On-Demand: High Noon with EisnerAmper - The Business of Cannabis

July 28, 2022

In this webinar, members of EisnerAmper’s Cannabis and Hemp Group are joined by Wanye Margoles, part of the Cannabis & Hemp Insurance Specialty Team at HUB International Limited, to cover key strategies cannabis business owners and leaders need to know to effectively scale their operations. 

 


Transcript

Eric Altstadter: Thank you, Bella. And welcome to the second edition of our ongoing webinar series, High Noon with EisnerAmper, The Business of Cannabis. My name is Eric Altstadter, and I am a partner with EisnerAmper and chair of the Firm’s National Cannabis and Hemp Group.

I am thrilled to be joined by Hubert Klein, partner and practice leader in the forensic, litigation and valuation support services group; Ben Aspir, tax senior manager and a member of the firm’s National Tax Group; Gaye Eschenbach, senior manager in the firm’s Private Business Services Group; and Wayne Marguilies, Cannabis Insurance Specialist at HUB International, who will all talk about where we are with regard to cannabis.

And as we sit here at the end of July, 2022, there are some good things to talk about and some not so good things to talk about. New Jersey is selling adult use recreational cannabis in retail dispensaries. New York has legalized adult use recreational cannabis, but the rules that would allow dispensaries to sell are still in process and are still months away from finalization. That hasn't stopped numerous dispensaries from popping up on the streets of Midtown. Those stores have purchased their product from what used to be known as the illicit market or the black market, and are now simply known as the legacy market.

At last count, and this might be off as the rules change daily, 19 states, plus Washington, D.C. and Guam have legalized adult use recreational cannabis. 37 states have legalized some form of medicinal or recreational cannabis, meaning cannabis is legal in some form in almost 75% of the country. But if you're in Iowa, where cannabis is illegal, Iowa continues to arrest individuals for possessing small amounts of marijuana, while neighboring Illinois has legalized adult use cannabis and Nebraska, Minnesota, Missouri have decriminalized simple possessions. In New York and New Jersey, states separated by a river, a few bridges and tunnels, cannabis purchased in one state can't be transported to another state.

I just mentioned that some states have decriminalized, but there is a distinction between decriminalization and legalization, a distinction not fully understood by some of those popup dispensaries in New York city I referred to earlier, but clearly discussed in the rules of the New York's Office of Cannabis Management.

Plus, in some markets, this very hot industry is cooled. The price of cannabis flour has declined, making it difficult for some cultivators to turn a profit, while new companies continue to open facilities and retail stores leading to increasingly complex and competitive marketplaces. If you look at Michigan, Michigan has seen some of its members lay off employees, consolidate operations, and even liquidate operations.

While many of us had hoped that federal legalization would occur soon, those hopes seem to grow fainter and fainter with each passing day. The proposed piece of legislation, the Marijuana Opportunity, Reinvestment and Expungement Act, known as the MORE Act, originally introduced into the house in May of 2021 has passed through the house twice, getting stalled in the senate. But the MORE Act is a Democratic Party led initiative and these days politics seem to rear their ugly head everywhere. There is a Republican Party bill backed by some Republicans, but not all, called the Strengthening The 10th Amendment Through Entrusting States Act, known as the STATES Act. There are commonalities between the two, but finding compromise has not been the modus operandi of our current elected officials.

The issue of federal illegality and partial state legality has created the 800 pound gorilla of the cannabis industry, Internal Revenue Code Section 280E. By enacting 280E, Congress sought to reverse a then recent tax export decision, the 1981 landmark case of Edmondson versus the Commissioner. In that case, the tax court allowed a trafficker of amphetamines, cocaine and cannabis to deduct ordinary and necessary business expenses related to an illicit drug business. Those expenses included rent, packaging, telephone, auto expenses, office expenses, and the purchase of small equipment. In response, 280E was enacted, preventing businesses engaged in certain illegal activities from recovering costs related to controlled substances or claiming associated business deductions that normally would be allowable under Internal Revenue code section 162. Generally section 162 allows a tax payer to deduct ordinary necessary expenses paid or incurred during the year in carrying on any trade or business, but deductions under 162 however are, as the adage goes, matters of legislative grace, and Congress may condition, limit, deny deductions from gross income in arriving at net income, which is to be taxed.

So what section 280E does, and I'm just going to read it. It takes a minute. "No deduction of credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business, if such trade or business or the activities which compromise such trade or business consist of trafficking in controlled substances within the meaning of Schedule One and Schedule Two of the Controlled Substance Act, which is prohibited by federal law or the law of any state in which such trade or business is conducted." And what that means, and I'll give you a good example.

If you're selling food in New York State, for example, and you have revenues of $2,000,000 and the cost of your food is $1,000,000, that leaves you a gross profit of $1,000,000 or 50%. Assume it costs another $600,000 for rent, salaries, office expense, power, and other sundry expenses, that leaves you a $400,000 profit before taxes. These days in New York State, you can use an effective tax rate of about 25%. I know it might be a little bit low, but it's an easier number to use. 25% of 400,000 is a $100,000. Your tax hit is 100 and your bottom line is 300.

Now let's look at the same facts only at a cannabis company. $400,000 profit before tax, but since cannabis is a schedule one drug, the operating expenses we spoke about earlier, the salaries, rent and other expenses are not deductible. So the effective tax rate of 25% is applied to the gross profit of 1,000,000, meaning your taxes are now $250,000. You are now paying an additional 150,000 in taxes and your bottom line is only $150,000. And your effective tax rate on your income before taxes is now in excess of 60%.

Now I've made the example here very basic, but in real life, it's never so easy. There might be multiple entities, some involved in cannabis, others not, and I won't get into other variables, LLC versus C Corp or if the state decouples from 280E, which some states like New York are starting to do. But as you can see, taxes are critical. And as you can see for a cannabis company, keeping track of expenses in the bucket the expenses belong in, deductible versus non deductible, is very important. When will this change? Well when the federal government decides to take cannabis off schedule one, which unfortunately looks to be far in the future to me. Well, thanks for listening to me to start this presentation off. And I'm happy to turn the microphone over to Hubert. Hubert?

Hubert Klein: Eric, thank you very much for that introduction. And that's great information, which is going to bring us right into the next section of this presentation. And we're going to have Gaye Eschenbach talk about, why is there need for formalized books and records and a formalized accounting, and why should a cannabis business run like a business and not a fly by night operation? So, Gaye, you want to talk to us a little bit more about what the need for books and records are, what the record keeping obligations are, and how those records help you manage the business, taking into consideration a lot of what Eric just spoke about. Okay? I think you're on mute, Gaye.

Gaye Eschenbach: Thank you, Hubert. I might have been more interesting on mute, you never know. But okay, I will take it from here. Okay. So you're running a cannabis business now, and it's extremely important to maintain good books and records. That is an essential skill to running any business. Poor accounting is one of the top reasons that businesses fail. Just a few of the reasons why maintaining books and records are important is, it provides you with an analysis of your ongoing operations and the results of those operations, tracking your profit and loss. It ensures that you're going to make informed business decisions. If you're not accounting for things properly, it would be garbage in, garbage out. You need to know exactly what you are dealing with. It gives you the ability to plan for the future. And it's certainly necessary if you plan on obtaining financing. If you have investors, investors will want to see the results of the operations and you'll need accurate reporting for them.

It is certainly important for tax preparation. You want to file an accurate tax return. And most importantly, peace of mind. You want to know how you stand, good, bad or indifferent. It'll only help you sleep at night.

Now, accounting skills may not be in your wheelhouse and that's perfectly okay. You may be great at managing people and the business, selling products, whatever it may be. But actual accounting may not be your strong point. Don't try to do everything. Absolutely do not. Know what you're good at and hire the people you need to handle that area that you're weak in. However, this is very important. Even if you outsource your accounting and bookkeeping or hire somebody in house, this is still your business. You don't have to become a CPA or anything, but it will always be in your best interest to, if you don't know accounting and bookkeeping, take an online course in just basic accounting. Learn how to interpret financial statements and the results. Again, you don't have to be the one counting the beans on a daily basis, but certainly enhance your understanding of your financial information.

