CategoryBusiness Coaching Archives — C. Lynn Northrup, CPA, CPIM
Managing and valuing inventories in cannabusinesses is the key to increasing cash flow and lowering taxes. Cannabusinesses are restricted to reducing gross revenues by the cost of goods sold because of IRS Section 280E. Section 280E was enacted in 1982 and provides that no deduction or credit is allowed for any amount paid or incurred in carrying on a trade or business consisting of the trafficking in controlled substances within the meaning of schedule I or II of the Controlled Substances Act. The only way cannabusinesses can reduce their tax burden is by maximizing cost of goods sold (COGS).
The tax laws and regulation associated with cannabusiness are complex. Understanding these complex laws and regulations makes the job of valuing inventories and determining COGS of cannabis businesses a challenge. This is compounded by the cannabis industry being a collection of complex processes and types of businesses.
Cannabusinesses include cultivators or growers that grow plants and then harvest the flower from these plants. In addition to selling flower, it can also be processed into a variety of marijuana infused products (MIPs). Marijuana infused products are created by extracting distillate which is then infused into other cannabis products such as vape cartridges, edibles, topicals, wax, and shatter. These products are then packaged and sold through dispensaries. The tax laws and regulations for determining COGS and inventory valuation for growers and MIPs are different for dispensaries.
Cultivation or farming of cannabis needs to track the flower yield from indoor and outdoor grows measured in grams to develop a cost for the harvested flower. Marijuana infused products are the result of process manufacturing operations creating multiple varieties of products requiring different types of packaging. Costs are developed based on the recipes for these products, including packaging.
These products are then sold and distributed to dispensaries for ultimate resale to the consumer. Dispensaries, in many cases, are required to inspect, repackage, and check the quality of products before they can be sold to the consumer.
Most cannabis businesses are using Quick Books to accumulate costs supplemented by spreadsheets to calculate yield and the cost of distillate. The costs of cultivation and marijuana infused products include direct labor, material, and allocation of overhead. Allocation of overhead should be based on guidance from Section 471 and Section 263A of the Internal Revenue Code. It is critical to determine any allocation of overhead to be included in COGS in compliance with IRS codes and regulation, but also to maximize costs that offset gross revenue.
Accounting for cannabis products needs to be accurate. In some cases, ERP (Enterprise Resource Planning) systems are being utilized by larger operations. Dispensaries determine cost based on the actual cost of products purchased and associated freight. Inventory tracking is required, and many dispensaries utilize point of sale systems and inventory management systems to control and manage activity.
Based on my experience, managing and controlling inventory costs and the associated investment is one of the most challenging and critical areas of cannabusiness. First, inventory investment requires a significant cash investment. This makes effective purchasing and inventory management vital. Second, accurate and maximum determination of COGS reduces the tax burden created by IRS Section 280E. This means that inventory costing and management should be a top priority for all cannabusinesses and their accountants.
Utilization of professionals who understand cost accounting and the unique taxation requirements of the cannabis industry represents the key component to success or failure.
It is important to understand that there are different entity (organizational) structures for conducting business. The form or type of organization will depend on the business purpose, a structure to provide legal protection, the size of the business, and the ease and cost to create the business organization.
Here are the common types of business organizations:
- Sole proprietorship
- Limited Liability Partnership
- S Corporation
- C Corporation
Each of these business organizations are described to provide background and understanding.
The Sole Proprietorship is the most common and easiest from of business organization to create. Typically, it is created by a person wanting to start a business out of their house or garage. The sole proprietor invests in their business, usually from their own savings, and begins operations. The type of business might be a service business, a small craft, or a distribution business. It also might involve an internet based business selling products, conducting affiliate marketing, and utilizing social media techniques.
A simple accounting system is used with these businesses which might include Quick Books, Xero, or other compatible bookkeeping/accounting system. The disadvantage of sole proprietorships is that it is exposed to legal liability with no limitation. The business of a sole proprietor itself does not pay income taxes. Profits and losses from the sole proprietor business flow through directly to the individual’s 1040 tax return on Schedule C and then taxed at the individual’s tax rate. However, it should be noted that profit reported on Schedule C is also subject to Self-Employment tax.
