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 (yes, really!).
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 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.
As you know, you should always run the numbers when comparing choices of business entity, to ensure you are making informed choices.
If you would like our help running your numbers, please give me a call on my direct line at 909-570-1102 and we will set a time to do this or visit us at HealthcareTaxAdvisor.com
Carlos Samaniego, EA, NATPI Tax Fellow
Enrolled Agent
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