Whether you’re shopping for infused stocking stuffers, or a few joints for your New Years Eve get together, you’ve probably noticed something about buying legal weed in December: it sucks.
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Shops are out of inventory. Budtenders are beleaguered. If you ask: “why are you so low on products?” you’ll be the fiftieth person of the day, most likely. You’ll hear back a tired response about “we’ll have better stock in January.”
Well informed budtenders might cite an “end of the year inventory tax.” They can’t stock
products because they’ll be taxed on them after the first. So who’s to blame? Well, it’s something to do with taxes, the 70s, and a whole lot of cocaine. Buckle up, and we’ll
discover…
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"Haven't done my
taxes, I'm too
turnt up"
- Drake
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Jeffery Edmonson of Minneapolis Minnesota, unlike Drake, was a tax savvy businessman.
His business was selling cocaine, amphetamines and marijuana. Unwilling to go down like Al Capone, he made it a priority to file and pay his taxes.
Edmonson, like all of us, wanted to pay as little in taxes as possible. To do this, he made sure to utilize any deductions available to him. Businesses are taxed based on profitability. The age old formula is: sales - expenses = profit.
Edmonson made sure to maximize those expenses, thus decreasing his taxable profit. One of those expenses is the price he paid for his inventory. We call this “Cost of Goods Sold” (AKA: COGS, (not to be confused with the cannabis strain Coked Out Girl Scout Cookies).
An easy way to determine this number is to compare the value of your starting inventory, plus your inventory purchases against the cost of the inventory you sold in the year. The difference can be expensed as your COGS.
This was long before the days of Metrc (and a little outside the scope.) He didn’t keep detailed records of his inventory. Luckily for him, he utilized a consignment model, wherein the actual “owners” of the cocaine he sold loaned it to him until he could complete the sale. Once his transactions were complete, he would then repay his higher level dealer.
It was easy for Edmonson to calculate his cost of goods sold with the consignment model, because his beginning inventory balance was $0. He sold 1.1 million tablets of amphetamine, 100lbs of marijuana and thirteen ounces of cocaine. He reported his COGS as $105,300.
Additionally, he had other expenses which decreased his revenue. He took frequent business trips, racking up tens of thousands of miles on his vehicle. Additionally, he utilized two thirds of his rental home to conduct business, so he wrote off that portion of his rent as well.
If you think an amphetamine dealer from the 70s filing an itemized tax return is a bit silly, then the US Congress of 1982 would tend to agree with you.
This instance led to the creation of tax code 280E. This tax code says, essentially, that any business trafficking illegal drugs cannot write off business expenses other than Cost of Goods Sold. Despite the state legality of cannabis, it remains a schedule 1 narcotic. Therefore, federal taxes are collected from cannabis businesses based on their gross sales minus COGS.
Effectively, this makes it harder to operate a cannabis business profitably than any other sort of business. Employees, utilities, rent and other expenses are paid in “after tax dollars.” This means that the business has to pay a tax on the money it spends on expenses, as well as on its taxable income.
So, to put it another way, if it costs the fictional fast food company Taco → Lips Now $16 per hour to pay an employee, it would cost fictional dispensary The Garden Secret $22.80 per hour to pay that same employee the same wage (generously assuming a 30% tax rate.)
How 280E Affects Dispensary Shelves
With Cost of Goods Sold as the only deduction dispensaries have, it is incredibly meaningful, especially in the brutal landscape of established markets. Because of this, dispensaries have a negative incentive toward purchasing late in the year. Imagine two buckets: one represents inventory, and the other represents cost of goods sold.
The goal at the end of the year is to move as much from the inventory bucket into the COGS bucket. The goal is to pour the inventory bucket into the COGS bucket. Filling the inventory bucket with more does not accomplish that goal.
So, is there an “end of the year inventory tax?” Well, no, not really. There is, however, an end of the year tax write off. Buying products shrinks that deduction, effectively creating a “tax.” Let’s think back to that bar chart from earlier comparing the end of the year inventory balance to the sum of the starting balance and purchases.
There’s a little magic there, a little light at the end of the tunnel: the starting balance. What isn’t expensed as COGS this year can and will be expensed next year. The greater the starting balance as compared to the ending balance, the bigger the deduction.
What cannot be recouped, however, are the lost sales in December due to poor selection. Customer demand doesn’t change based on a tax calendar. Customers are, in many ways, the primary asset of any dispensary. Losing sales to increase deductions is a short sighted trade off, and damaging in the long run.
That being said, how can I tell a dispensary who pays $23 an hour to staff a $16 an hour employee to hold out longer for a meaningful tax break?
Of course dispensaries have to shrink inventory at the end of the year. Every penny matters. Is there a way we can have both? Can we maximize our deduction and keep our customers satisfied and spending?
The answer is yes. Just ask our old friend Jeffrey Edmonson.
Have Your Cake and Sell It Too (Just Don't Put it on the Balance Sheet)
Think back to earlier in this article. Jeffrey Edmonson’s starting inventory balance was easy to calculate. Why? Because he didn’t own any of his inventory.
The number was a big zero. Consignment means the inventory is loaned to the consignee. It isn’t added to the inventory balance, and thus it doesn’t interfere with increasing the COGS deduction.
By taking on consigned inventory in December, dispensaries can keep their shelves stocked without sacrificing their deduction.
There is an important caveat: having inventory to sell that isn’t on the balance sheet doesn’t magically increase your deduction. Owned inventory still needs to be sold to maximize the deduction.
As a best practice, dispensaries should still encourage the sell through of the inventory they own. They can utilize promotions, or avoid restocking certain items in categories that have too much owned inventory on the books.
If a dispensary is overstocked on Topicals, for example, it might make sense to allow that category to sell out without stocking additional consigned inventory on top of it. Stocking cartridges on consignment when the inventory balance is depleted compared to the demand, however, won’t get in the way of continuing to sell those Topicals so long as that category isn’t replenished.
This can also be accomplished per product line, per brand. Skus can be refilled on consignment, and older inventory can be hit with targeted promotions to encourage sell-through without losing customers who are loyal to specific products.
Dispensaries can and should utilize consignment to keep inventory stocked such that they don’t lose real sales. A balance can be struck between wanting to sell owned inventory and not wanting to lose sales.
So, instead of asking “why are your shelves empty”the next time you visit a dispensary in December, ask “have you thought about restocking key inventory on a consignment basis to fulfill demand without increasing tax liability?”
The budtenders, I’m sure, will be delighted to hear your feedback.
- Will Irwin