Cannabis Tax Memo: November 4, 2019

Subchapter S Corporations

As you may expect, the greater Salinas Valley agricultural area is home to many legal marijuana-related businesses. It’s no secret that businesses that touch marijuana, cannabis-based products and any other product containing THC must deal with substantially more rules and regulations as compared to most other businesses. Not the least of which is Internal Revenue Code Section 280E.

Section 280E of the Internal Revenue Code forbids businesses from deducting otherwise ordinary business expenses from income associated with the “trafficking” of marijuana, as defined by the Controlled Substances Act.

As specialists in the tax challenges of the marijuana industry, we’ve been seeing some troubling tax situations as we begin working with new clients in the industry. One area we’ve seen with alarming frequency of late is new clients that have used a Subchapter S corporation in their business structure. Buoyed with a U.S. Tax Court ruling last year, the federal government can essentially double-tax some income of a Subchapter S corporation that is subject to Section 280E.

Given what we have been seeing coming in the door, we thought a quick update about Subchapter S corporations and the marijuana industry would be appropriate as year-end tax planning season approaches.

With the recent court ruling there is not much positive to be seen about a Subchapter S corporation for a marijuana company. In Loughman v. Commissioner the operators of a Colorado marijuana dispensary argued that for a marijuana dispensary operating as an S corporation, Section 280E discriminates against S corporation shareholders by double taxing income when shareholder salary is disallowed because of Section 280E as a deduction from flow-through S corporation income and also included on the shareholder’s individual tax return as W-2 wages. The Tax Court noted that the catch-22 was not discriminatory, but instead applied equally, because Section 280E disallows salaries not attributable to cost of goods sold whether or not the salaries are paid to the shareholder.

One of the harsh realities of operating a S Corporation marijuana business is that Section 280E can often create double taxation for owners who receive payments for services from marijuana companies. It would seem the only way to avoid this is if the owner’s sole responsibility is activities related to the production of inventory. But, any officer/owner’s responsibilities are bound to include some sort of management and oversight. While making an election to be taxed as a C corporation can minimize the cost of double taxation in this situation, it won’t eliminate it.

The Tax Court showed little sympathy for marijuana companies when it comes to the punitive realities of Section 280E. I’ll let the Tax Court’s direct words convey it all.

“To the extent that petitioners believe they received disparate tax treatment as a result of organizing their marijuana business as an S corporation, petitioners were free to operate as any business entity and in other trades. Petitioners chose to operate Palisades as an S corporation in the marijuana business. Petitioners are responsible for the tax consequences of their decision.”

Clearly the Tax Court is taking no Section 280E prisoners anytime soon based on this direct quote from the court decision. If you’re a marijuana business considering a structure that includes a Subchapter S corporation, or already have one, be very sure you investigate your options to turn the table on this double-tax trap.

If you’re in the marijuana, cannabis, CBD or hemp industries and are concerned about tax planning and strategies unique to your industry you should give us a call at Scholl & Company, LLP. We understand the unique challenges and opportunities you face. For a free, no-obligation consultation with one of our cannabis industry tax experts give us a call at (831) 758-5966.

Tax Memo: October 25, 2019

Pumpkin Spice-Flavored Taxes

October is chock-full of obscure holidays and commemorations. October 3rd is National Boyfriend Day. October 15th — the real personal tax filing deadline — is National Grouch Day. (Coincidence? We think not.) October 19th serves up National Seafood Bisque Day (which sounds a lot tastier than today, October 25th, National Greasy Food Day). 

But none of those can compare to the big orange ball of fun waiting for us just around the corner. We're talking about tomorrow, October 26th: National Pumpkin Day. Believe it or not, pumpkins are more than just everyone's favorite gourd — they're responsible for generating millions of tax dollars for the government.

For starters, check out pumpkin sales. Americans are expected to spend $377 million on cucurbita pepos to carve into jack o'lanterns in 2019. That means the IRS and state tax departments will harvest millions in income taxes from the farmers who grow them, then millions more in sales taxes from the families who buy them. No wonder all those pumpkins are smiling!

