sending out print mailers addressing specific tax problems, US Code 280E (the ruling which prevents an owner from taking tax deductions for significant business expenses associated with selling. This is because marijuana is still considered a Schedule 1 substance), and best practices. Many standard accounting practices used in other industries were foreign to these new cannabis business owners, and it was clear they needed help.
By 2013, Cornelius was fully in the cannabis niche. He had 30-40 clients that he was managing with one other person. It kept them both busy, full time. They started actively marketing.
In the first month of 2014, it came down that any operator that was engaged in adult use cannabis had to do monthly tax returns and address monthly excise tax if they were growing. There were a lot of new reporting requirements coming down from the state level.
The federal government hadn’t flexed their muscles yet.
“A lot of operators looked for CPAs and found out there were not that many willing to work with the industry,” Cornelius says. “They are conservative by nature. Some clients with $10-30 million businesses found that their CPA firm would not be willing to do tax returns or provide professional advice, so they started looking around. There was way more work than practitioners, and we ended up picking up a pile of clients in the first year.”
That said, Cornelius stresses that he doesn’t just work with anyone.
“We do a lot more due diligence upfront to make sure the clients we take on are people we want to work with,” he says. “We want to work with people who take their businesses seriously, have regard for ethics and the laws, and that they are people we can develop a long-term relationship with.”
Today, Cornelius’ focus has pivoted a bit. Not surprisingly, there has been a lot of trials and tribulations that his clients face navigating this new industry. As a result, he spends his time advocating for his clients embroiled in tax controversies.
“The IRS, in about 2015, started actively auditing the larger companies in the region,” Cornelius says. “That created a demand for representation and a lot of clients ran into the same thing. They tried to find tax litigators or CPAs to represent them, and nobody wanted to work with the operators, so it defaulted back to the CPA firms in town, like us. We weren’t originally going to do it. We got pulled in. It’s become a focal part of our practice.”
Cornelius CPAs is now six people (Cornelius himself included), and they help clients with other issues too – day-to-day business issues, tax returns, planning, advisory, fraud, as well as buy-side and sell-side due diligence. His clients are within each category of licensing in Colorado – cultivators, manufacturers, retailers and quality control.
“When I got into this industry, I didn’t realize how cash intense it was,” Cornelius says. “I realized I could provide some value because all I had been doing [in the gaming industry] was auditing internal controls for cash handling.”
That was an advantage for Cornelius, but also because he has a background in agriculture, which helped give him a full picture.
“The indoor growers were not out of my wheelhouse,” he says. “It did take a couple of years to try to gain an understanding of the metrics of these grows. I didn’t know how difficult it was to run a growth cycle. I knew how the plants grew, but I had to understand how many grams can be extracted from a pound of marijuana and how do you properly report those? How do you implement controls to prevent theft?”
Cornelius points to the growth of the industry in just a couple of years – in 2013, medical marijuana operators within the state generated $350 million in sales. Now it’s worth $1.2 billion. And growing. Still, he says there are maybe eight accounting firms in the state that do cannabis accounting work, but only probably three that are truly qualified.
“People come in with a unique problem, maybe something we don’t work in,” Cornelius says. “If we don’t know how to address it, you typically refer them out. Unfortunately, in this industry, there is not that luxury. We’ve had to become proficient in a lot of different areas.”