Sole proprietorships are the easiest business to form and operate. If a person does business under any name other than their true name, most states will require the filing of a fictitious business name which is known as a “Doing Business As” or a DBA Statement. These forms are available at the county recorder’s office as well as through some newspapers. There is no tax effect if a sole proprietor takes money out of their business, or transfers money to or from their business. However, it is a good idea to set up a draw account to help identify amounts that are not business but are for personal use.
Advantages of a Sole Proprietorship:
- All business tax advantages flow to the owner.
- Organizational costs are low.
- Legal & Accounting fees can be lower.
- State & Federal taxes may be lower.
- Administration is less complicated.
- Can be easily converted to another entity.
Disadvantages of a Sole Proprietorship:
- Personal liability.
- Inability to income split.
- Limited fringe benefits.
- Subject to Self-employment tax.
This covers the basic elements of sole proprietorships.
Partnerships can be defined as a relationship between two or more people (an individual, a corporation, a trust, an estate, or another partnership) who carry on a trade or business with each person in the relationship contributing money, property, labor or skill and with each expecting to share in the profits and losses of the business.
The partnership will be based on a partnership agreement together with any modifications and agreed to by each partner. The partnership agreement and any modifications can be either oral or written.
A partner’s share of income, gains, losses, deduction, or credits will typically be spelled out in the partnership agreement. The partnership agreement and any modification will be disregarded if the allocations to a partner under the agreement fail to have a substantial economic effect. An allocation will have a substantial economic if there is a reasonable possibility that the allocation will affect the dollar amount of a partners’ shares of partnership income or loss independently of tax consequences and the partner actually receives the economic benefit or bears the economic burden corresponding to the allocation.
Partnerships can have both general and limited partners. Limited partners are partners whose personal liability for the partnership is limited to the amount of money or other property they contributed to the partnership. Limited partners are not generally considered to materially participate in trade or business activities conducted through partnerships.
Limited partnerships can allow a sole proprietor to have part of his/her income from the business to be taxed in lower rather than the sole proprietor’s higher brackets. Family partnerships are a popular income-splitting concept by utilizing §704(e). One thing to note is that when the partnership is not recognized for tax purposes, the tax liability stays with the sole proprietor. Family members can contribute a capital interest in a partnership that can be withdrawn from the partnership or upon the liquidation of the partnership. The right to share in the earnings and profits is not a capital interest in the partnership. Family members in such partnerships can only include husband and wife, ancestors, lineal descendants, and any trust created for the benefit of such persons.
Advantages of partnerships include:
- Income is taxed to the partners rather than to the partnership.
- Distributed income is not subject to double taxation.
- Losses and credits will generally pass through to partners.
- The liability of limited partners is normally limited as in a corporation.
- There can be more than one class of partners.
- Partners can obtain basis for partnership liabilities.
- Special allocations are permitted.
- A partnership can be used to transfer value and income within a family group by making family members partners.
Disadvantages of a partnership include:
- The liability of general partners is not limited.
- Partners are taxed on earnings even if the earnings are not distributed.
- Partners cannot exclude certain tax favored fringe benefits from their taxable income.
- Partners may be required to file numerous state individual tax returns for multistate partnership businesses.
- In the absence of a business purpose, a partnership must use either a calendar year or the same year as the partners who own a majority of the interests in the partnership.
Limited Liability Companies
LLC’s are non-corporate businesses that provide its members with limited liability, a single tax, and the option to actively participate in the entity’s management. The IRS does not recognize an LLC as a distinct entity so for tax purposes the LLC may be treated as:
- A partnership,
- An association taxable as a corporation, or
- A trust.
While LLC’s have the corporate characteristics of limited liability, they are usually treated as a partnership for federal tax purposes since they can be organized without continuity of life, centralized management, or free transfer ability of interests.
When a limited liability company (LLC) is a partnership they include benefits such as the following:
- It provides the pass-through attributes provided under partnership tax rules;
- Limited liability to all members;
- It offers control membership control over the business without the risk that management participation will cost members their limited liability; and
- Provides freedom from S corporation eligibility requirements.