What do I mean by maintaining good books and records? First and foremost, timely bank reconciliations. Yes. The good old balance your checkbook. Bank accounts absolutely should be reconciled monthly at the minimum. Now businesses usually have access to the their business activity in real time, so actually accounts can be reconciled more frequently. And I can guarantee you that every accountant on this panel can tell you a horror story about a company that didn't keep up with their bank reconciliations. And when the bank activity was eventually examined, because check started bouncing, or perhaps the bank contacted the business owner because they detected unusual activity, either theft or fraud was discovered. And that ranges from internal theft where an employee was culpable, or perhaps even outside forces that got access to the bank account through fraudulent checks. So the sooner you detect it all the better. Very, very important.
Eric Altstadter: Thank you, Bella. And welcome to the second edition of our ongoing webinar series, High Noon with EisnerAmper, The Business of Cannabis. My name is Eric Altstadter, and I am a partner with EisnerAmper and chair of the Firm’s National Cannabis and Hemp Group. I am thrilled to be joined by Hubert Klein, partner and practice leader in the forensic, litigation and valuation support services group; Ben Aspir, tax senior manager and a member of the firm’s National Tax Group; Gaye Eschenbach, senior manager in the firm’s Private Business Services Group; and Wayne Marguilies, Cannabis Insurance Specialist at HUB International, who will all talk about where we are with regard to cannabis.

And as we sit here at the end of July, 2022, there are some good things to talk about and some not so good things to talk about. New Jersey is selling adult use recreational cannabis in retail dispensaries. New York has legalized adult use recreational cannabis, but the rules that would allow dispensaries to sell are still in process and are still months away from finalization. That hasn't stopped numerous dispensaries from popping up on the streets of Midtown. Those stores have purchased their product from what used to be known as the illicit market or the black market, and are now simply known as the legacy market.

At last count, and this might be off as the rules change daily, 19 states, plus Washington, D.C. and Guam have legalized adult use recreational cannabis. 37 states have legalized some form of medicinal or recreational cannabis, meaning cannabis is legal in some form in almost 75% of the country. But if you're in Iowa, where cannabis is illegal, Iowa continues to arrest individuals for possessing small amounts of marijuana, while neighboring Illinois has legalized adult use cannabis and Nebraska, Minnesota, Missouri have decriminalized simple possessions. In New York and New Jersey, states separated by a river, a few bridges and tunnels, cannabis purchased in one state can't be transported to another state.

I just mentioned that some states have decriminalized, but there is a distinction between decriminalization and legalization, a distinction not fully understood by some of those popup dispensaries in New York city I referred to earlier, but clearly discussed in the rules of the New York's Office of Cannabis Management.

Plus, in some markets, this very hot industry is cooled. The price of cannabis flour has declined, making it difficult for some cultivators to turn a profit, while new companies continue to open facilities and retail stores leading to increasingly complex and competitive marketplaces. If you look at Michigan, Michigan has seen some of its members lay off employees, consolidate operations, and even liquidate operations.

While many of us had hoped that federal legalization would occur soon, those hopes seem to grow fainter and fainter with each passing day. The proposed piece of legislation, the Marijuana Opportunity, Reinvestment and Expungement Act, known as the MORE Act, originally introduced into the house in May of 2021 has passed through the house twice, getting stalled in the senate. But the MORE Act is a Democratic Party led initiative and these days politics seem to rear their ugly head everywhere. There is a Republican Party bill backed by some Republicans, but not all, called the Strengthening The 10th Amendment Through Entrusting States Act, known as the STATES Act. There are commonalities between the two, but finding compromise has not been the modus operandi of our current elected officials.

The issue of federal illegality and partial state legality has created the 800 pound gorilla of the cannabis industry, Internal Revenue Code Section 280E. By enacting 280E, Congress sought to reverse a then recent tax export decision, the 1981 landmark case of Edmondson versus the Commissioner. In that case, the tax court allowed a trafficker of amphetamines, cocaine and cannabis to deduct ordinary and necessary business expenses related to an illicit drug business. Those expenses included rent, packaging, telephone, auto expenses, office expenses, and the purchase of small equipment. In response, 280E was enacted, preventing businesses engaged in certain illegal activities from recovering costs related to controlled substances or claiming associated business deductions that normally would be allowable under Internal Revenue code section 162. Generally section 162 allows a tax payer to deduct ordinary necessary expenses paid or incurred during the year in carrying on any trade or business, but deductions under 162 however are, as the adage goes, matters of legislative grace, and Congress may condition, limit, deny deductions from gross income in arriving at net income, which is to be taxed.

So what section 280E does, and I'm just going to read it. It takes a minute. "No deduction of credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business, if such trade or business or the activities which compromise such trade or business consist of trafficking in controlled substances within the meaning of Schedule One and Schedule Two of the Controlled Substance Act, which is prohibited by federal law or the law of any state in which such trade or business is conducted." And what that means, and I'll give you a good example.

If you're selling food in New York State, for example, and you have revenues of $2,000,000 and the cost of your food is $1,000,000, that leaves you a gross profit of $1,000,000 or 50%. Assume it costs another $600,000 for rent, salaries, office expense, power, and other sundry expenses, that leaves you a $400,000 profit before taxes. These days in New York State, you can use an effective tax rate of about 25%. I know it might be a little bit low, but it's an easier number to use. 25% of 400,000 is a $100,000. Your tax hit is 100 and your bottom line is 300.

Now let's look at the same facts only at a cannabis company. $400,000 profit before tax, but since cannabis is a schedule one drug, the operating expenses we spoke about earlier, the salaries, rent and other expenses are not deductible. So the effective tax rate of 25% is applied to the gross profit of 1,000,000, meaning your taxes are now $250,000. You are now paying an additional 150,000 in taxes and your bottom line is only $150,000. And your effective tax rate on your income before taxes is now in excess of 60%.

Now I've made the example here very basic, but in real life, it's never so easy. There might be multiple entities, some involved in cannabis, others not, and I won't get into other variables, LLC versus C Corp or if the state decouples from 280E, which some states like New York are starting to do. But as you can see, taxes are critical. And as you can see for a cannabis company, keeping track of expenses in the bucket the expenses belong in, deductible versus non deductible, is very important. When will this change? Well when the federal government decides to take cannabis off schedule one, which unfortunately looks to be far in the future to me. Well, thanks for listening to me to start this presentation off. And I'm happy to turn the microphone over to Hubert. Hubert?

Hubert Klein: Eric, thank you very much for that introduction. And that's great information, which is going to bring us right into the next section of this presentation. And we're going to have Gaye Eschenbach talk about, why is there need for formalized books and records and a formalized accounting, and why should a cannabis business run like a business and not a fly by night operation? So, Gaye, you want to talk to us a little bit more about what the need for books and records are, what the record keeping obligations are, and how those records help you manage the business, taking into consideration a lot of what Eric just spoke about. Okay? I think you're on mute, Gaye.

Gaye Eschenbach: Thank you, Hubert. I might have been more interesting on mute, you never know. But okay, I will take it from here. Okay. So you're running a cannabis business now, and it's extremely important to maintain good books and records. That is an essential skill to running any business. Poor accounting is one of the top reasons that businesses fail. Just a few of the reasons why maintaining books and records are important is, it provides you with an analysis of your ongoing operations and the results of those operations, tracking your profit and loss. It ensures that you're going to make informed business decisions. If you're not accounting for things properly, it would be garbage in, garbage out. You need to know exactly what you are dealing with. It gives you the ability to plan for the future. And it's certainly necessary if you plan on obtaining financing. If you have investors, investors will want to see the results of the operations and you'll need accurate reporting for them.

It is certainly important for tax preparation. You want to file an accurate tax return. And most importantly, peace of mind. You want to know how you stand, good, bad or indifferent. It'll only help you sleep at night.

Now, accounting skills may not be in your wheelhouse and that's perfectly okay. You may be great at managing people and the business, selling products, whatever it may be. But actual accounting may not be your strong point. Don't try to do everything. Absolutely do not. Know what you're good at and hire the people you need to handle that area that you're weak in. However, this is very important. Even if you outsource your accounting and bookkeeping or hire somebody in house, this is still your business. You don't have to become a CPA or anything, but it will always be in your best interest to, if you don't know accounting and bookkeeping, take an online course in just basic accounting. Learn how to interpret financial statements and the results. Again, you don't have to be the one counting the beans on a daily basis, but certainly enhance your understanding of your financial information.

What do I mean by maintaining good books and records? First and foremost, timely bank reconciliations. Yes. The good old balance your checkbook. Bank accounts absolutely should be reconciled monthly at the minimum. Now businesses usually have access to the their business activity in real time, so actually accounts can be reconciled more frequently. And I can guarantee you that every accountant on this panel can tell you a horror story about a company that didn't keep up with their bank reconciliations. And when the bank activity was eventually examined, because check started bouncing, or perhaps the bank contacted the business owner because they detected unusual activity, either theft or fraud was discovered. And that ranges from internal theft where an employee was culpable, or perhaps even outside forces that got access to the bank account through fraudulent checks. So the sooner you detect it all the better. Very, very important.

