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Cannabis Industry Entity Selection with Tax Reform

11/5/2018

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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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    Spencer Accounting Group, LLC does not provide investment, tax, legal, or retirement advice or recommendations in these blogs. The information presented here is not specific to any individual's personal circumstances.

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    To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances.
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    These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable — we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.

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    Author

    Keana Spencer is an Accountant, Entrepreneur, and Educator to her clients, with a strong passion.  Keana has over 10 years of experience and through her practice, she is a source of knowledge and strategies to her clients.

    Keana founded this website and decided and created this blog page to offer a space for those seeking knowledge to understand, however not to be confused with advice or planning strategies.

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