In addition, when an LLC holds assets with fair value in excess of basis, the availability of such an adjustment can be helpful by helping the transferring member to obtain a higher price for their interest. These situations are not available to shareholders of C corporations.
There are some non-tax benefits of LLCs which include:
- They can provide members with unique economic, voting, and other rights without creating a second class of stock.
- Rights of members can be modified by amending the LLC operating agreement which is not a publicly filed document.
- LLC members can be elected according to procedures set forth in the operating agreement.
- LLC members are not susceptible to piercing the corporate veil attacks solely as a consequence of the member’s failure to satisfy certain administrative formalities.
There are some disadvantages of LLCs which include:
- Uncertainty over self-employment taxes.
- They can be restricted to certain businesses and professions.
- In some instances, there can be additional taxes and filing fees.
- They are required to use the calendar method for accounting and taxes.
- A cancellation of indebtedness might stick to a member.
- There are issues with recourse and non-recourse debt.
- LLCs have no at-risk amounts because of the limited liability afforded to each member.
To sum up, LLCs are non-corporate businesses that provide members with limited liability, a single tax, and the option to participate actively in the entity’s management.
There are two types of corporations, S corporations and C corporations. We’ll discuss both together with their advantages and disadvantages. First, it is important to point out the characteristics of a corporation which include:
- Associates (shareholders).
- An objective to carry on a business or profession and to divide the profits from the business.
- Continuity of life.
- Centralized management.
- Limited liability to the associates.
- Free transfer ability of interests.
C corporations have a number of tax advantages over S corporations and unincorporated businesses. First, C corporations can be used to split income between itself and its owners with potentially lower overall tax rates.
C corporations can deduct fringe benefits paid for its employees in contrast to S corporations who are not able to deduct these expenses for employees who are 2% or larger shareholder. Unincorporated businesses cannot deduct these payments for its owners. C corporations can elect a fiscal tax year whereas S corporations and partnerships must be on a fiscal year for the most part with some limited exceptions. Corporations are able to deduct up to 80% of the dividends they receive from investments in other domestic Corporations.
C corporations can have an unlimited number of owners and multiple classes of stock ownership. The owners of the shares are not restricted to being United States citizens or to the numbers of shareholders. Forming a corporation involves a transfer of money, property or both by prospective shareholders in exchange for capital stock in the corporation. When money is exchanged for stock, the shareholder or corporation realizes no gain or loss. The stock received by the shareholder has a basis equal to the money transferred to the corporation by the shareholder.
There are a number of complex restrictions associated with corporations which are beyond the scope of this post. The most significant issue is that C corporations are not allowed to use the cash basis of accounting and are required to use the accrual method. The accrual method requires that income needs to be reported when it is earned in contrast to the cash method of accounting used by sole proprietors, S corporations, qualifying partnerships, qualified personal service corporations, and small businesses with less than $5 million in gross receipts.
Because of the restrictions and complexity of C corporations, most small businesses and service companies will not use this method of business formation. These reasons when combined with the double taxation of earnings of C corporations will cause smaller entities to form as an S corporation, partnership, LLC, or as a sole proprietor.
Domestic corporations can avoid double taxation by electing to be treated as an S corporation allowing small business corporations to elect special rules under Subchapter S. The treatment allows S corporations to be treated similar to partnerships whereby income, deductions, credits, and gains and losses are passed through to shareholders on a pro rata basis. S corporations are taxed like a partnership in that it pays no taxes, and its income and deductions pass through to the shareholder.
Here are some of the advantages of S corporations:
- S corporations can distribute its profits to shareholders with only a single tax in sharp contrast to C corporations where a double tax is incurred because dividends are not deductible.
- Losses of S corporations are deductible by shareholders in contrast to C corporations where losses are not deductible by shareholders.
- A new corporation may elect S corporation status in its initial year of operation in order to utilize losses even though they may ultimately want to be taxed as a C corporation.
- An S corporation is exempted from the accrual method of accounting rules and can use the cash method of accounting.
- An S corporation provides a corporate shield for liability purposes for those who want the income and losses taxed to them, but do not want the potential liability problems of a partnership.
