The cannabis industry is accustomed to shockwaves, between voter referenda, congressional bills and state-wide policy shifts. But of all the cannabis news to break over the past few years, nothing has the power to change the landscape like the potential for the Drug Enforcement Agency (DEA) to reschedule cannabis from Schedule 1 to Schedule 3. Although the industry’s ultimate goal is for complete descheduling, the proposed shift would be a game-changer for cannabis operators because it would nullify the federal tax provision 280e which essentially taxes cannabis retailers on gross margin.
It’s hard to overstate the financial benefits of a reschedule, especially when the news is considered in light of the SAFER banking bill moving past the Senate banking committee. Most dramatically, there’s the sharp decrease in effective federal tax rate: If we look at a sample forecast for a $12 million in revenue cannabis retailer, we can see the end of 280e would mean a $4-$6 million increase in income after taxes over a four-year period (depending on their tax rate), allowing them to build cash from operations in year 1 rather than staying in the red until year 4.
Simply put: this move will allow more operators to stay in business, and those who are already achieving profitability will be able to shift into a higher gear and invest back into the business.
Once cannabis businesses are taxed on net income and overhead becomes deductible, the industry will feel more benefits from every angle. Dispensary owners will be more incentivized to invest in things like budtender education, which will improve employee retention, customer satisfaction, brand recognition and sales. They’ll have more dollars to spend on marketing and branding, data analytics tools, and financial advisory services, all of which will mean an even more dynamic, innovative industry.
It’s all very exciting. But it’s also important not to get ahead of ourselves. The most frequently asked question I get from cannabis business owners today is: What do we do now?
My answer: wait and plan.
2024 is right around the corner. If the rescheduling does happen next year, 280e would no longer apply. However, until the rescheduling has been formalized, we still advise making your estimated quarterly tax payments throughout the year, even though it will likely result in overpayments and a refund in 2025.
For example, if the reschedule is formalized in November 2024, businesses will already have made three estimated payments, exceeding the amount that would actually be due. That means they’ll be able to skip the January 15th coupon and expect to receive a significant refund in April 2025.
That said, all cash flow and tax planning needs to continue, unchanged, until a date is formalized. The last thing a business owner wants is to expect the best-case scenario, come up short, and be hit with significant penalties in 2025.
That doesn’t mean plowing ahead like the reschedule will never happen. It will. That’s where forecasting comes in. When we set up our long-term forecast, we can plan for a range of best- and worst-case scenarios, including the rescheduling. We discuss goals and priorities, so we have a good idea of how we would handle any additional profit – or a huge refund check from the IRS: whether we want to make additional investments in the business, increase working capital, pay off debt or look into scaling.
This wait-and-plan strategy allows us to be ready for 2025, regardless of what happens in the regulatory environment.
One last take-away as we approach year-end with 280e still in effect: One of the most common questions I’m getting is how to maximize tax offsets into COGS. There’s not much leeway at the moment, but you can improve the timing of the tax offset by increasing sales and reducing inventory at the end of the year.
That does not mean deeply discounting all your inventory. We always focus on implementing a sound strategy for discounting that leads to incremental sales and profit, which means looking at slow moving inventory and working with vendors to share discounting. This time of year, there’s an extra incentive to look into getting product out the door to improve the timing of the tax offset via cost of goods sold.