Moving on, credit card statements and supporting receipts. What I would absolutely recommend is you keep one credit card that is used exclusively for business purposes. Do not commingle it with personal expenditures. Keep it strictly for business and keep the supporting receipts for each credit card charge. I mean, technically the credit card statement would almost mean nothing in an audit. You need the supporting documents. Now you might think, okay, there's certainly some recurring business charges that you might put on a credit card that you don't have a receipt for each month. Just thinking like, if you have an account with Zoom and they automatically charge the card. Obviously you don't have a receipt for that, but you would have the underlying contract that would support that charge.

Always maintain proper documentation and receipts for travel and meals. And for that, remember to include the who, what, why, where, when. In other words, who were you with? What was the business purpose? What did you discuss? Where was it? When did it occur? If you're ever audited, those are the things that will be looked for.

Payroll. I have two words of advice when it comes to payroll, and that is outsource it. Even if you are a payroll guru, preparing payroll in house is way more trouble than it's worth. Using a reputable, reliable payroll service that will prepare your recurring payroll, quarterly and annual filings, having your withholding and employer taxes impounded, that will keep you in compliance and keep you out of wearing stripes.

Inventory management, and control. Now this technically could, there could be a whole seminar on this for a cannabis business, but proper inventory management, it's always integral to a business that carries inventory, but even more so in a cannabis business. As Eric stated at the beginning at the federal level, a cannabis business faces unique tax restrictions. Your cost of goods sold is the only deduction you get. So you want to make sure you capture all the legally acceptable costs that get baked into your inventory. Accurate inventory costing is essential, and you don't want inventory walking out the door without receiving payment for it. Inventory needs to be safeguarded.

Cannabis inventory management is especially important because you have to protect yourself from regulatory fines and license revocation. I mean, clearly Uncle Sam will be watching you. Use reliable software to track it. From the moment in order is placed to the moment it is handed to the customer, you want to be aware of where it stands, and that software should be able to produce good reports that give you really vital information for running the business and making decisions. If you don't understand the reports, contact your accountant. He or she will clearly be happy to explain what it means and what you need to do, understanding your margins, your gross profit, which is absolutely crucial.

Another important aspect for running a business is having strong internal controls, and an internal control is just a process that's designed to provide reasonable assurance that the business operations are effective and reliable. Internal controls can minimize errors in irregularities and fraud and maintain the integrity of the financial information. There are many internal controls that can be implemented, but I will say the two most frequently employed by businesses of all sizes is a proper segregation of duties. For example, the person that's reconciling the bank account, you don't want that same person to be making vendor payments or approving vendor payments or handling cash deposits. Another example, you don't want the person that's hiring employees to also be the person that's paying salaries and they could add a fictitious employee and make sure the money is diverted to themselves. And secondly, just management must have oversight over all of the accounting functions. This certainly helps to ensure that your employees act with integrity. I mean, as there's an old saying, that says the purpose of a lock is to keep an honest person honest, and that's what it does.

Something you should also take into consideration along with this proper record keeping is document management. Keep a database of the important contracts and agreements that you undertake. Retain records for the recommended amount of time, and that depends on what type of document it is. I mean, there's all different recommendations for the different types of documents. Generally speaking, it's five to seven years is where most documents fall. I've heard that they recommend that you keep insurance policies forever, even if they are no longer in existence. The statute of limitations for federal tax returns is generally three years, but in the case of a substantial omission of income, it goes up to six years. And there's actually no statute of limitations if fraud occurs, which is a willful intent to evade taxes. So don't do that. Or if no return is ever filed, the statute of limitations does not apply. So, consider those audit periods when you're deciding how long to maintain documents. Consider insurance claims, lawsuits. Those are all things to keep in mind.

Other considerations for running a business, I would say, maintain a budget. Maintain a budget, compare to actual results on a periodic basis. This will allow you to change course if necessary, or maybe perhaps the budget wasn't realistic. But again, it's always good to benchmark things and to keep tab of how things are going. Maintain compliance with laws and regulations through timely reporting requirements. You want to file your payroll tax returns. Timely income tax returns, sales tax returns, extremely important. And your 1099 filings. At the end of the year, you got to look and see, did you hire independent contractors or pay other non-employee compensation? You want to make sure you file the correct reports to the government and to those recipients at that time.

The other consideration is cyber security. I mean, in this now, you're collecting credit cards or other personal identifying information. If you keep that information on file or any medical type of information, you really do need to make sure that that data is safeguarded. That is extremely important, your liability. If you let that information get into the wrong hands, you'll have a very big problem on your hands. And lastly, and of course, Wayne will be talking more about this, but maintain insurance. This is your business. You need to protect it. You need to protect yourself. Feel free to ask any questions.

Hubert Klein: Thank you very much, Gaye. That was excellent information for people looking to start a business or currently in business. And you're ending segues right into Wayne. Wayne is our next speaker, from Hub International. He's going to talk about risk mitigation and controls revolving around insurance policies and other issues. And Wayne's going to talk about what types of coverages are available and what types of coverages are needed. So without any further ado, Wayne, you're up.

Wayne Margulies: Hubert, thank you very much for the introduction. What type of insurance coverages are needed? You know, it's a very good question, but I have to apologize to everyone. I have a very hoarse voice. I've had all my COVID shots and boosters, but I'm getting over my second bout. And I'm feeling better. And I was planning on wearing this shirt, which is very appropriate. And if you can't read it, well, it says, "When this virus thing is over, I still want some of you to stay away from me." I bet a lot of you feel the same way.

So it's really great to be invited to talk about the insurance segment of this of this presentation. I want to thank all the folks at EisnerAmper and especially Eric Altstadter. What an amazing lineup of truly professional cannabis industry experts we have on this call.

So in all fairness, today's discussion, including my area of specialty, cannabis insurance, is not the sexiest of topics, but it's essential. And just like any other business sector, understanding and taking organized and preventative measures in setting up your organization or realizing your existing operations do not address these concerns well enough. Those on today's call are innovative thought leaders and advocates for a truly underserved industry.

So at Hub International, we've been in the cannabis space for close to 10 years, and we're currently servicing over 700 cannabis clients. There's 250 of us on our cannabis specialty team. So I like to say we're the 800 pound gorilla in this space. A basic tenet of insurance is to eliminate unnecessary risk through comprehensive risk management plans. And for the risk you can't control, transfer the majority of them to insurance carriers who focus in the sector.

Again, I apologize for my hoarseness. Risk management can include written plans and procedures on security, physical structures, administrative as well as training and accountability, procedures and policies for staff awareness, violence prevention, threat reporting, and conflict management for when these things do happen. It's so much more than which insurance policies do I need.

Going back to the initial question, which insurance coverages are needed? Well, it's not the simplest of answers, and it really depends on your individual operations and how you operate. All these things are considered by underwriters when deciding if they will provide coverage. And the more prevention that is put in place will help you secure coverage and reduce the premium. So whether you're a grower, an extractor, manufacturer, processor, testing lab, dispensary, delivery service, or a lounge, or any one of the other cannabis business operations, they all have some common statutory requirements like workers comp and disability, which do vary by state regulation.

And each operation all has different exposures that with the help of a specialist will be identified and presented to potential carriers in the most advantageous light. Most cannabis organizations have, or begin operations with a combination of property, general liability and product liability coverages, which is typically combined into what is called a business owner's policy or BOP for short. Property insurance protects your facility, equipment and operations. General liability covers you and your company for claims involving injuries and property damage resulting from your product, services, or operation. It typically also covers you if you're held liable for damages to your landlord's property. Product liability applies to every business that brings a product to market. This coverage helps to defend your company against claims and allegations and help pay damages if you are found legally liable when something bad happens in connection with the use of your product.

As you know, we live in a very litigious society. Some other included or additional coverages can be business interruption and crime or theft. If raising capital, then protecting the board should be a consideration as sophisticated and experienced individuals in any sector will not consider becoming a member of a board without an appropriate directors and officers policy being in place. They do not want to be personally held responsible for business decisions.

We also need to recognize staffing considerations. To attract and retain employees, employee benefits, such as health insurance, vision, dental are basic coverages most companies provide. Providing them with financial advice, for example, 401k solutions is now an offering.