- S corporations can adopt tax deductible and non-deductible fringe benefit plans subject to special rules and limitation applicable to these plans.
- An interest deduction is allowed for funds borrowed by a shareholder to purchase stock in the S corporation and such interest constitutes business interest when the shareholder materially participates in the business.
- Many problems of C corporations such as alternative minimum taxes and personal holding taxes do not apply to S corporations.
There are some disadvantages associated with S corporations:
- Because there is no corporate tax rate it makes deferred compensation programs impractical.
- There is no opportunity to accumulate corporate earnings at a lower tax bracket which makes it difficult for S corporations to reinvest profits in the business.
- Split-dollar and other non-deductible fringe benefits for shareholders can’t be paid for by lower taxed corporate funds.
- The 80% dividend received deduction is lost.
- In some states, the S corporation election will not avoid the double tax.
- A new or dissident shareholder can cause termination of the Subchapter S election through a disqualified transfer of stock.
- S corporations lack the flexibility that partners, and partnerships have to equalize the outside basis of owner’s interest with the inside basis of the entity’s assets.
- All income, except long term capital gains, received by the corporation are taxable to shareholders.
- More record keeping may be required to maintain accurate records for basis in shareholders stock to maintain the accumulated adjustments account, and to determine the tax ability of distributions.
Becoming an S Corporation
In order to become an S corporation, it must be formed in accordance with both state and federal laws. The corporate capitalization involves the transfer of money and/or property to the corporation in return for stock. The corporation must meet the requirements of S corporation status and all shareholders must consent to the S corporation status. The corporation will utilize a tax year status unless it meets special requirement to select another tax year and it will have to file Form 2553, Election by a Small Business Corporation, to indicate that it chooses S corporation status.
S corporation status is only permitted to “small business corporations.” S corporations are limited to a maximum of 100 shareholders who are U.S. citizens and non-resident aliens are prohibited from being shareholders. While this is the primary rule, resident aliens who possess a green card could be a shareholder, but this puts the corporation in jeopardy should this status change after achieving S corporation status. The requirement is to have only individuals as shareholders who are advised to establish a buy-sell agreement that restricts transfers to ineligible persons.
There are some special situations that allow estates and certain trusts to be a shareholder. In these instances, it is essential that the laws and regulations be carefully followed so as to not jeopardize the sub-chapter S status of the organization. Non-resident aliens may not be S corporation shareholders. In addition, a C corporation is not allowed to be a shareholder in an S corporation.
There you have the basics of business entities.
Helping small businesses is my focus. Business owners are short of time and need help in creating success. Why not offer an intense training boot camp that gives business owners the essential tools they need to achieve success? Thus, the Boot Camp.
The Boot Camp establishes a foundation for Small Businesses to grow and increase their value. Business owners receive problem solving techniques for greater profitability and increasing cash flow. Basically, they are provided with a road map for business planning. This is important because business planning and good strategy is a critical component of success.
One of the elements of effective business planning is assessing the business to determine what needs to be done to get small businesses on the road to success. The Boot Camp spells out business development questions together with guidance on conducting a SWOT (Strengths, Weaknesses, Opportunities, and Threats) analysis. A key component of the Boot Camp include the basics of profit improvement which are spelled out and combined with the elements of creating value.
The 2nd program of the four-part series addresses the development of a business vision and mission. This discussion evolves into the creation of the business plan and evolving the roadmap to success. The challenge of change is provided together with the steps needed to make change become a reality. Accounting, performance measurement, and the basics of business structure are also components of the session 2.
The third session addresses the basic components of business. Effective sales and marketing steps are rolled out and combined with the processes needed to achieve outstanding customer service. Business processes are one of the keys to greater profitability. The Boot Camp outlines how to achieve more efficient processes. The tools for success are exposed together with how to achieve more effective business operations. Effective application of the tools provides business owners with an effective tool kit and a clear road map for achieving success.
The Boot Camp outlines how you can spend more time working on your business rather than in your business. The Boot Camp concludes with the discussion of the commitment needed to launch the Journey to Results. The Boot Camp will be available by the end of August.
