ACCOUNTING CONTINUING EDUCATION Accounting, Auditing and Tax Considerations for the Cannabis Industry (CANA4) Accounting, Auditing, and Tax Considerations for the Cannabis Industry (CANA4) 2021 Edward K. Zollars, CPA Kenneth Heaslip, MS, MBA, CPA, CGMA ACCOUNTING, AUDITING, AND TAX CONSIDERATIONS FOR THE CANNABIS INDUSTRY (CANA4) ©2021 Kaplan, Inc. Published in 2021 by Kaplan Financial Education. Printed in the United States of America. All rights reserved. The text of this publication, or any part thereof, may not be translated, reprinted or reproduced in any manner whatsoever, including photocopying and recording, or in any information storage and retrieval system without written permission from the publisher. TABLE OF CONTENTS SECTION 1 The Cannabis Industry ........................................................................................................................ 1 Learning Objectives ........................................................................................................................................................................................ 1 History................................................................................................................................................................................................................ 1 Organizational Structure ............................................................................................................................................................................... 4 Risks ................................................................................................................................................................................................................... 6 Ethics .................................................................................................................................................................................................................. 8 Separating Product and Period Costs ........................................................................................................................................................ 8 Segment Reporting ...................................................................................................................................................................................... 12 Internal Control ............................................................................................................................................................................................ 12 Financial Statements and Audits of Cannabis Entities ....................................................................................................................... 12 SECTION 2 Internal Control for Cannabis Entities .............................................................................................. 15 Learning Objectives ..................................................................................................................................................................................... 15 Overview ......................................................................................................................................................................................................... 15 Internal Controls For the Cannabis Industry ......................................................................................................................................... 16 Regulatory Considerations ........................................................................................................................................................................ 17 Smaller Entities and Challenges in Implementing Internal Controls ............................................................................................... 18 The Three Critical Controls ....................................................................................................................................................................... 20 Control Environment ................................................................................................................................................................................... 30 Risk Assessment ........................................................................................................................................................................................... 46 Information and Communication ............................................................................................................................................................ 55 Monitoring ..................................................................................................................................................................................................... 63 iv SECTION 3 Federal Income Taxation of Cannabis Businesses ............................................................................ 69 Learning Objectives ..................................................................................................................................................................................... 69 Federal Taxation of an Ordinary Business vs. a Cannabis Business .................................................................................................69 Inventory Costs ............................................................................................................................................................................................. 70 Other Ordinary and Necessary Business Deductions (§162) .............................................................................................................. 81 How This Works for a Cannabis Business ............................................................................................................................................... 83 §199A and the Cannabis Business ........................................................................................................................................................... 97 What if §199A Doesn’t Apply to a Cannabis Business? ...................................................................................................................... 109 SECTION 4 Federal Income Tax Issues for Cannabis Businesses ...........................................................................................1 20 Learning Objectives ................................................................................................................................................................................... 120 Tax Court Decides that §280E Does Not Violate the EightH Amendment ..................................................................................... 120 IRS Using State Reports Filed by Legal Sellers to Target §280E Examinations ............................................................................ 123 Maintenance of Books and Records – Reconstruction of Income Issues ..................................................................................... 124 Multiple Trades or Businesses ................................................................................................................................................................ 126 CHAMP – A Truly Separate Trade or Business ..................................................................................................................................... 127 Olive – Did Not Have a Separate Trade or Business .......................................................................................................................... 132 Alterman – Taxpayer Again Fails to Meet the CHAMP Standard ..................................................................................................... 135 Businesses Related to Cannabis Businesses ....................................................................................................................................... 137 Impact of State Level Taxes on Federal Taxable Income ................................................................................................................. 139 Risks in Using the Special Inventory Rules Under §471(c) ................................................................................................................ 140 SECTION 5 State and Local Tax Issues for Cannabis Businesses ............................................................................................14 4 Learning Objectives ................................................................................................................................................................................... 144 Introduction ................................................................................................................................................................................................ 144 v State Taxation in General ......................................................................................................................................................................... 146 Sales and Use Tax Issues .......................................................................................................................................................................... 147 State Income Taxation of Cannabis Businesses ................................................................................................................................. 148 State and Local Excise Taxes Specific to Cannabis Businesses