The cannabis industry has spent much of its history operating through uncertainty. Federal and state regulations continue to evolve, access to capital remains complex, and tax rules such as Section 280E have placed unusual pressure on the economics of many businesses.
Recent federal rescheduling developments have created new tax and financial planning considerations, but regulatory progress does not change one of the industry’s fundamental realities: cannabis companies still need to operate as disciplined businesses.
For management teams, this means looking beyond tax planning to the infrastructure supporting the business, from documentation and financial reporting to the metrics used to evaluate stores, products, customers and growth opportunities.
How Does Cannabis Rescheduling Affect Section 280E and Tax Planning?
Cannabis rescheduling gives qualifying medical cannabis operators reason to revisit tax-planning assumptions shaped by Section 280E. Historically, this provision significantly restricted deductions available to cannabis businesses involving Schedule I or II controlled substances. For companies with both medical and adult-use operations, the key question is which activities and related expenses qualify for different tax treatment.
Management should review how the changing treatment affects operating expenses such as rent, marketing, compensation and benefits, as well as depreciation, estimated tax payments and applicable state pass-through entity tax elections. The specific tax treatment depends on the business, its activities and applicable guidance.
Changes to projected tax obligations should also flow through budgets and cash-flow forecasts. Capital investments should be modeled under the revised tax assumptions, and compensation and benefit decisions should be reevaluated as part of this planning.
The broader objective is to connect tax planning with the financial decisions management is making across the business.
What Documentation Do Cannabis Companies Need to Support Tax Positions?
Cannabis companies need records that support how revenue, expenses and shared costs are classified and allocated to qualifying activities. For companies with both medical and adult-use operations, this requires more than a general ledger. Management needs workpapers, payroll records, documented job responsibilities and support for cost-of-goods-sold allocations to substantiate its methodology.
Hybrid businesses deserve particular attention. Separating historically integrated medical and non-medical activities requires deliberate changes to accounting processes and recordkeeping.
“Make sure that your internal controls are strong…when it comes time for an audit, you want to make sure that you have all your records available and everything is separated from medical and non-medical.”
– Tara Williams, Senior Tax Manager, Grassi
Strong controls should also create a process that management can explain and support after the fact. Management should be able to identify what was done, why and what documentation supports the treatment.
The benefit extends beyond tax support. More disciplined records also give management more reliable information for running the business.
Turn Financial Reporting into a Management Tool
Timely financial reporting helps cannabis operators identify problems earlier and adjust course while management still has options. A consistent monthly close, supported by budgets, forecasts and variance analysis, shows where revenue or expenses are moving away from expectations and where management needs to investigate performance more closely.
The monthly close should start the decision-making process, not end an accounting exercise. Leadership should use this information to compare:
- Actual performance against budget
- Actual performance against updated projections
- Revenue and expense variances
- Cash flow and liquidity
- Performance across revenue centers
- Current financial obligations and available resources
A budget establishes expectations against which actual results can be measured. When revenue falls short or expenses move above plan, management should understand what changed and whether the underlying strategy still makes sense.
Forecasts should evolve as well. Changes in taxes and Section 280E treatment, financing, expenses, pricing, expansion plans and operating results can alter projected cash flow. Leadership also needs visibility into liquidity, current obligations, borrowing costs and available cash before committing resources to a new initiative.
Which Business Metrics Should Cannabis Operators Monitor?
Cannabis companies should monitor customer retention, average basket size, margins, inventory performance, product performance, customer mix by location and pricing to understand what is driving results. Looking at these measures together helps management move beyond top-line revenue and identify whether performance issues are tied to customers, products, pricing, inventory or a particular location.
For example, a store with growing revenue but declining margins presents a different issue from a location struggling with customer retention. A slow-moving product may reflect its pricing, how well it fits the location’s customer base or how effectively it is communicated to customers.
Pricing and product decisions should account for those differences. Lower prices may address an immediate need, but repeated discounting without understanding the underlying issue can further pressure margins. Before changing the assortment or pricing strategy, management should determine whether the problem is the product, its price or how well it fits the location’s customers.
What Should Cannabis Operators Consider Before Expanding?
Cannabis companies should evaluate whether their existing business and financial position can support the demands of a new market or acquisition before expanding. An attractive opportunity still must be weighed against the needs of the existing business.
Distressed acquisitions can require significant capital, integration work and management attention beyond the purchase itself. An attractive purchase price does not eliminate the need for substantial investment after closing. Management should compare this commitment with what the same resources could accomplish if invested in areas where the company already performs well.
Before pursuing growth, management should understand:
- The expected financial contribution
- The effect on cash flow and liquidity
- Integration requirements
- Management capacity
- The strength of current operations
- Alternative uses of the same capital
The same factors apply to geographic expansion. Moving into another state introduces a different regulatory environment, market dynamics and customer base. Weaknesses in the existing operation do not disappear when adding another market.
Management should establish what an investment is expected to accomplish, monitor the results and be willing to change course when performance falls short of those expectations.
How Can Cannabis Companies Prepare for What Comes Next?
Cannabis will continue to operate within a changing environment. Management cannot control the timing or outcome of every development, but it controls how prepared the business is to respond. This starts with reliable financial information, supportable tax positions and a clear understanding of operating performance.
The industry’s next phase should not depend on waiting for the next regulatory development. Cannabis operators should strengthen their businesses now, from Section 280E reviews and tax planning to financial reporting, and position themselves to respond as the industry evolves.
Contact Grassi’s Cannabis Advisors to discuss how these considerations may apply to your organization.
Disclaimer: This article is provided for general informational purposes only and does not constitute tax, legal or accounting advice.