I wanted to share some exciting news about the Small Business Road Map to Success. This program is an introduction to our Small Business Boot Camp.
The Road Map gets you to think about the state and condition of your business. Small businesses need to think about what needs to be done to put their business on the path to increased profit and cash flow. The program helps business owners understand the signs and signals for potential trouble spots so they can take corrective action.
The Boot Camp expands the Road Map by offering more business diagnostic and development assistance. The Small Business Road Map spells out the following 10 Step Approach for focusing on your business:
- Get to the point of pain experienced by the business
- Scope out what needs to be done
- Orient the business to the reality of economic and market conditions
- Manage the scale of the business to fit current and future reality
- Structure debt to maximize cash flow
- Maximize assets to get the most bang for the buck
- Optimize products and services
- Improve employee effectiveness
- Improve productivity of the business
- Change the right processes for the right reasons
The Small Business Road Map is a system that defines profitability in terms of return on investment and takes aim at boosting the return above the cost of that investment. It provides a back to basics approach focusing on long-term results utilizing common sense financial management and business concepts. This approach applies a blend of financial and non-financial measurements to monitor your progress on achieving your business goals and objectives.
The Road Map and Boot Camp addresses the types of corrective that might be required. A business evaluation addresses who you are and what you do. It guides you through the process of where you have been and where you want to be. The process requires a thorough assessment of the current state of the business.
The business development process includes a SWOT assessment (strengths, weaknesses, opportunities, and threats). This sets the stage for problem identification and solutions. From here, we create a Journey to Results with a road map to achievement.
The Journey to Results includes guidance on making the needed improvements and overcoming resistance to change. Business owners will learn how to work on their business rather working in the business. Training topics include customer service, sales and marketing, operations, business structure, and accounting for results.
The Boot Camp will be available soon. Stay tuned for updates and details.
For motivation Monday, I thought it would be good to talk about SUCCESS. Just what is success? There are lots of opinions on success. Here are my thoughts.
I think success is how you define yourself and being ok with yourself. Success lies within your self-esteem and knowing that you are capable and worthy. It is accepting your uniqueness as an individual. Success is living within your identity and your character.
It is essential that you see the strength and courage of your identity and are comfortable that you have done your best. You have faced adversity and maintained control over your mind, thoughts, and how you feel. Success is making your own decisions based on how you think and feel about yourself.
Success is forgetting the past and looking to the future. Success is the journey to who you want to be, and creating your own identity. It begins with a dream that becomes your vision and your mission. This is how you create success. How do I get there? Well, as they say, sometimes all it takes is a leap of faith.
Success starts with a dream and committing to fulfilling that dream. Commitment requires that you have a process to get there. Trust in getting out of your own way and having confidence in your ability. Know that you will succeed. The process is doing what needs to be done and when it needs to be done.
Dreams are what you want to be, who you want to be, and where you want to be. The key to dreams is having them. Let your mind do what it can do and follow your dream. Don’t let other people’s thoughts and opinions take you off your track on where you want to go. Ask questions, listen, and then reach your own conclusions.
Commit to trusting the process and the never-ending pursuit of improvement. Turn your dreams into reality and SUCCESS!
I have developed a mini-program on Creating Success focusing on the 5 steps required to achieve success in business and in life. Creating Success provides a pathway on what you need to do to accomplish your success. The program takes less than an hour and is affordable.
My Business Coaching programs are available to help guide you through the process. They ask the right questions and get you to think about the right things. Having a coach pays big dividends. Forbes Magazine reports that an investment in coaching yields a ROI of 700%. In many cases the returns can be even higher. Imagine 10 to 49 times return from investing in a coach.
Check my videos on Business and Financial coaching. The Coaching Process provides:
- Coaching Support
- Goal Setting
- Setting Direction
- Support and Motivation
My video on Creating Success spells out the process essential for creating a successful business and a successful life. The program is self-paced for your convenience plus I am available to answer questions via email at firstname.lastname@example.org.
Creating Success is an ongoing effort to provide additional training focused on specific areas that will help guarantee success. Topics will include change, mastery, business assessment, performance measurement plus other areas of learning.