Next up, pumpkin pie: in 2015, Costco alone sold 5.3 million of them at $5.99 each. For those of you who weren't math majors, that's $31.7 million worth of creamy goodness. The high fat content in the crust, along with the egg-based custard filling, make them ideal for freezing until Christmas. So pick up two or three, and consider the extra sales tax a small price to pay for the taste of nostalgia.

And next, there's canned pumpkin pie filling. A couple of years ago, a vicious rumor started making the rounds that the glop you whip into your pie is actually just butternut squash. But Libby's, the Nestle subsidiary that sells $130 million cans of pumpkin filling every year, reports that they're just using a different strain of pumpkin that makes a richer, sweeter puree than regular carving pumpkins. Governments collecting sales on the pies can sigh in relief that they're not abetting a scam.

But while we're on the topic of "Things That Aren't Really Pumpkin for $200, Alex," pies are just the warm up for the real action. Love it or hate it (and there's not a lot of in-between), it's pumpkin spice season. It started as a twee Starbucks gimmick. But today's Pumpkin Spice Industrial Complex has inched its creepy tentacles into everything from candles to kale chips, and donuts to dog treats. Head to your doctor to get a flu shot, and the nurse will probably ask if you want it pumpkin spice flavored.

Here's the thing. Pumpkin spice — a blend of cinnamon, nutmeg, ginger, cloves, and allspice — started out as something called "pumpkin pie spice" to amp up the sometimes-bland pies. But lazy Americans quickly dropped the "pie" part.

And ever since 2004, when Starbucks rolled out their flavored lattes nationwide, pumpkin spice has become a symbol for all things autumn. Americans will gobble $600 million worth of the stuff this fall, putting millions more in tax collectors' pockets.

Now, this whole discussion may sound like a silly exercise. (OK, it is.) But there's an important lesson lurking under the filling and the whipped cream. Every financial decision you make has at least some tax consequence, even if it's just a trip to the bakery aisle (or in my case, the South Main Street Starbucks). That's why it's so important to keep us involved before big financial choices, and avoid expensive tax mistakes!

Are you thinking about making a large purchase this fall? Let us help ensure you're making the best financial choices. Please give us a call at (831) 758-5966 and we’ll help you keep more of what you make!

Tax Memo: October 10, 2019

Teeny Little Slices

Here in the United States, we spend a lot of time arguing about income taxes... who should pay, how they should pay, and how much they should pay. Right now, the average American forks over 13.5% of their income in individual income tax, and 30% of their income in federal, state, and local taxes overall.

Of course, "average" covers a pretty wide range — 50 million families pay no income tax at all, while the top twenty percent of earners pay over 69% of all revenue collected. It costs the economy $409 billion just to figure out the bill and get it paid.

Here's the biggest problem with today's tax system: no matter where rates fall or who picks up the tab, Uncle Sam still spends more than he takes in. Keeping up with spending is like playing tennis against Serena Williams — if Serena was an octopus with rackets in eight arms. So politicians are constantly looking for new ways to cover their bills.

Now some politicians are proposing wealth taxes on the richest Americans. Massachusetts Senator Elizabeth Warren's plan starts at two cents for every dollar of net worth above $50 million, rises to three cents on amounts above a billion, and raises $2.75 trillion over 10 years. Vermont Senator Bernie Sanders's plan climbs all the way to 8% on assets over $10 billion. Both senators argue that limiting their reach to board-certified fat cats means most voters have nothing to fear from their plans.

A wealth tax may sound like an impossible lurch to the left in today's politically polarized era. But polls show it winning more support than higher income taxes. And if you own your own home, you're already paying one in the form of your local property tax. The real problem with a wealth tax is making it work. It doesn't matter how small a slice it takes if the people who owe it can't or won't report their balance sheet accurately — especially if it's stuffed full of hard-to-value things like businesses, real estate, and art.

