As seen in the Trusted Professional

CPAs are facing many challenges and risks when serving cannabis companies. The main challenge is the fact that cannabis remains federally illegal under the Controlled Substances Act. As a result, all ordinary and necessary business deductions are disallowed under Section 280E of the Internal Revenue Code.

The federal illegality and state legality of cannabis result in difficult tax rules and a scarcity of traditional capital sources available to other industries.

As of February 2023, the medical use of cannabis has been legalized in 39 states and the District of Columbia. The recreational, or adult-use, of cannabis has been approved in D.C. and 21 states.

New York State legalized medical marijuana in 2014. On March 31, 2021, The Marihuana Regulation & Taxation Act (MRTA) was signed into law, legalizing adult-use cannabis in New York state. The legislation created a new Office of Cannabis Management (OCM), governed by a Cannabis Control Board to comprehensively regulate adult-use, medical, and hemp cannabis.

Since then, New York began the process of issuing conditional cannabis licenses to targeted groups of individuals and businesses—first to hemp cultivators, then to hemp processors and, finally, to certain qualifying retail applicants that were previously impacted by marijuana related convictions in the state.

In November 2022, the OCM issued proposed regulations for the general adult-use cannabis prospective licensees, addressing nonconditional license requirements, authorizations, and prohibitions (Part 118, 119, 120, 121, 123, 124, 125 and 131).

The proposed regulations were issued along with a comment period ending on Feb. 13, 2023. Various groups working in the NYS cannabis space, along with a number of CPAs, took this opportunity to voice their opinions, concerns, and recommendations via the following comment letter:

Comment letter

The NYSSCPA’s Cannabis Industry Committee consists of New York state CPAs who are servicing cannabis businesses across the state.

Prior to the issuance of the Proposed Adult-Use Cannabis regulations, many CPAs faced challenges regarding the interpretation of the regulations related to conditional licenses. Consequently, to minimize similar challenges, the committee made a decision to voice its opinion, concerns, and recommendations via comment letter responding to the Proposed Adult-Use Regulations.

Committee members Elana Tamas, John Pellitteri, Martin Lager and Renata Serban collaborated to formulate the commentary.

Main issues and recommendations

The main concerns that the authors addressed in the comment letter were related to definitions, control issues, burden on businesses created by Section 280E and the THC tax, and the impact of various forms of state aid to licensees.

Many professionals would argue that net income for tax and accounting purposes as well as investment purposes, even within traditional industries, has different definitions and variables.

In the cannabis space, additional variables, such as disallowance of Section 280E, comes into play. For federal income tax purposes, net income is gross profit, which is sales, less cost of goods sold. For accounting purposes, net income is the remaining amount after ordinary and necessary expenses are deducted from gross profit.

The committee recommended that net income be defined in accordance with the U.S. Generally Accepted Accounting Principles (GAAP).

The commentary also included concerns and recommendations over the general lack of clarity in terms of key definitions relating to ownership and control of licenses, and the inflexibility of the regulations regarding prohibitions that would not account for common business arrangements.

Additional commentary was issued related to the impact of a potency-based tax, called the THX tax, which will be imposed on retailers by distributors. The members of the committee argued that the retailer will have to absorb this tax without much ability to increase the price of cannabis beyond what a consumer is willing to spend.

While New York state decoupled from Section 280E as of Jan. 1, 2023 (i.e., for state income tax purposes cannabis businesses can take ordinary and necessary deductions), the commentary included the general impact of Section 280E, as well as a discussion regarding the tax impact of various forms of state aid to licensees.

Role of the CPA in the regulations-making process

CPAs have a unique ability to understand how policy and financial factors intersect and affect the ability of cannabis entrepreneurs to succeed.

As a committee established in the nascent state of the industry, we perceive an obligation to communicate with regulators via public comment and in other capacities.

We will continue to assist regulators with creating a workable legal framework for cannabis operators by illustrating how certain aspects of the law and regulations will affect licensees’ ability to keep the lights on and their doors open.

For more information, reach out to our Cannabis Advisory Services professionals or Renata Serban at rserban@citrincooperman.com.