Why business owners get in trouble is a question I’ve had on my mind for some time. Here are the prime reasons based on my experience over the years.
Firefighting takes top priority. Running a business is challenging and involves a lot of detail work. Business owners get too deep in the forest making it tough from them to see the trees.
People do what they like, it’s human nature. Some business owners love the finance part of their job while others gravitate towards the marketing aspects and still others favor sales or manufacturing. At the end of the day, the business owner’s interests will determine what gets the most attention.
They’re making money. Many companies don’t know where they make their true profits but are still profitable. They make money despite themselves. When people are making enough money to supporting their lifestyles and pay their employees, things tend not to change. This is a situation where if they’re making enough money to support a lifestyle, being the most profitable company possible isn’t necessarily a top priority.
Some of the value is hidden. Inventory and materials need to be tracked. Costs need to be correctly allocated to product lines. When a business owner visits their warehouse, they shouldn’t just see goods and materials… they should see cash.
Finally, another reason is the lack of training and knowledge. Business owners might not want to invest in training and coaching, but it could make a huge difference on the bottom line and value of their business.
I can help improve your bottom line and increase the value of your business. Contact me at email@example.com.
Tim had a one-man wood working shop. His son, Arnie was his only helper. Tim asked me to help with a problem. The debt and bills were piled high. Tim didn’t know what to do or where to turn. To make things worse, Tim’s health was failing. We needed a plan.
First, we tightened up on receivables to get some cash flow. This bought time and some much-needed relief. Then we looked at expenses and started cutting back. It didn’t seem like much, but it put the business into the black.
Then I got Tim to secure a life insurance policy naming Arnie as the beneficiary. This was a key step in creating some peace of mind. Tim knew Arnie would be OK.
I think of Tim as I work at the desk he made for me. I look at the mantle over the fire place and the front door Tim crafted. They are constant reminders of our journey together.
Not long after our work together, Tim passed away. Arnie moved to Florida and got his college degree. Arnie is now pursuing his dream of being a football coach. Tim is looking down from heaven with a smile knowing that a coach made a difference.
Jerry built a printing business that always had lots of sales but no profits. I was introduced to Jerry by his CPA who thought maybe I could get Jerry to listen. I came in, wandered around and asked questions. That’s what I always do. It’s amazing how much you learn when people get comfortable and share concerns, questions and ideas.
People tend to get too close to the action and never take time to step back. We began analyzing the numbers to find out the little details that can lead to big results. These steps started having Jerry’s team building trust in my suggestions. By paying attention to the little details that matter, the company achieved record sales and profits. Jerry started to believe. Having the discipline and patience to focus on the right details can produce big results. That’s what coaching gives to business owners. Once they start seeing the results, coaches become part of the team.
Once I became accepted as a member of the team greater achievement became possible. We identified that a purchasing agent was taking kickbacks. Family members got new job assignments and a succession plan was put in place. The company went from almost going out of business to becoming the most respected printer in the region.
Overcoming the initial resistance can be an obstacle but the proof is in the results and on the bottom line. I went on to implement a team building effort and a management succession plan. I’ll tell you about this effort in another post.
I would like you to meet Harry and Susan. They are a husband and wife team running a business that just couldn’t turn the corner. Their business was breakeven at best and paying the bills was a constant struggle.
In desperation, Harry and Susan asked me to do an assessment of their business. It was tough for them to ask a stranger for help. I asked questions, listened and observed. They quickly became comfortable with my low-key approach to identifying issues and solving problems.
Based on the assessment, we prioritized the problems and created an action plan to address them. The entire process was a team effort that was built on a foundation of trust. The coaching process allowed them to see the problems more clearly. Once you can see the problem, solutions start to emerge.
One by one, we tackled the issues. Things started to turn around and profits became a reality. Having cash to pay the bills was a nice bonus. After the initial wave of success, we began taking on tougher problems. Plus, we developed business plans and forecasts. Combined with the performance measurement systems we created it became much easier to manage the business.
Our initial team effort developed into a long-term relationship. Profits and cash flow have a way of building trust. Harry and Susan’s stress went away. The business grew and prospered. They became believers that coaches can make a difference.