The Tax Cuts and Jobs Act: Key Considerations for Cannabis Businesses
By Mary Amato, CPA, Partner
The Tax Cuts and Jobs Act (“the Act”), signed by President Trump on December 22, 2017, is the most sweeping update to the tax code since 1986. While technical corrections and interpretive guidance issued by the IRS are forthcoming, taxpayers must understand which provisions will affect them and how. Cannabis businesses should focus on several areas, and thoughtful review is needed to determine how the new law may impact their federal taxes.
The following are items that owners of cannabis-related companies should consider:
20% deduction for flow-through business income: The new law creates a deduction from adjusted gross income equal to 20% of the taxpayer’s qualified business income (QBI). The 20% deduction is available to taxpayers who own eligible businesses operating as a sole proprietorship or as a flow-through entity (S corporation or partnership). The deduction could help to significantly lower an owner’s tax liability. We understand that – because of Section 280E – cannabis businesses will typically have a higher effective tax rate than other businesses. That will make the 20% deduction even more valuable to cannabis businesses.
While 280E prevents companies from deducting most expenses related to cannabis operations, the new 20% deduction will be taken on the individual partner’s or shareholder’s personal return. Therefore, it seems that Section 280E would not, on its face, prevent the owner of a cannabis-related business from taking advantage of the new 20% deduction.
Even though the new rule seems to be available to owners of cannabis-related entities, it is possible that future regulations and other IRS guidance will limit its use. The 20% deduction is limited to the greater of 50% of the company’s W-2 wages or 25% of the company’s W-2 wages, plus 2.5% of the unadjusted basis of qualified assets. It is possible that when the IRS interprets these new rules, it will not allow companies to include non-deductible cannabis-related W-2 wage expenses in the limitation calculation. If the IRS were to do that, the benefit from the new 20% deduction could be severely limited.
Lower corporate rates: For businesses operating as C corporations, the 20% deduction is not available. However, corporations are now subject to a flat 21% rate. Additionally, the corporate alternative minimum tax (AMT) has been repealed. A lower corporate tax rate will help companies pay less tax. However, a C corporation structure remains subject to double taxation if cash is distributed out to its shareholders. If cash is not distributed, the C corporation can be subjected to the accumulated earnings tax.
The new corporate rate and the 20% deduction give companies reasons to reconsider the best taxable entity with which to conduct business. Owners should consider how and when they plan to exit a given company before making a decision about entity type.
Changes to individual income tax rules: After considering the changes to the business rules, it is key to also consider changes to the individual income tax rules. With the vast tax law changes, it is not business as usual. The individual AMT remains in place, but with higher exemption amounts. Personal exemptions have been removed. A larger dependent tax credit may apply. Interest on home equity loans is no longer deductible, and the standard deduction has been raised to $24,000. Some of these changes are favorable, and some are unfavorable. Therefore, the impact on any given individual will vary. Individuals should work with their tax preparers to estimate how these changes will affect their 2018 income taxes.
The potential to reduce the effective tax rate on QBI may be a cannabis business-friendly provision. We will continue to monitor how the new law may impact those operating in the cannabis industry. There is much uncertainty in the law as written, however, there are many applications to explore.
For additional information, please contact Mary Amato, CohnReznick Partner, at firstname.lastname@example.org or 914-922-2116.
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