The list goes on and depending on your operations, you might consider cargo, commercial auto, crop insurance, cyber, employment practices liability, product withdrawal, special events like exhibiting or selling at a trade show, or farmer's markets. Markets are coverage for consideration. Right now, crop insurance for cannabis is just too expensive for outdoor growers so no one is buying it, but indoor crop coverage is available in true greenhouses, but not in hoop houses.

For those not yet licensed, secure or review your existing life and disability policies to protect your income and legacy, as once licensed, it's quite difficult to find an insurance carrier willing to be on the other side of the federal illegality of cannabis. And it doesn't matter whether the individual or organization is plant touching or not, and for the most part will decline to provide a policy. Hard to believe, but true.

Now let's address the risk of not having proper coverage. If operating in the cannabis sector, you need to make sure existing policies do not have cannabis exclusions, exposures where if that thing, incident occurred, happened, or a claim that such a thing happened, well, it gives the carriers the out from covering just such a claim. For example farm policies exclude hemp and cannabis operations, and hemp policies exclude cannabis operations. Therefore, in attempting to drum in the understanding that cannabis specific policies are a required expense or said better, protection every cannabis business needs. As mentioned above briefly, insurance is also not only there to provide the money to pay for claims against the organization, but as importantly, to provide for the legal defense costs for attorneys, defend you against real or frivolous claims within the limits of the policy that you secure. Excuse me, one second.

Lastly, let's briefly discuss other risk issues. Risk management is a whole separate topic, and you must be proactive in creating, reviewing, modifying standard operating procedures in all aspects of your operation. These can include regulatory compliance, safety and training, operational hazard, and site security, behavior based safety, fleet and equipment safety driver, accountability, emergency response, and business continuity. And this is not the full list that we recommend should be considered.

In closing, as compared to any other business sector, there are very few carriers offering coverage in the cannabis space. So in order to protect and preserve your leverage in securing the best policies, it's essential to vet the insurance broker you want to represent you out to the marketplace, and not have more than one broker represent your needs to this very limited marketplace. I was not sure I would be able to get through the entire presentation. So thank you all for listening in.

Hubert Klein: Wayne. Thank you very much. I mean, there was a lot there and I particularly took it to know what's in the policies. And Wayne brought up a very good point, how with the cannabis exclusions and all these other things, you need to know what you're buying, and that's why you need to reach out to someone like Wayne, who knows these policies, who knows what the companies that cover this type of stuff. And he went to a whole list of different segments of the cannabis industry, from growers to retailers, to delivery systems, things that we don't even think about that touch cannabis, but just the delivery system and the shipment systems, right? There's all things that go into that outside of just the growing in the selling. So, Wayne, thank you very much. That was great.

Wayne Margulies: You're welcome.

Hubert Klein: Okay. So now that we've covered why do you need accounting records and how are they useful managing the business to understanding risk management and why you need to insure yourself for risk management and what types of coverages are out there, it always comes back around to the tax and compliance end, right? There's always, Eric talked about the legacy business, right? Which is the old guy selling on the street corner. Today we have the regulated business, which is the legalized cannabis space. And in there, it has its whole host of things that we need to deal with. And we have Ben Aspir here today from Eisner, who's going to talk about tax and compliance issues, and from income to sales tax and other localized tax issues, and give you a flavor for what's going on. So Ben, you're up. I think you're on mute too, Ben.

Ben Aspir: Thank you, Hubert. As a tax professional, as someone that has been in the cannabis group, the EisnerAmper cannabis group for the last six or seven years, it's been amazing to see the evolution of the industry and to learn about the nuances that apply specifically to the cannabis industry. I'm sure everyone on today's webcast is aware that cannabis is federally illegal, but regardless of an industry's legality at the federal level, they're still required to pay taxes. As most of you are aware of the infamous case with Al Capone, regardless of locality, you still have to file your taxes. As Eric mentioned at the beginning of today's session, he touched on 280E, and then 280E really is the albatross around the neck of the cannabis industry, because essentially it, you can see industries, you can see cannabis companies that have an effective tax rate of 70%.

You know, usually it can be about half that. So it's sucking the cash out of the cannabis businesses. So it's important to be aware of the federal tax implications of 280E, and I'll touch upon the state tax implications, because just like the legality at the state level is very different from state to state, the taxation of cannabis varies from state to state. There's just income tax through sales tax. There could be excise taxes.

I'm going to start off just going briefly through 280E and this history. And Eric touched on it before, but 280E was precipitated by the case of Jeffrey Edmondson. And Jeffrey was a drug dealer in the early '80s. And it was challenged. They made him file tax returns and he deducted all the expenses that were related to his illegal drug trafficking businesses. And he prevailed and he was able to deduct a significant amount of expenses.

And Congress was none too fond of that ruling. So after that they enacted section 280E of the revenue code. And then 280E disallows deductions for sales of schedule one and schedule two substances under the Controlled Substances Act. And the Controlled Substances Act was passed I believe in the early '60s, and it schedules out different types of drugs, one through five, one being the most addictive with no medicinal use. So schedule one drugs would be cannabis, heroin, methamphetamines, LSD. So being that cannabis is a schedule one drug, cannabis businesses are limited to their cost of goods sold as deduction.

Now that would have a significant detrimental effect on retail businesses, because what are the costs of goods sold? The products purchased, and that's pretty much it. They wouldn't be able to deduct any of their GNA expenses, any rent, any insurance, any payroll, whereas a grow operation, cultivators have a significant amount of expenses allocated to cost of goods sold growing the product, from depreciation, salaries of the actual growers. So it's important to engage a proper CPA firm, to do essentially a 280E analysis to make sure that it's being reported properly and that also that the cannabis business is maximizing their allowable deductions.

Additionally, there are many states that have what's called decoupled from 280E. And what that means is you have state taxes, state income taxes, and they're saying, "Fine, you have 280E at the federal level. We're not going to go by that. We have our own state tax regime. You're allowed to deduct any ordinary necessary expenses that any of our other businesses in the state." There are about a, more than a dozen states that have so far decoupled from 280E. And my, the neighboring state, New York has done that. It's been in the works for New Jersey for a while. They have not done that as well. They have been trying to push that through to decouple, to at least ease the tax burden on cannabis businesses and allow them to deduct any ordinary necessary expenses that any other non-cannabis business could deduct.

Part of the 280E analysis that should be performed is determining if there are other lines of business that wouldn't be subject to 280E. And a lot of, 280E has been litigated a significant amount. There's been numerous cases that I've read through. And a common theme is, and as Gaye spoke about the importance of books and records, right? So a common theme is that the IRS disallowed deductions not necessarily because they weren't legitimate, but because there was lack of records. There's lack of any proof, any backup. There was extremely poor records by the taxpayer and the taxpayer couldn't provide any support for the deductions that they were trying to claim. So the importance of proper records, having good bookkeeping and accounting in place, is really important.

So in addition to income taxes, the states have sales taxes. And even within that, so New Jersey now exempts, my home state exempts sales taxes on medical cannabis, whereas recreational is still subject to it. So even for a non-cannabis business, sales taxes, excise taxes can be a trap for the unwary. So it's important to engage a knowledgeable professional in the area. And, you know, with the lack of ... As I mentioned, cannabis businesses have to pay their taxes, but a lot of them have, there's a lack of banking access, especially most federally chartered banks aren't, do not want to work with cannabis businesses. And so it leaves room for the smaller state chartered banks that charge exorbitant fees.

So with the lack of banking access, cannabis companies have to pay taxes, but a lot of them don't have bank account, so literally the IRS has cash counting rooms for cannabis businesses that are bringing in ... It's almost like out of the movies. And they have to bring in significant amounts of cash and the IRS, to pay their taxes, whether it be payroll taxes, federal income taxes. So it's important to have proper books of records to pay the taxes and to make sure that they're accurate.

In my time, I've done several due diligence projects with cannabis businesses and from the buyer side, we get a peak into the seller's books and records. And I could tell you, there's a lot of bad cannabis tax advice there where companies were deducting way more expenses than they should be taking on the tax returns, extremely aggressive. So, there's a lot of bad tax advice out there, and make sure to hire a competent tax professional experienced in 280E and in the cannabis industry. Thank you everyone. And I believe now I'm going to turn it over to Eric.

Eric Altstadter: Thank you, Ben. Thanks for that presentation.

Hubert Klein: You're up, Eric.

Eric Altstadter: Hubert, do you have any, we have any questions for the audience that we want to address to the panel?

Hubert Klein: We do have one question and I guess it'll pertain to the accountants on here, but basically regarding the discussion of outsourcing the payroll, the questioner says, "Isn't it true that not all payroll companies will service a cannabis business?" So I don't know, Gaye, Ben, Eric, you want to address that?

