How a small group of financial wizards aims to help former New York cannabis operators go legal
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As the Office of Cannabis Management pushes to open up the state’s adult-use marijuana market by fall, financial experts surveyed wonder if New York regulations will freeze legacy operators .
Conditional retail license applications are due out later this year, but the qualification criteria are very specific. Paula Collins and Allison Kirchhofer, co-founders and co-directors of the New York Consortium of Cannabis Accountants (NYCCA), are concerned that some applicants lack the information and tax history necessary to apply for a conditional license. For this reason, both use forensic accounting measures.
Forensic accounting is a specialized area of accounting that is often used to investigate white collar crimes. It involves analysis of financial records and transactions, asset tracking, etc.
NY Cannabis Insider spoke with Collins and Kirchhofer about how forensic accounting can help applicants who are in the process of obtaining a conditional license and what they need to know before joining the legal market.
This interview has been edited for length and clarity.
NY Cannabis Insider: What does the NYCCA do?
Kirchhofer: The Consortium was founded by six female cannabis accountants working in New York and we all have our specialties – be it CPA, an agent – but we all focus on the cannabis industry. Our mission and the way we want to do good in the industry is to promote financial literacy among New York’s historic market leaders and social equity entrepreneurs.
We also want to be a support network for other cannabis accountants working in New York.
What is the general process for making the transition from inheritance to legal?
Kirchhofer: I don’t feel able to convince anyone of the need to enter the legal market. But if they decide that’s what they want to do, they should do their best to stop the illegal operations. The next step, and there are certainly conflicting opinions on this, is to report money earned in the illegal market, as your tax return must show all worldwide income from any source. This would include illegal operations. After going out of business, people should find specialists who can do forensic accounting so they can report that income.
collins: It’s an interesting thing that New York prepared us for. What we know of the rules so far is that a person must have owned or operated a profitable business for at least two years. We get stuck when a client wants to report their legacy market earnings, but New York needs them to show the numbers. And when the income is declared, taxes must be paid. It’s an art, not a science.
Some of my guys have a pretty good idea of what went in and what went out, in terms of cash flow. They know exactly what they spent to get their product and what they benefited from. A client of mine was arrested for selling cannabis, but in the years he worked he had ballpark numbers. For people who haven’t been arrested, however, it takes a lot of truth and analysis.
Is there any other business this person might have that we could say was generating enough money to support other activities? Or does a person have no other activity that he is obliged to declare this income? We don’t mind paying taxes. The Supreme Court case Gonzales v. Raich says that we are obligated, even in a criminal enterprise, to pay federal income tax.
Does New York State provide enough guidelines for applicants to know what tax information they need?
collins: Reporting legacy market income is the right thing to do, but then how much money is enough? How much story can we safely tell? New York doesn’t give us much in terms of the number of tax years needed. There is also no guarantee that a client will not be punished by the state when reporting this income as well. We really don’t know.
What exactly is forensic accounting?
collins: With forensic accounting, we are able to create books and create – at least – a very generalized profit and loss statement and then prepare the tax return knowing that clients cannot deduct things that business normal would do, because of 280E . In a way, it helps us when we do forensic accounting, because we’re trying to show that the business was a profitable business.
Kirchhofer: When you do this forensic accounting, you have to think about what the IRS wants to see when they do an audit. What they’re looking at is a person’s type of lifestyle: what their rent is, the car they drive, their phone bill, and whether their income supports it. So when it comes to balancing how you are going to report your income, you have to think about what the IRS is going to think and do.
What are the things and processes people need to keep in mind when transitioning from inheritance to legal?
Kirchhofer: The first thing I get asked all the time is 280E, and that any tax paid must be calculated correctly. This impacts cash flow at the end of the day when you’re trying to figure out “what’s my break-even point?” Another thing is that what you declare as cost of goods sold is reasonable and specific, which can be supported by documents.
Another great conversation I have with people when they’re ready to start working on their business plan, is the consideration of the tax-related entity. Entities like LLCs and S-Corps aren’t always ideal for cannabis. The partners and the owners of the business absorb the tax payable and it is a significant burden. Small cannabis businesses choose C-Corps because the business takes the tax hit, not the owners personally.
Some things people can do now are develop a business plan and show that someone can find capital to support the plan. People can also learn about what their cities and towns are doing about getting involved in the cannabis industry and get involved in the local community. I think that’s the best way to ensure success.
collins: Some of my friends haven’t filed taxes since they were 19 and are now in their 40s. So they kind of lived their lives as low-level drug dealers. They didn’t really have a big lifestyle, so they were under the radar. My other guys who have a great lifestyle have filed taxes and corporate taxes, from LLCs and other businesses. When I say “clean the house,” it means someone has to step into some sort of legitimacy as a taxpayer, like someone who hasn’t filed returns in years. On the Cannabis Application there is a place to submit the most recent tax return, and you cannot do this if you have not filed.
For others who have filed returns, but have filed a number of different entities that show the money is somehow floating around, then “cleaning the house” means making sure the numbers on their books are connected. and accurate, as if they were going to be audited by their own.
I’ve spoken to a lot of people who are interested in the legal market, but they haven’t read the full framework of rules that we know of so far. So, in addition to being active in the local community, I think it’s important to really read what we know so far about the licensing structure. A lot of people envision a superstore where you can grow, process, sell, and consume all in one place, but the structure doesn’t quite allow for that. People need to think about how they want to be in this market.