On Tuesday, California voters passed historic legislation by voting to allow the recreational use of marijuana in California. Regardless of your opinion about marijuana use, the legislation will have a huge impact on the state of California and its citizens and will bring a large source of new taxable revenue into the state. Because of the complexity surrounding the tax laws surrounding the new measure, I have put together a rough guide of issues for marijuana businesses and California citizens to be aware of.
First, I want to discuss the sales and use tax implications for marijuana related businesses in California. First, any sort of dispensary operating within California will need a valid seller's permit and will need to register with the Board of Equalization. Under the new law, certain sales of medical cannabis in California are exempt, but all other recreation sales are now subject to taxable. Each dispensary should go through the process of becoming sales tax compliant with the Board of Equalization.
Keep in mind that the collection of sales tax is the obligation of the retailer, or the dispensary. This means that whether or not the retailer collects sales tax from an individual, it is ultimately liable for its sales tax obligation to the state.
Here is a practical example of this point. Let’s say you run a dispensary and charge $50 for three grams of marijuana as a flat rate and forget to add sales tax to the underlying sale. In this example, the dispensary is now on the hook for the sales tax obligation that is owed to California. This relates not only to the payment of tax, but the dispensary has a filing and reporting obligation with the Board of Equalization, which will vary based on their volume of sales. Also something to keep in mind is that the Adult Use of Marijuana Act imposes the obligation to collect sales tax on the sales of all marijuana-related items as well. This would include pipes, rolling papers, rolling machines, edibles, lotions, and any other newly legal marijuana related products.
One of the other big issues is that dispensaries and marijuana related businesses are probably going to be subject to heightened risk of audit for the first few years of the new legislation. There are two reasons for this.
1. Marijuana related businesses and dispensaries typically deal with large amounts of cash because of the limitations associated with the federal banking system and marijuana business. Traditionally, businesses that deal in large amounts of cash are more likely to get audited by the Board of Equalization and it is anticipated that, now that Prop 64 has been passed, that we will see more and more audits of marijuana-related businesses. This is because there is a high potential for abuse and generally poor recording keeping associated with businesses that deal principally in cash.
2. We anticipate a heightened risk of audit is because this is a “new” industry for the Board of Equalization and there’s not a lot of statistical data associated with marijuana businesses. Because of the heavy reliance of the Board of Equalization on statistical data, which is generally collected through audits and the examination of business records, I would not be surprised to see “scope” audits being done of a random sampling of dispensaries. This would allow the Board to get a baseline for what types of transactions that dispensaries have, how much their sales volume is, and what the typical markup percentage is for items that are sold in a dispensary.
In addition the sales tax obligations placed on retail marijuana businesses, there are some concerns for wholesalers/growers as well. Growers traditionally sell their crop to dispensaries or to others down the supply chain and traditionally this would classify as a sale for resale. As such, growers need to obtain a valid resellers permit from those that they sell to in order for the sale of their product to qualify as tax-exempt.
This now places an additional record keeping requirement on the grow operation and records are going to be critical going forward in order to mitigate any potential consequences with the Board of Equalization. Growers are advised to invoice each purchaser of their product and to keep resale numbers on file in case of an audit.
Having sales invoices that match a company’s bank statements (mitigating the potential for unreported sales) and having resale permits on file that match the invoices (mitigating any issue with the resale) will greatly help a grow operation that is unfortunate enough to get audited.
In addition to issuing invoices, we highly recommend that grow operations and dispensaries alike utilize sales tracking and accounting software. Grow operations can use this to track the volume of their sales and to contradict any thinking that the grow might have unreported cash sales.
For example, when a grower is selling to a dispensary, the grower is going to want to make sure that there is a record of that transaction, how much yield was sold, what the price was, and then getting a Reseller's permit file for that transaction where applicable. Likewise, dispensaries can use software to track their markup percentages to contrast to an auditor’s determined markup percentage during the course of an audit.
Here are the additional things that may come up in an audit of a marijuana business.
- Typically, a dispensary is going to publish a price list based on certain types of products that they seller. Because of the variation in the strains of marijuana they may be selling, both their cost of sales and their markup percentages may be different from strain to strain. Dispensaries need to make sure that they are not just recording overall sales, but also accounting for variations in markup percentages.
- Another thing growers and dispensaries both need to be aware of is waste and spoilage. If there is a batch of product that becomes unusable or spoils for whatever reason, it is going to be critically important for both growers and dispensaries to keep track of that information. If they don’t adequately measure their spoilage/waste percentages, then the Board is going to include these amounts when determining its markup percentage and assess the excess as unreported taxable sales.
In short, there are a variety of tax issues that marijuana related businesses need to be aware of. Sales tax collection represents a significant revenue stream of the State of California and because of the relative infancy of the industry, the potential for unreported cash sales, and the need for the Board of Equalization to collect data, we anticipate a lot of action in this area of tax law.