Gaye Eschenbach: I will address it. That's correct. Much like in the banking industry, there are few and far between, but there are services out there that will service it. It's a matter of research, talking to other people in the industry, see what they're using, but yeah, absolutely correct. Just like with banking, it's slim to none as far as the providers, but they do exist.

Eric Altstadter: And Wayne, a quick question for you, one of the questions that came up also is the cost of insurance for cannabis companies versus a non-cannabis related business. How different is the price structure? How much of a burden are cannabis companies handling with insurance?

Wayne Margulies: Well, again, it relates to which coverages. So if it's directors and officers, so directors and officers is expensive in any business sector, but in the cannabis sector, it could be 50 to 100% higher. So it's good to have someone know the different marketplace that play in the sector. With the other lines of coverage, more standardized coverages, I would say it could run 10 to 30% higher than standard, than non-cannabis sectors. And I say on health insurance, there's basically no difference. Hope that helps.

Eric Altstadter: Hubert, you mentioned earlier the cost of banking in this industry. I think it was you that mentioned this. And certainly what we're seeing is, I think Gaye had mentioned this, that we're seeing more state chartered banks and credit unions are in the industry. But there are some national banks who are getting into it, but the cost of banking is not inconsequential. What are you guys seeing as far as additional costs related to banking these days, and are you seeing any changes in the industry?

Hubert Klein: Well, Eric, I know you and I have spoken about this before and Ben actually brought it up which is a really good point about the cost for banks, but the banks are getting more aggressive with the fees that they're charging people, because they have a captive audience. So unless something happens federally to change all this, to make it easier for the federal banks and the state banks, it's a cost that's passed through to the cannabis company and it's also going to be hit with the 280E exclusion.

Eric Altstadter: You know, while we have everybody here, I'm just curious, Wayne, I'm just curious for your view about federal legality. Do you see anything down the road in the near future?

Wayne Margulies: Let me put on my Carnac hat. You had to be a fan of the Tonight Show and Johnny Carson to understand that reference. We have no crystal ball. I think it'll require more and more states to adopt. I think it'll require most states to adopt legality in different aspects for federal legality to happen throughout the country. So there's no timeframe on what we're working with. So it's just good to know and understand each state's individual compliance regulations, follow them, keep your books and records in check and updated and review your policies and procedures.

Hubert Klein: Eric, I think I have a question for Gaye and Ben because they touched on the record keeping obligations and the compliance side. And it sounds like a lot and it sounds scary at the beginning of it, because it seems like a lot, but Ben, Gaye, isn't this the same advice we'd give to a non-cannabis business as well?

Ben Aspir: Yeah, absolutely.

Gaye Eschenbach: Absolutely.

Ben Aspir: Oh, you can go, Gaye.

Gaye Eschenbach: I'm going to say the same thing. Yes. It's basic business advice that you would really give to any business. I think the issue with cannabis businesses is they will be subject to so much oversight that when, you want to make sure that you've crossed the T's, dotted the I's because you don't want to lose any available deduction as it relates to cost of goods sold at the federal level. And then again at the state level, if they have decoupled from 280E, that's another story. But again, you still need to substantiate those deductions as well.

Hubert Klein: And Gaye, from your experience is not having those basic systems in place one of the main reasons that businesses get into financial trouble? Not paying the taxes?

Gaye Eschenbach: Absolutely. Yes.

Ben Aspir: Yes. Much better to be proactive. And from the foundation up to have, like Gaye said, internal controls set up, especially because you're dealing with a lot of cash. There's generally no access to credit card. So it's mostly cash only business and it prevents major headaches in the future and anyway, benefit to you as a cannabis operator is, you have a full understanding if you have proper books and records and as Gaye mentioned earlier, you can sleep at night knowing that you have proper internal controls in place.

And then understanding how your cannabis entity is operating, is there room for additional improvement in operations? And I would even mention that, like I mentioned earlier, having been for almost the majority of a decade been involved servicing the cannabis industry, just the evolution in the last three, four years of service providers, like with Wayne, five, six years ago, there were so few service providers, even accounting firms or attorneys that were willing to service the industry. It's been pretty remarkable to see the evolution.

Eric Altstadter: Yeah. I think Ben, you had raised a very good point and I think when you're running a cannabis company, you have to run a cannabis company like you'd run any other business. And I think Gaye, you mentioned that projections, budgets, you really have to maintain a good set of internal support to allow you to make contemporary decisions about what you're doing with your operations. If your information's not good, your decision making is going to be somewhat lacking. So I think that's very important. And Hubert, I think I interrupted you. Hubert?

Hubert Klein: That's right. We did have another question come in that I don't know the answer to, and obviously I think the other accountants in here might have it, but how is cannabis inventory treated for the cannabis product? Are the plants themselves considered inventory, or are they a depreciable asset? My basic understanding is you grow the plant, the plant is killed off and dried, but I don't know that answer. So does anybody know that answer?

Eric Altstadter: It's actually a little bit of both. It depends if you're following U.S. GAAP or IFRS. There's different ways to account for depreciable assets or plants. U.S. GAAP is one way. IFRS is a little different view of it. So for those companies that are operating, like particular north of the border in Canada and following Canadian GAAP, the literature is a little bit different than how that gets handled, but it's usually, it's either ... Actually with respect to the question, it's one of the two. It can be a depreciable asset or it can be just an inventoriable asset, but it's one of those two, and it depends on the GAAP that you're following.

Hubert Klein: Okay.

Wayne Margulies: You know, I'm not going to answer from the accounting side, but from the insurance side, it really depends on again, are you a grower? So now we have to look at it one way. Is it in a dispensary? Is it in transit? So let's say for a grower in crop insurance, the plant, if grown indoors in a true greenhouse, is protected and covered for X dollars in the first 10 days of growth. Then the next stage, however long that is, is covered for two X, three X all the way up to just before it's harvested. So the valuations change through the growth period, and that might be helpful in addressing accounting procedures to what the value is at different points of the grow.

Hubert Klein: So it would be safe to say that the accountants should really consult with the insurance companies on the valuation or any other subset there of what that may be worth, because somebody may be under or over-insured on their product.

Wayne Margulies: It's hard to get over-insured, just for the crime potential that someone would fake a claim or something like that. So we're not, you can't look to make money off of insurance, even though in the end, that never happens. But yeah, there could be a relationship between how the accountants look at it and what coverages are in place and what the growers are anticipating, what the value of their product is in the field. You know, they have to come up with projections, et cetera.

Eric Altstadter: Wayne, at what stage of the companies should they reach out to you? I know it's going to be different depending if it's a dispensary or a cultivator, but at what point, I mean, New York is going through so much changes right now, as licenses are being issued and things are, applications are being made and so much is happening. When should these companies start to get their ducks in a row and get their insurance in place to start operations?

Wayne Margulies: So that too is an interesting question. The last three weeks I've been inundated with calls from the newly licensed New York growers. So far there, I believe there are 223 New York State farms growing up to one acre of outdoor grow or a certain number of indoor grow. And the numbers are a little flexible because the growers did some pushback with the New York State OCM and they had to leave some ground for, they're considering the canopy space. So was it one physical acre or enough to cover how the canopy expands?

We as a company, it's too early for us to go out to the marketplace before anyone is licensed. We have been down that path too many times and we made a decision not to go out to the marketplace for pre-licensed organizations. So on new operations, once licensed, they should reach out to us. For existing operations we should be looking to help them. For a multi-state operator who, when they were growing by states and cross border, their existing insurance broker had them have over 100 separate policies to cover each different state. By the time they added up all the states, we were able to bring it down to 15 policies. Just think about the management oversight. So we're at all stages, but not pre-licensed.

Eric Altstadter: Great. Well, I think we're getting close to the end of our hour. So I wanted to thank everyone for joining us. I wanted to thank our speakers here for joining us on this presentation. Hopefully my speaker and my mic is a little better now than it was at the beginning. I heard my discussion was a little muffled at the start. So my apologies. So with that, I want to thank everybody for joining us today. Please pay attention our alerts for future events. We'll be doing this on a somewhat regular basis. So with that, I want to turn it over to Bella.

Moving on, credit card statements and supporting receipts. What I would absolutely recommend is you keep one credit card that is used exclusively for business purposes. Do not commingle it with personal expenditures. Keep it strictly for business and keep the supporting receipts for each credit card charge. I mean, technically the credit card statement would almost mean nothing in an audit. You need the supporting documents. Now you might think, okay, there's certainly some recurring business charges that you might put on a credit card that you don't have a receipt for each month. Just thinking like, if you have an account with Zoom and they automatically charge the card. Obviously you don't have a receipt for that, but you would have the underlying contract that would support that charge.

