If you follow the accrual method and recognize income as it is incurred and someone does not pay you, you have a bad debt. However, in the case of cannabis, you are stuck with Section 280E, which only allows you to deduct the cost of goods sold (COGS). A bad debt is not COGS, so you have to find another way around it. So how to deduce it? Returns and Indemnities.
Returns and Allowances is a contra income account that shows the sales price returned by customers and the discounts taken. However, in cannabis, it is your bad debt account. Section 280E states that you can only take COGS as a deduction. Moreover, these customers claimed the income, paid taxes on it and now the dispensary does not want to pay the grower. The only option you have to offset the bad debt is returns and allowances.
I know with section 280E, cannabis accounting is hampered by this law, which has been in place since 1982. In California, for example, it’s very common. A grower will sell his crop on consignment. With the flood of dispensaries and cultivators, the cannabis industry is no longer as lucrative as it used to be. That being said, growers often get burned on the issue of shipping.
If it was another company under the accrual method, it could deduct as a bad debt. If you work in cannabis, you know you have to get creative. Returns and indemnities are the only way forward.
Craig W. Smalley, MST, EA, is the founder and CEO of CWSEAPA, PLLC. He was admitted to practice before the Internal Revenue Service as an Enrolled Agent and holds a Masters Certificate in Taxation from UCLA. In practice since 1994, Craig is well versed in US tax law and US Tax Court cases, and specializes in personal, partnership and corporate taxation for high net worth clients; structuring and restructuring of entities; and representation before the IRS regarding negotiations, audits and appeals.