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Tax Reform and the Cannabis Industry

You won’t get a Section 199A tax deduction for your cannabis business. But some of the other tax reform changes may make the C corporation a more attractive choice of entity than before.

Let’s look at an example. Say the cannabis business has the following financials:

 

Cash

Tax

Gross Receipts

$500,000

$500,000

Cost of Goods Sold

-$325,000

-$325,000

Gross Income

$175,000

$175,000

Business Expenses

-$100,000

-$0

Taxable Income

$75,000

$175,000

If the business is an S corporation and you are in the 32 percent federal income tax bracket:

  • You’ll pay $56,000 in federal income tax on the taxable net income (32 percent of $175,000)
  • You’ll need to distribute 75 percent of the $75,000 net cash income just to cover the federal income tax bill.
  • Your adjusted gross income increases by $175,000, not only causing you to lose various tax benefits but also subjecting you to possible additional taxes (such as the net investment income tax).

 

If the business is a C corporation:

  • Your corporation pays $36,750 in federal income tax on the net income (21 percent of $175,000)
  • Your after-tax profit is $38,250, which you can retain in the C corporation or distribute as a dividend. For every $1,000 you distribute as a dividend, you take a $150 tax hit on your individual tax return. If you distribute the entire $38,250, your tax on the dividends would be $5,737 and your total tax would be $42,487 (significantly less than the $56,000 as an S corporation owner).
  • Your personal Form 1040 adjusted gross income is unaffected by the C corporation’s net income (unless you distribute dividends). The key is that the “phantom” income created by Section 280E doesn’t impact your individual tax return—only the corporation’s.

Because Section 280E creates “phantom” income for tax purposes (that is, the income doesn’t exist in real cash), it makes the S corporation and other pass-through entities less attractive overall for the cannabis business.

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