Always maintain proper documentation and receipts for travel and meals. And for that, remember to include the who, what, why, where, when. In other words, who were you with? What was the business purpose? What did you discuss? Where was it? When did it occur? If you're ever audited, those are the things that will be looked for.

Payroll. I have two words of advice when it comes to payroll, and that is outsource it. Even if you are a payroll guru, preparing payroll in house is way more trouble than it's worth. Using a reputable, reliable payroll service that will prepare your recurring payroll, quarterly and annual filings, having your withholding and employer taxes impounded, that will keep you in compliance and keep you out of wearing stripes.

Inventory management, and control. Now this technically could, there could be a whole seminar on this for a cannabis business, but proper inventory management, it's always integral to a business that carries inventory, but even more so in a cannabis business. As Eric stated at the beginning at the federal level, a cannabis business faces unique tax restrictions. Your cost of goods sold is the only deduction you get. So you want to make sure you capture all the legally acceptable costs that get baked into your inventory. Accurate inventory costing is essential, and you don't want inventory walking out the door without receiving payment for it. Inventory needs to be safeguarded.

Cannabis inventory management is especially important because you have to protect yourself from regulatory fines and license revocation. I mean, clearly Uncle Sam will be watching you. Use reliable software to track it. From the moment in order is placed to the moment it is handed to the customer, you want to be aware of where it stands, and that software should be able to produce good reports that give you really vital information for running the business and making decisions. If you don't understand the reports, contact your accountant. He or she will clearly be happy to explain what it means and what you need to do, understanding your margins, your gross profit, which is absolutely crucial.

Another important aspect for running a business is having strong internal controls, and an internal control is just a process that's designed to provide reasonable assurance that the business operations are effective and reliable. Internal controls can minimize errors in irregularities and fraud and maintain the integrity of the financial information. There are many internal controls that can be implemented, but I will say the two most frequently employed by businesses of all sizes is a proper segregation of duties. For example, the person that's reconciling the bank account, you don't want that same person to be making vendor payments or approving vendor payments or handling cash deposits. Another example, you don't want the person that's hiring employees to also be the person that's paying salaries and they could add a fictitious employee and make sure the money is diverted to themselves. And secondly, just management must have oversight over all of the accounting functions. This certainly helps to ensure that your employees act with integrity. I mean, as there's an old saying, that says the purpose of a lock is to keep an honest person honest, and that's what it does.

Something you should also take into consideration along with this proper record keeping is document management. Keep a database of the important contracts and agreements that you undertake. Retain records for the recommended amount of time, and that depends on what type of document it is. I mean, there's all different recommendations for the different types of documents. Generally speaking, it's five to seven years is where most documents fall. I've heard that they recommend that you keep insurance policies forever, even if they are no longer in existence. The statute of limitations for federal tax returns is generally three years, but in the case of a substantial omission of income, it goes up to six years. And there's actually no statute of limitations if fraud occurs, which is a willful intent to evade taxes. So don't do that. Or if no return is ever filed, the statute of limitations does not apply. So, consider those audit periods when you're deciding how long to maintain documents. Consider insurance claims, lawsuits. Those are all things to keep in mind.

Other considerations for running a business, I would say, maintain a budget. Maintain a budget, compare to actual results on a periodic basis. This will allow you to change course if necessary, or maybe perhaps the budget wasn't realistic. But again, it's always good to benchmark things and to keep tab of how things are going. Maintain compliance with laws and regulations through timely reporting requirements. You want to file your payroll tax returns. Timely income tax returns, sales tax returns, extremely important. And your 1099 filings. At the end of the year, you got to look and see, did you hire independent contractors or pay other non-employee compensation? You want to make sure you file the correct reports to the government and to those recipients at that time.

The other consideration is cyber security. I mean, in this now, you're collecting credit cards or other personal identifying information. If you keep that information on file or any medical type of information, you really do need to make sure that that data is safeguarded. That is extremely important, your liability. If you let that information get into the wrong hands, you'll have a very big problem on your hands. And lastly, and of course, Wayne will be talking more about this, but maintain insurance. This is your business. You need to protect it. You need to protect yourself. Feel free to ask any questions.

Hubert Klein: Thank you very much, Gaye. That was excellent information for people looking to start a business or currently in business. And you're ending segues right into Wayne. Wayne is our next speaker, from Hub International. He's going to talk about risk mitigation and controls revolving around insurance policies and other issues. And Wayne's going to talk about what types of coverages are available and what types of coverages are needed. So without any further ado, Wayne, you're up.

Wayne Margulies: Hubert, thank you very much for the introduction. What type of insurance coverages are needed? You know, it's a very good question, but I have to apologize to everyone. I have a very hoarse voice. I've had all my COVID shots and boosters, but I'm getting over my second bout. And I'm feeling better. And I was planning on wearing this shirt, which is very appropriate. And if you can't read it, well, it says, "When this virus thing is over, I still want some of you to stay away from me." I bet a lot of you feel the same way.

So it's really great to be invited to talk about the insurance segment of this of this presentation. I want to thank all the folks at EisnerAmper and especially Eric Altstadter. What an amazing lineup of truly professional cannabis industry experts we have on this call.

So in all fairness, today's discussion, including my area of specialty, cannabis insurance, is not the sexiest of topics, but it's essential. And just like any other business sector, understanding and taking organized and preventative measures in setting up your organization or realizing your existing operations do not address these concerns well enough. Those on today's call are innovative thought leaders and advocates for a truly underserved industry.

So at Hub International, we've been in the cannabis space for close to 10 years, and we're currently servicing over 700 cannabis clients. There's 250 of us on our cannabis specialty team. So I like to say we're the 800 pound gorilla in this space. A basic tenet of insurance is to eliminate unnecessary risk through comprehensive risk management plans. And for the risk you can't control, transfer the majority of them to insurance carriers who focus in the sector.

Again, I apologize for my hoarseness. Risk management can include written plans and procedures on security, physical structures, administrative as well as training and accountability, procedures and policies for staff awareness, violence prevention, threat reporting, and conflict management for when these things do happen. It's so much more than which insurance policies do I need.

Going back to the initial question, which insurance coverages are needed? Well, it's not the simplest of answers, and it really depends on your individual operations and how you operate. All these things are considered by underwriters when deciding if they will provide coverage. And the more prevention that is put in place will help you secure coverage and reduce the premium. So whether you're a grower, an extractor, manufacturer, processor, testing lab, dispensary, delivery service, or a lounge, or any one of the other cannabis business operations, they all have some common statutory requirements like workers comp and disability, which do vary by state regulation.

And each operation all has different exposures that with the help of a specialist will be identified and presented to potential carriers in the most advantageous light. Most cannabis organizations have, or begin operations with a combination of property, general liability and product liability coverages, which is typically combined into what is called a business owner's policy or BOP for short. Property insurance protects your facility, equipment and operations. General liability covers you and your company for claims involving injuries and property damage resulting from your product, services, or operation. It typically also covers you if you're held liable for damages to your landlord's property. Product liability applies to every business that brings a product to market. This coverage helps to defend your company against claims and allegations and help pay damages if you are found legally liable when something bad happens in connection with the use of your product.

As you know, we live in a very litigious society. Some other included or additional coverages can be business interruption and crime or theft. If raising capital, then protecting the board should be a consideration as sophisticated and experienced individuals in any sector will not consider becoming a member of a board without an appropriate directors and officers policy being in place. They do not want to be personally held responsible for business decisions.

We also need to recognize staffing considerations. To attract and retain employees, employee benefits, such as health insurance, vision, dental are basic coverages most companies provide. Providing them with financial advice, for example, 401k solutions is now an offering.

The list goes on and depending on your operations, you might consider cargo, commercial auto, crop insurance, cyber, employment practices liability, product withdrawal, special events like exhibiting or selling at a trade show, or farmer's markets. Markets are coverage for consideration. Right now, crop insurance for cannabis is just too expensive for outdoor growers so no one is buying it, but indoor crop coverage is available in true greenhouses, but not in hoop houses.

For those not yet licensed, secure or review your existing life and disability policies to protect your income and legacy, as once licensed, it's quite difficult to find an insurance carrier willing to be on the other side of the federal illegality of cannabis. And it doesn't matter whether the individual or organization is plant touching or not, and for the most part will decline to provide a policy. Hard to believe, but true.

