An Overview of Cannabis Business Entities in California
Ready to join the green rush? We’re here to help with a basic understanding of marijuana and cannabis business entities in California.
So, you’ve made the decision to join the cannabis industry and now you’re ready to take the first steps towards starting your business. Congratulations, cannabis entrepreneur! With so much change happening within the industry- legalization, new regulations, tax reform, and an excess of new license and permit requirements – it’s no surprise there’s a laundry list of questions that you’ll need answered. One of the first decisions you will make is choosing a business entity. Here we will help you brush up on the fundamentals of business structures.
What kind of entity should I form for my cannabusiness?
California recognizes a number of different business entity types including Corporations (for profit and nonprofit), Limited Liability Companies (LLCs), Limited Partnerships (LPs), General Partnership (GP), Limited Liability Partnerships (LLPs) and Cannabis Cooperative Associations (CCA). General Partnerships are not required to register, although they may choose to, while Sole Proprietorships absolutely do not require registration. The most common entity types for canna-businesses are LLCs, S corporations, and C corporations.
The first important decision that any business owner will make is choosing a business entity. The entity you choose will affect how you are taxed, how you run your business, your ability to transfer assets and ownership, and your protections against liability in any potential lawsuits. It’s important to thoroughly evaluate the effects of your choice on your cannabusiness and also speak with trusted professionals to weigh out your options.
Can I Register My Cannabusiness as an LLC?
Common options for cannabis/marijuana business owners looking for liability protection are an LLC or a corporation. The more traditional entity for any business, including cannabusinesses, is an LLC, also known as a “pass through” entity because owners pay taxes on their stake of the company’s income. LLCs are an alternative to corporate entities because they provide limited liability, are easy to form, are less formal, have simpler taxes, offer flexibility, and provide owners protection from creditors. LLCs are not taxed as a separate business entity like corporations. Rather, the profit and loss (P&L) works as “pass through” income from the business to each member of the LLC. This structure can be a fit for companies that have a small number of owners/financial partners, will not need substantial backing, and plan for the principles to fund the business’ progress. An important consideration is how this type of business can be passed on after a single owner’s death. Which takes forethought and preparation to avoid complications.
Can I Register My Cannabusiness as Corporation?
A cannabis/marijuana business can register as a corporation in California. This structure can be pricier, more difficult to run, and is more intricate than an LLC. Corporations are obligated to implement bylaws, legally describe officer and director roles, preserve thorough records, adhere to compliance and most important to note, are subject to double taxation. Corporations can take more than one form. The most common forms are S corporations, and C corporations. Both offer shareholders limited liability, while they vary on taxes and investment options.
Are cannabis companies eligible for all the business entities including Corp and S-corp, public corp?
S corporations are similar to LLCs since taxes are passed on to individual business owners, but an LLC offers owners more perks. One perk for an LLC entity is having no limits on the number of owners, whereas an S corporation has a limit of 75 shareholders. Also, S corporations require that all shareholders must be individuals and that owners must be compensated a, “reasonable” salary. This requirement poses problems for cannabis retail stores, because tax code 280E makes most salaries nondeductible or only partially deductible. Ultimately, this can cause a double tax rate on shareholder employee salaries.
C corporation are a popular choice for those that will raise capital because it is able to offer stock to investors. It is not a pass-through entity like LLCs or S corporations, it is a tax-paying entity, which means shareholders are not responsible for taxes. Ultimately, the downfall of C corporations is that they are taxed at the corporate level, and again as owners divide profit. This means that this type of entity is taxed twice, which isn’t as favorable. This gives owners asset protection in case there was ever a difficulty paying taxes. C corporations are the best choice for California cannabusinesses like dispensaries or retail stores.
No public corporations. Overall, marijuana companies are eligible for most business entities in California except public corporations. Since marijuana is still federally illegal, the U.S. stock market will not acknowledge these businesses, meaning it cannot be publicly traded. As a result, the Canadian Securities Exchange is swiftly becoming the headquarters for U.S. businesses.
Choosing A Marijuana Business Entity Impacts Taxes
The process of selecting a business entity, and also tax planning, has dramatically changed due to the 2017 Tax Cuts and Jobs Act. The Act was the most substantial renovation of the U.S. Tax code since 1986. The most important changes include lowering the corporate tax rate to 21%, and the new 20% deduction for non-corporate and individual taxpayers who run a business. Regardless of the lowered tax rate, a corporation and its shareholders are still issued double taxation, meaning they are taxed on income at the corporate level, and then owners are also personally taxed on their business income. This leads to a higher total tax overall. For cultivators who have likely formed as an LLC or an S corporation, the new corporate tax rate makes a C-corporation worth reviewing to see if it’s a better choice.
What does the 2017 Tax Cuts and Jobs Act mean for growers, dispensaries, and manufacturers of products in CA?
While the 2017 Tax Cuts and Jobs Act was updated, it did not revoke IRC 280E. Section 280E prevents cannabis producers and vendors from deducting expenses from their income, except for those considered a Cost of Goods Sold because cannabis is still a schedule I controlled substance. IRC 280E 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 . . . which is prohibited by Federal law or the law of any State in which such trade or business is conducted.” Essentially, canna-businesses pay taxes on gross profit versus their net income. For dispensaries, this prevents deductions from Section 162(a). There is an exception that you want to be aware of- Reg. 1.61-3(a). This regulation, regardless of involvement with a schedule I controlled substance, allows taxpayers to subtract the cost of goods sold from total sales.
Be sure to consult your accounting professional for guidance and current information.
Cannabis Business Resources
Starting a cannabusiness in an extremely regulated industry can be challenging. This is why we highly suggest putting a great deal of effort into your planning along with building a team of professionals to consult on legal, accounting, and compliance. Find a trusted private attorney and a tax advisor that specializes in the cannabis industry to get the most current information to help structure your business around your needs and regional laws. To further explain each entity and help you decide which to form, the California Secretary of State created an overview of each: https://bit.ly/2Dp5YG9. Once you have decided, you will also need to properly register your business through the California Secretary of State. For a startup checklist and online help to start your canna-business in California, visit: https://bpd.cdn.sos.ca.gov/cannabizfile/10steps2.pdf
Good luck, cannabusiness entrepreneur!
DISCLAIMER: Cannabiz Digital does not sell cannabis. This publication covers business topics surrounding legal cannabis in California and the United States. It does not provide legal or medical advice. Consult your physician, lawyer, and local laws regarding cannabis. We do our best to provide current information at the time of publishing with no guarantees to accuracy. We understand this industry changes quickly and welcome your feedback. [Send Feedback]