Want to see how much we can raise with even smaller slices? Consider calls for a tax on financial transactions. Hawaii Senator Brian Schatz's proposal is typical: he would charge just one-tenth of a penny for every dollar on stock, bond, and derivative trades. The Joint Committee on Taxation estimates this would raise about $777 million over 10 years.

Bernie Sanders has a similar proposal that would charge 0.5% on stocks, which he says would raise enough to pay for free college (and bring the species Homo Billionairus to the brink of extinction). 

A financial transaction tax would be far easier to manage than a wealth tax. It would-also take dead aim at the sort of high-speed trading Michael Lewis described in his 2014 book, Flash Boys, which Schatz says accounts for half of the market's eight billion daily trades. "High-frequency trading... screws regular people; that's the main reason to do this," he says. Does that sound like creeping socialism? Well, Australia, France, Hong Kong, Italy, South Korea, Switzerland, and the U.K. already have financial transaction taxes, and their markets seem to be doing just fine.

We spend most of our time looking for the green lights in the income tax system that let you pay less. But we'd be negligent if we weren't keeping our eyes out for new ways the government can nick you for small percentages (which add up big time). But not to worry! We'll be ready with the plans to help you pay the least.

In the News: September 28, 2016

Moneyball? Ehhh, Not Really
America is a nation divided. Cat people vs. dog people. Trump people vs. Clinton people. And last week, we discovered a new gulf to bridge: "Brad" people and "Angelina" people. That's right, Brad Pitt and Angelina Jolie are filing for divorce after two years of wedded non-bliss. Will the "Brangelina" breakup turn into a fight club? Will it drag out, or will she be gone in 60 seconds?

Whose side are you on? How much do you care about the biggest celebrity divorce of 2016? Will you breathlessly wait for the next issues of your favorite supermarket tabloid, follow #brangelina on Twitter, and pass along rumors of infidelity, drug use, and child abuse? Or will you turn your nose up at the whole celebrity gossip machine and get on with your own life, thank you very much?

Odds are good that our friends at the IRS will fall into that second group that just doesn't care. It's not that there aren't oceans of money at stake — it's just that the divorce isn't likely to change how much of it falls into IRS hands. Let's take a closer look:

•    Jolie isn't asking for alimony. But even if she were, both stars earn well into the top 39.6% bracket on their own. (Forbes estimates Pitt has raked in $315.5 million since the couple met, with Jolie picking up $239.5 million more.) Alimony is deductible by the payor and taxable to the payee. That means, with Brangelina, it would be deductible by Pitt at 39.6%, and taxable to Jolie at . . . 39.6%. It's hard to see the IRS caring much who pays the tax on that last slice of income.

•    Next, property settlements. Pitt is a renowned architecture buff, with homes in Malibu, Manhattan, New Orleans, and the south of France. Jolie was famous for wearing a locket of her ex-husband Billy Bob Thornton's blood around her neck. (Let's just call that "separate property" and move on.) But transfers of property between divorcing spouses are tax-free — as far as the IRS is concerned, it's a wash no matter who winds up owning what.

•    Next, child support. Jolie has requested full physical custody of the couple's six children. (She's accused Pitt of being an inglorious bastard with the kids.) If she wins, Pitt will probably wind up paying child support. However, child support in any amount is nondeductible by the payor and nontaxable to the payee. In fact, it doesn't even appear on a tax return. Once again, there's no reason for the IRS to get excited.

•    If Pitt and Jolie really were just like us, the one area where the IRS might get concerned involves their filing status. Generally, when a couple earning more than about $100,000 gets divorced, they wind up paying less tax as singles than they would jointly. But again, Pitt and Jolie will both still pay the maximum 39.6% on the vast bulk of their income.

We talk a lot here about the importance of planning. When it comes to divorce, it's almost inconceivable that Brangelina, with three previous divorces between them, didn't have a plan for it — also called a prenuptial agreement. Now, prenups are an asset protection tool, not a tax-planning tool. But it's equally inconceivable that a couple earning $555 million between them doesn't also have a plan to beat the IRS. So, while we can't get your picture on the cover of People magazine, we can help you with that same sort of protection. So call us!