“I am making the industry better at following the rules.”
By CPA Trendlines Research
Massachusetts has always been at the forefront of social and legal progress. It’s where the Pilgrims signed their Compact. It’s where the first shots of the American Revolution were fired. In 1911, it became the first state to outlaw possession of “Indian hemp.”
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And 101 years later, it became one of the first to allow sales of cannabis for medical purposes.
In that auspicious year of 2012, Charlotte Cathro was a CPA with a regional firm in Holyoke, an hour and a half west of Boston. The firm started getting inquiries and referrals from attorneys. They had clients applying to open dispensaries of medicinal weed, but they weren’t quite sure how the tax, finance and business entity rules were going to work.
And no wonder. It was complicated – a new frontier in accountancy.
Cathro accepted an assignment to explore that frontier. It wasn’t exactly the wild west, but it was an uncharted territory of convoluted rules.
The most worrisome convoluted rule, from the client perspective, was IRS Code Section 280(e), the one dealing with taxation of illegal enterprises. The IRS would happily accept tax returns for such businesses, but the deductions were limited to cost of goods sold.
To complicate matters, that initial state law required dispensaries to be not-for-profit entities. A given entity also had to own the entire supply chain, from seed to sale – an expensive venture that required substantial investment.
But who wants to invest in a not-for-profit, especially one of such dubious legality?
Cathro figured it out.
“We had to do some complex structures where people would purchase equipment and property and get money through leases,” she said. “We looked at existing not-for-profits that were not charity organizations – membership organizations and not-for-profit hospitals that had for-profit sectors. We were kind of stealing ideas that had been done before.”
As Cathro developed expertise in this new niche, she saw that there was going to be great demand. Everybody was pretty sure that sales of recreational cannabis would eventually be legalized. Opening a medical dispensary would be a good way to stage for eventual expansion. It would be a good investment.
In 2015, she left her firm to start her own, Cathro, LLC. Since then, she’s been on her own in an industry that’s expanding as fast as it can. In November of 2016, as predicted, voters passed a ballot initiative legalizing recreational cannabis. Two years later, sales by licensed dealers became legal.
Today, more than 90 percent of her clients are cannabiz companies.
“I still have some clients in the medicinal space that have not opened for recreational,” Cathro said, “and I have many clients who are in the process of applying for licensing.”
She also has clients in Oregon and Maine.
It’s slow in Massachusetts
Oregon legalized the sale and possession of recreational cannabis in 2014, and its taxation structure is well established. Maine voters opted to legalize possession and use on the same day as Massachusetts, but today it seems to be better positioned for fast expansion.
“Maine is an interesting case,” Cathro said. “I expected them to be behind us. They were for a while. They are now ahead in that their medicinal dispensaries have opened very quickly. Their licensing process is going much more quickly. It’s slow in Massachusetts. We inherited some ills from the medical dispensary system – the not-for-profit structure and the requirement of a self-contained supply chain. By law you had to have a minimum investment of $500,000, but really, to get started in cultivation, extraction, and retail, you needed $5 million to $10 million. In Maine, you could just get licensed as a caregiver, which allowed smaller projects. I think that’s more efficient.”
The rules have changed in Massachusetts. Neither medical nor recreational sales require not-for-profit status, and entities can focus on any given part of the supply chain.
The state expects tremendous growth, of course, but no one can say how far or fast it will expand. One big unknown is how municipalities will react. They need to approve any related activities before a business can apply to the Cannabis Control Commission.
IRS 280(e) still limits deductions, but it allows full absorption costing, so entities can use direct materials, direct labor and some indirect costs that are allocable to inventory or that go into the product indirectly. Entities need to come up with an average cost system for products that matches cost of goods sold.
Or, in layman’s terms, get an accountant.
Arguably drug trafficking
Get a good bank, too. And good luck with that. The big, publicly-owned banks are reluctant to get involved in what the federal government still considers a felony. Getting involved in what is arguably drug trafficking could result in a loss of federal deposit insurance.
But three smaller banks, and soon a fourth, have increased their risk management and are eager to get into this burgeoning new business.
Cathro still gets most of her clients from attorney referrals. The owners of new ventures, well aware that they are walking a fine line between big business and bad, tend to seek their earliest counsel from an attorney. And the first thing the attorney says is, get a good accountant.
Cathro is the good accountant. She’s been steeped in the business since it was born.
No dollar signs in your eyes
To those who want to crank up a cannabis business, Cathro said, “Don’t have dollar signs in your eyes. Think about the business from the beginning and how much you can really make, and think about it as a real industry, not as a bubble. Think about where the industry will be in five years. Think about market strategy. Think about differentiation, as in any other industry.”
To accountants looking to get into this niche, she said, “This is not an industry where you want to dabble. You don’t want to have just one client in any industry. Accountants have been dealing with that for a long time. There are a lot of complications. The IRS doesn’t have a guide for the industry. You cannot go there for clear answers to all questions. You have to be up on case law. Don’t think that you can give people some magic solution. There is no magic solution. You need to read everything that comes out, all of the IRS case laws. You don’t want to ask your clients how they grow or what a clone is. You need to do that research before you get into it.”
Is she concerned about how banks, friends or the federal government feel about her work with her clients who would have been felons between 1911 and 2012?
“It’s an industry,” she said. “They need advice. I am making the industry better at following the rules. So in my opinion, I don’t think it should be looked down upon.”