Ask Our Experts 2/10/2019: Why A Cannabis LLC Beats a C-Corp
By Beau Whitney, Senior Economist, New Frontier Data
Q: Why Does A Cannabis LLC Beats a C-Corp?
A: With the deployment of the Trump tax cuts in late 2017, there was a renewed focus on how a company’s business structure can reduce overall tax liabilities. Taxes are one of the biggest expenses outside of operations for cannabis businesses, mainly due to IRS code 280e. Reducing exposure to 280e requires, in part, a focus on business structure. This is also revisited in New Frontier Data’s joint report produced with CohnReznick, U.S. Economy: Jobs, Growth & Tax Revenue – 2018 Edition. The corporate structure debate settles on two business structures: a C corporation (C-Corp) versus a limited liability company (LLC).
With U.S. companies having limited access to financial resources in the U.S., many are looking to Canada for access to capital markets. Some Canadian companies listed on the Canadian Securities Exchange (CSE) have amassed so much money that they are starting to invest in U.S. cannabis companies. New Frontier Data is regularly asked about which business model is best: whether to be vertically integrated or to focus on one pillar of the industry (e.g., cultivation or processing, etc.).
The example I like to use is that of a ketchup company: Is it better to be vertically integrated and grow all your own tomatoes, or to contract out the tomatoes cultivation to others in order to focus on your core competency of producing ketchup? In more mature industries, under normal tax environments, it would be best to contract out the tomato growing; however, the differences in the cannabis industry offer more benefits to being vertically integrated.
Canadian companies are investing in U.S. cannabis businesses and driving consolidation and vertical integration in the more mature markets. The question then becomes which is the better corporate structure for accommodating that?
In a C-Corp, taxes are paid on profits. Profits are taxed at 20%. Dividends are then paid to the partners, and they individually will pay a 15% tax. Thus, the total tax paid is roughly 35%.
In an LLC, no taxes are paid on profits, which are distributed to partners. Each partner individually pays taxes, of which the highest rate is 37%. All else being equal with 280e, it would appear that there is little difference between a C-Corp and LLC.
Yet, this is where CohnReznick thinks differently than others. The 2018 provision of the Tax Cuts and Jobs Act provides a deduction equal to 20% of qualified business income. The pass-through deduction makes it more favorable to have an LLC structure.
The deduction cannot be taken by lawyers, accountants, medical doctors (or others where partners are most involved in the profits). However, there is nothing explicitly preventing cannabis companies from taking that deduction.
To compare off profits of $1 million: A C-Corp’s 20% tax on profits plus 15% dividend would equate to $350,000 in taxes, while an LLC’s profits would be reduced to $800,000 due to 20% deduction, with an individual tax of 37% equating to $296,000 in taxes.
Thus, the value of the tax savings for the latter versus the former would be $54,000.
Reminder: Whenever making decisions on business structures and taxation, it is strongly recommended to talk to a specialized CPA and tax accounting firm with a cannabis practice, such as CohnReznick LLP. The conversation may save considerable time, money, and stress.