Now let's address the risk of not having proper coverage. If operating in the cannabis sector, you need to make sure existing policies do not have cannabis exclusions, exposures where if that thing, incident occurred, happened, or a claim that such a thing happened, well, it gives the carriers the out from covering just such a claim. For example farm policies exclude hemp and cannabis operations, and hemp policies exclude cannabis operations. Therefore, in attempting to drum in the understanding that cannabis specific policies are a required expense or said better, protection every cannabis business needs. As mentioned above briefly, insurance is also not only there to provide the money to pay for claims against the organization, but as importantly, to provide for the legal defense costs for attorneys, defend you against real or frivolous claims within the limits of the policy that you secure. Excuse me, one second.

Lastly, let's briefly discuss other risk issues. Risk management is a whole separate topic, and you must be proactive in creating, reviewing, modifying standard operating procedures in all aspects of your operation. These can include regulatory compliance, safety and training, operational hazard, and site security, behavior based safety, fleet and equipment safety driver, accountability, emergency response, and business continuity. And this is not the full list that we recommend should be considered.

In closing, as compared to any other business sector, there are very few carriers offering coverage in the cannabis space. So in order to protect and preserve your leverage in securing the best policies, it's essential to vet the insurance broker you want to represent you out to the marketplace, and not have more than one broker represent your needs to this very limited marketplace. I was not sure I would be able to get through the entire presentation. So thank you all for listening in.

Hubert Klein: Wayne. Thank you very much. I mean, there was a lot there and I particularly took it to know what's in the policies. And Wayne brought up a very good point, how with the cannabis exclusions and all these other things, you need to know what you're buying, and that's why you need to reach out to someone like Wayne, who knows these policies, who knows what the companies that cover this type of stuff. And he went to a whole list of different segments of the cannabis industry, from growers to retailers, to delivery systems, things that we don't even think about that touch cannabis, but just the delivery system and the shipment systems, right? There's all things that go into that outside of just the growing in the selling. So, Wayne, thank you very much. That was great.

Wayne Margulies: You're welcome.

Hubert Klein: Okay. So now that we've covered why do you need accounting records and how are they useful managing the business to understanding risk management and why you need to insure yourself for risk management and what types of coverages are out there, it always comes back around to the tax and compliance end, right? There's always, Eric talked about the legacy business, right? Which is the old guy selling on the street corner. Today we have the regulated business, which is the legalized cannabis space. And in there, it has its whole host of things that we need to deal with. And we have Ben Aspir here today from Eisner, who's going to talk about tax and compliance issues, and from income to sales tax and other localized tax issues, and give you a flavor for what's going on. So Ben, you're up. I think you're on mute too, Ben.

Ben Aspir: Thank you, Hubert. As a tax professional, as someone that has been in the cannabis group, the EisnerAmper cannabis group for the last six or seven years, it's been amazing to see the evolution of the industry and to learn about the nuances that apply specifically to the cannabis industry. I'm sure everyone on today's webcast is aware that cannabis is federally illegal, but regardless of an industry's legality at the federal level, they're still required to pay taxes. As most of you are aware of the infamous case with Al Capone, regardless of locality, you still have to file your taxes. As Eric mentioned at the beginning of today's session, he touched on 280E, and then 280E really is the albatross around the neck of the cannabis industry, because essentially it, you can see industries, you can see cannabis companies that have an effective tax rate of 70%.

You know, usually it can be about half that. So it's sucking the cash out of the cannabis businesses. So it's important to be aware of the federal tax implications of 280E, and I'll touch upon the state tax implications, because just like the legality at the state level is very different from state to state, the taxation of cannabis varies from state to state. There's just income tax through sales tax. There could be excise taxes.

I'm going to start off just going briefly through 280E and this history. And Eric touched on it before, but 280E was precipitated by the case of Jeffrey Edmondson. And Jeffrey was a drug dealer in the early '80s. And it was challenged. They made him file tax returns and he deducted all the expenses that were related to his illegal drug trafficking businesses. And he prevailed and he was able to deduct a significant amount of expenses.

And Congress was none too fond of that ruling. So after that they enacted section 280E of the revenue code. And then 280E disallows deductions for sales of schedule one and schedule two substances under the Controlled Substances Act. And the Controlled Substances Act was passed I believe in the early '60s, and it schedules out different types of drugs, one through five, one being the most addictive with no medicinal use. So schedule one drugs would be cannabis, heroin, methamphetamines, LSD. So being that cannabis is a schedule one drug, cannabis businesses are limited to their cost of goods sold as deduction.

Now that would have a significant detrimental effect on retail businesses, because what are the costs of goods sold? The products purchased, and that's pretty much it. They wouldn't be able to deduct any of their GNA expenses, any rent, any insurance, any payroll, whereas a grow operation, cultivators have a significant amount of expenses allocated to cost of goods sold growing the product, from depreciation, salaries of the actual growers. So it's important to engage a proper CPA firm, to do essentially a 280E analysis to make sure that it's being reported properly and that also that the cannabis business is maximizing their allowable deductions.

Additionally, there are many states that have what's called decoupled from 280E. And what that means is you have state taxes, state income taxes, and they're saying, "Fine, you have 280E at the federal level. We're not going to go by that. We have our own state tax regime. You're allowed to deduct any ordinary necessary expenses that any of our other businesses in the state." There are about a, more than a dozen states that have so far decoupled from 280E. And my, the neighboring state, New York has done that. It's been in the works for New Jersey for a while. They have not done that as well. They have been trying to push that through to decouple, to at least ease the tax burden on cannabis businesses and allow them to deduct any ordinary necessary expenses that any other non-cannabis business could deduct.

Part of the 280E analysis that should be performed is determining if there are other lines of business that wouldn't be subject to 280E. And a lot of, 280E has been litigated a significant amount. There's been numerous cases that I've read through. And a common theme is, and as Gaye spoke about the importance of books and records, right? So a common theme is that the IRS disallowed deductions not necessarily because they weren't legitimate, but because there was lack of records. There's lack of any proof, any backup. There was extremely poor records by the taxpayer and the taxpayer couldn't provide any support for the deductions that they were trying to claim. So the importance of proper records, having good bookkeeping and accounting in place, is really important.

So in addition to income taxes, the states have sales taxes. And even within that, so New Jersey now exempts, my home state exempts sales taxes on medical cannabis, whereas recreational is still subject to it. So even for a non-cannabis business, sales taxes, excise taxes can be a trap for the unwary. So it's important to engage a knowledgeable professional in the area. And, you know, with the lack of ... As I mentioned, cannabis businesses have to pay their taxes, but a lot of them have, there's a lack of banking access, especially most federally chartered banks aren't, do not want to work with cannabis businesses. And so it leaves room for the smaller state chartered banks that charge exorbitant fees.

So with the lack of banking access, cannabis companies have to pay taxes, but a lot of them don't have bank account, so literally the IRS has cash counting rooms for cannabis businesses that are bringing in ... It's almost like out of the movies. And they have to bring in significant amounts of cash and the IRS, to pay their taxes, whether it be payroll taxes, federal income taxes. So it's important to have proper books of records to pay the taxes and to make sure that they're accurate.

In my time, I've done several due diligence projects with cannabis businesses and from the buyer side, we get a peak into the seller's books and records. And I could tell you, there's a lot of bad cannabis tax advice there where companies were deducting way more expenses than they should be taking on the tax returns, extremely aggressive. So, there's a lot of bad tax advice out there, and make sure to hire a competent tax professional experienced in 280E and in the cannabis industry. Thank you everyone. And I believe now I'm going to turn it over to Eric.

Eric Altstadter: Thank you, Ben. Thanks for that presentation.

Hubert Klein: You're up, Eric.

Eric Altstadter: Hubert, do you have any, we have any questions for the audience that we want to address to the panel?

Hubert Klein: We do have one question and I guess it'll pertain to the accountants on here, but basically regarding the discussion of outsourcing the payroll, the questioner says, "Isn't it true that not all payroll companies will service a cannabis business?" So I don't know, Gaye, Ben, Eric, you want to address that?

Gaye Eschenbach: I will address it. That's correct. Much like in the banking industry, there are few and far between, but there are services out there that will service it. It's a matter of research, talking to other people in the industry, see what they're using, but yeah, absolutely correct. Just like with banking, it's slim to none as far as the providers, but they do exist.

Eric Altstadter: And Wayne, a quick question for you, one of the questions that came up also is the cost of insurance for cannabis companies versus a non-cannabis related business. How different is the price structure? How much of a burden are cannabis companies handling with insurance?

