In California, dealing with the cannabis distributor is not optional. The law forbids the grower from selling directly to the retailer. There should be a middle man, so-called the distributor, who conducts the sale. The cannabis distributor has three main responsibilities:
- Sell cannabis to dispensaries
- Work with testing Labs to ensure that sold products pass CA requirements
- Collect Cultivation and Excise taxes
To become a cannabis distributor, you will need to get a special cannabis distributor license, which you can get in addition to your main license. For example, a cultivator can sell directly to the dispensary if they hold a distributor license. A cannabis dispensary may own a distribution license and purchase products directly from cultivators and manufacturers, bypassing outside distributors.
A big issue for cannabis distributors is pass-through taxes that distributors must remit to state authorities. In California, cannabis distributors are in charge of collecting and submitting excise and cultivation taxes. The excise tax is collected from cannabis dispensaries, and the cultivation tax is collected from cultivators. Cannabis distributors file the return and submit those taxes on behalf of dispensaries and cultivators.
One of the tax issues for cannabis distributors lies in the collection of the cultivation tax. Although distributors are in charge of remitting the tax, they are not always able to collect it from cultivators. Some cultivators simply ignore the tax issue. Others sneak the cultivation tax as a discount on their invoices. By the time the distributor figures out that the cultivator actually never paid the tax, it is already too late, and it is the deadline for the CDTFA filing. I’ve seen many distributors paying this tax out of their pockets just because they were inattentive with their invoices.
The other issue is the excise tax. Not everyone knows the difference between Full-Arm length vs Non-Arm’s Length Transactions. Unknowingly distributors collect 15% excise tax when in reality, their tax rate can be much higher. To shortly explain the problem, if you and your retailer are none related parties, your excise tax rate is 15%. However, if you are both the distributor and the retailer, you are conducting Non-Arm’s Length Transactions and should calculate your excise tax liability based on your gross receipts. You can read how to calculate your cannabis excise tax here.
The third issue is too much cash, which is not yours. Because the cannabis distributor collects so much in taxes, they mistakenly assume that the money is their revenue and decide to put it back into the business. When the time comes to file and pay the excise tax return, the distributor cannot immediately come up with such a huge amount of the money owed. The cash was invested in the business, and the cannabis distributor ends up being late on their tax payment. And oh well, surprise, surprise, the CDTFA applies a 50% penalty on all late excise tax payments.
There is, however, such a thing as an installment plan. It is not guaranteed, and you cannot abuse it. The CDTFA decides whether they should waive your 50% penalty ONLY after you finished making payments. So, there is always a chance that the CDTFA rejects your installment plan, and you end up owning 50% penalty plus interest. One day late on your installment payment and the CDTFA will not approve your installment plan. One of my clients was able to get three installment plans in a row, but every time they were told that their chances of the next installment plan being approved were diminishing. Each big cannabis distributor gets assigned their own CDTFA tax specialist. So, it is very important to be nice to this person since he or she is not going away. Crack some jokes; find a common ground. You know the drill.
Another tip is that you never ask to break down your installment plan in more than six payments. The CDTFA requests financial statements for all installment plans with over 6 payments. The last thing you want to do is to give the CDTFA your financial information. Here are a couple of tips that you can find useful when you start your cannabis distribution business:
- Lean up your variable costs. Fixed costs are such things as rent, insurance, utilities, software. These costs stay the same regardless of how much product you sell. Your variable costs are your delivery costs, and they vary based on the volume of your sales. One way to reduce your variable costs is to have an efficient delivery schedule. Instead of driving around randomly delivering your products, try to come up with good logistics. For example, drive to San Diego only on Mondays and drive to Los Angeles only on Tuesdays. Leave Riverside deliveries for Wednesdays only. This type of arrangement will reduce your gas and labor costs. Besides, it will also save you time on the actual deliveries and cash collections. Dispensaries will know your schedule and will be ready for you.
- Figure out your Break-Even Point and try to generate additional sales to make your business profitable. I wrote about break-even point here.
- Educate yourself on 280E and how it affects your profitability. This blog explains what tax deductions are available for cannabis distributors. In short, anything related to handling inventory is a tax allowed deduction. But expenses that are not associated with the inventory procurement are not deductible. So, for example, you can deduct the cost of the purchased product but won’t be able to deduct your marketing expense. Figure out which of your costs are deductible and try to be lean with non-deductible expenses.
- Leave some cash for excise tax payments. It is overwhelming to see a big cash inflow, but you have to remember that not all of this cash is yours. Excise tax returns are filed and paid four times a year, and I suggest that at the end of each month you set aside a chunk of cash for your tax expense. Of course, first, determine whether you and your retailers are related parties. If you are not related parties, save up 24% percent of all of your monthly cannabis sales (you can read here why it is 24% and not 15%). If you and your retailer are related parties, your excise tax is going to be based on gross sales. This is a complicated topic, about which you can read here. If you are a dispensary that holds a distributor license, run a sales report from your Point of Sales system. Ideally, the POS system should show the amount of excise tax that your clients paid, and this is the amount that you should set aside. Of course, tax settings of POS systems are rarely configured correctly, but it is a story for another post. At this point, the best you can do is to set aside the exact number that is shown on your sales report.
This was a quick overview of cannabis distribution. To summarize, you will need to acquire a license to become a distributor. Profit margins for cannabis distributors are pretty thin, and to make yourself profitable, you have to be lean, need to know your break-even point, and need to take care of your excise and cultivation tax liabilities.
Daria Nagal, Cannabis CPA