Wayne Margulies: Well, again, it relates to which coverages. So if it's directors and officers, so directors and officers is expensive in any business sector, but in the cannabis sector, it could be 50 to 100% higher. So it's good to have someone know the different marketplace that play in the sector. With the other lines of coverage, more standardized coverages, I would say it could run 10 to 30% higher than standard, than non-cannabis sectors. And I say on health insurance, there's basically no difference. Hope that helps.

Eric Altstadter: Hubert, you mentioned earlier the cost of banking in this industry. I think it was you that mentioned this. And certainly what we're seeing is, I think Gaye had mentioned this, that we're seeing more state chartered banks and credit unions are in the industry. But there are some national banks who are getting into it, but the cost of banking is not inconsequential. What are you guys seeing as far as additional costs related to banking these days, and are you seeing any changes in the industry?

Hubert Klein: Well, Eric, I know you and I have spoken about this before and Ben actually brought it up which is a really good point about the cost for banks, but the banks are getting more aggressive with the fees that they're charging people, because they have a captive audience. So unless something happens federally to change all this, to make it easier for the federal banks and the state banks, it's a cost that's passed through to the cannabis company and it's also going to be hit with the 280E exclusion.

Eric Altstadter: You know, while we have everybody here, I'm just curious, Wayne, I'm just curious for your view about federal legality. Do you see anything down the road in the near future?

Wayne Margulies: Let me put on my Carnac hat. You had to be a fan of the Tonight Show and Johnny Carson to understand that reference. We have no crystal ball. I think it'll require more and more states to adopt. I think it'll require most states to adopt legality in different aspects for federal legality to happen throughout the country. So there's no timeframe on what we're working with. So it's just good to know and understand each state's individual compliance regulations, follow them, keep your books and records in check and updated and review your policies and procedures.

Hubert Klein: Eric, I think I have a question for Gaye and Ben because they touched on the record keeping obligations and the compliance side. And it sounds like a lot and it sounds scary at the beginning of it, because it seems like a lot, but Ben, Gaye, isn't this the same advice we'd give to a non-cannabis business as well?

Ben Aspir: Yeah, absolutely.

Gaye Eschenbach: Absolutely.

Ben Aspir: Oh, you can go, Gaye.

Gaye Eschenbach: I'm going to say the same thing. Yes. It's basic business advice that you would really give to any business. I think the issue with cannabis businesses is they will be subject to so much oversight that when, you want to make sure that you've crossed the T's, dotted the I's because you don't want to lose any available deduction as it relates to cost of goods sold at the federal level. And then again at the state level, if they have decoupled from 280E, that's another story. But again, you still need to substantiate those deductions as well.

Hubert Klein: And Gaye, from your experience is not having those basic systems in place one of the main reasons that businesses get into financial trouble? Not paying the taxes?

Gaye Eschenbach: Absolutely. Yes.

Ben Aspir: Yes. Much better to be proactive. And from the foundation up to have, like Gaye said, internal controls set up, especially because you're dealing with a lot of cash. There's generally no access to credit card. So it's mostly cash only business and it prevents major headaches in the future and anyway, benefit to you as a cannabis operator is, you have a full understanding if you have proper books and records and as Gaye mentioned earlier, you can sleep at night knowing that you have proper internal controls in place.

And then understanding how your cannabis entity is operating, is there room for additional improvement in operations? And I would even mention that, like I mentioned earlier, having been for almost the majority of a decade been involved servicing the cannabis industry, just the evolution in the last three, four years of service providers, like with Wayne, five, six years ago, there were so few service providers, even accounting firms or attorneys that were willing to service the industry. It's been pretty remarkable to see the evolution.

Eric Altstadter: Yeah. I think Ben, you had raised a very good point and I think when you're running a cannabis company, you have to run a cannabis company like you'd run any other business. And I think Gaye, you mentioned that projections, budgets, you really have to maintain a good set of internal support to allow you to make contemporary decisions about what you're doing with your operations. If your information's not good, your decision making is going to be somewhat lacking. So I think that's very important. And Hubert, I think I interrupted you. Hubert?

Hubert Klein: That's right. We did have another question come in that I don't know the answer to, and obviously I think the other accountants in here might have it, but how is cannabis inventory treated for the cannabis product? Are the plants themselves considered inventory, or are they a depreciable asset? My basic understanding is you grow the plant, the plant is killed off and dried, but I don't know that answer. So does anybody know that answer?

Eric Altstadter: It's actually a little bit of both. It depends if you're following U.S. GAAP or IFRS. There's different ways to account for depreciable assets or plants. U.S. GAAP is one way. IFRS is a little different view of it. So for those companies that are operating, like particular north of the border in Canada and following Canadian GAAP, the literature is a little bit different than how that gets handled, but it's usually, it's either ... Actually with respect to the question, it's one of the two. It can be a depreciable asset or it can be just an inventoriable asset, but it's one of those two, and it depends on the GAAP that you're following.

Hubert Klein: Okay.

Wayne Margulies: You know, I'm not going to answer from the accounting side, but from the insurance side, it really depends on again, are you a grower? So now we have to look at it one way. Is it in a dispensary? Is it in transit? So let's say for a grower in crop insurance, the plant, if grown indoors in a true greenhouse, is protected and covered for X dollars in the first 10 days of growth. Then the next stage, however long that is, is covered for two X, three X all the way up to just before it's harvested. So the valuations change through the growth period, and that might be helpful in addressing accounting procedures to what the value is at different points of the grow.

Hubert Klein: So it would be safe to say that the accountants should really consult with the insurance companies on the valuation or any other subset there of what that may be worth, because somebody may be under or over-insured on their product.

Wayne Margulies: It's hard to get over-insured, just for the crime potential that someone would fake a claim or something like that. So we're not, you can't look to make money off of insurance, even though in the end, that never happens. But yeah, there could be a relationship between how the accountants look at it and what coverages are in place and what the growers are anticipating, what the value of their product is in the field. You know, they have to come up with projections, et cetera.

Eric Altstadter: Wayne, at what stage of the companies should they reach out to you? I know it's going to be different depending if it's a dispensary or a cultivator, but at what point, I mean, New York is going through so much changes right now, as licenses are being issued and things are, applications are being made and so much is happening. When should these companies start to get their ducks in a row and get their insurance in place to start operations?

Wayne Margulies: So that too is an interesting question. The last three weeks I've been inundated with calls from the newly licensed New York growers. So far there, I believe there are 223 New York State farms growing up to one acre of outdoor grow or a certain number of indoor grow. And the numbers are a little flexible because the growers did some pushback with the New York State OCM and they had to leave some ground for, they're considering the canopy space. So was it one physical acre or enough to cover how the canopy expands?

We as a company, it's too early for us to go out to the marketplace before anyone is licensed. We have been down that path too many times and we made a decision not to go out to the marketplace for pre-licensed organizations. So on new operations, once licensed, they should reach out to us. For existing operations we should be looking to help them. For a multi-state operator who, when they were growing by states and cross border, their existing insurance broker had them have over 100 separate policies to cover each different state. By the time they added up all the states, we were able to bring it down to 15 policies. Just think about the management oversight. So we're at all stages, but not pre-licensed.

Eric Altstadter: Great. Well, I think we're getting close to the end of our hour. So I wanted to thank everyone for joining us. I wanted to thank our speakers here for joining us on this presentation. Hopefully my speaker and my mic is a little better now than it was at the beginning. I heard my discussion was a little muffled at the start. So my apologies. So with that, I want to thank everybody for joining us today. Please pay attention our alerts for future events. We'll be doing this on a somewhat regular basis. So with that, I want to turn it over to Bella.

 

About Eric Altstadter

Eric Altstadter CPA is an Audit Partner and Chair of the firm's Cannabis and Hemp practice with over 30 years of experience working with public companies and privately held businesses

About Hubert Klein

Hubert Klein a Partner, the Firmwide Valuation Services Leader, and the New Jersey Forensic, Litigation & Valuation Services (“FLVS”) Market Leader, is a nationally recognized expert witness and professional educator in forensic accounting, damages, and valuation topics.

About Gaye C. Eschenbach

Gaye Eschenbach is a Senior Manager in the Private Client Services Group assisting many industries including manufacturing, wholesale distribution and real estate with tax planning and review, financial statement compilation and review services.

About Ben Aspir

Benjamin Aspir is a Senior Manager and a member of the firm’s National Tax Group, with more than 10 years of public accounting experience. He has extensive experience with IRC Section 1202 - Qualified Small Business Stock and advising cannabis clients on IRC Section 280E, within the Manufacturing and Distribution practice.

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