Hemp Accounting vs. Marijuana Accounting: What are the differences?
Until recently, hemp and marijuana businesses generally applied similar accounting methods and assumptions. Both cannabis sativa, in general hemp plants have less than .3% THC and marijuana plants have more. Producing and selling industrial hemp is legal in the United States under the 2018 Farm Bill, pending the release of USDA approved plans by the individual states. Producing and selling marijuana on the other hand is not.
Traditional cannabis accounting focuses on compliance, record keeping and tax limitations for marijuana businesses. Marijuana business operations require conformance to IRC §280E. This code section limits marijuana businesses from deducting ordinary and necessary business expenses for federal income tax purposes. Marijuana businesses are also required to follow inventory accounting under §471, which limits what costs they are able to attribute to inventory. Along with additional regulatory, record keeping and audit trail compliance, there are many nuances in marijuana accounting that require specialized expertise.
Expert knowledge of marijuana accounting does not necessarily translate to the knowledge required to understand hemp accounting however. Hemp accounting follows traditional agricultural accounting, or farm accounting, methods and standards.
Where marijuana and hemp business accounting are most similar are the same areas all businesses have similar accounting practices – all require standard bookkeeping, financial reporting, and adherence to GAAP or generally accepted accounting principles. All also require filing tax returns and paying taxes on taxable income. The exception may be record keeping requirements, as both marijuana and hemp businesses have additional rules to follow here (hemp businesses must prove their plants are in fact not marijuana plants). So, where do marijuana and hemp businesses differ in their accounting applications?
US Internal Revenue Code: §280E and §471 vs. §263A
There are several tax code sections that apply to hemp farming businesses that marijuana businesses are not able to follow, and vice versa. For example, marijuana businesses must follow restrictive internal revenue code §280E. However, hemp businesses operating under US Department of Agriculture approved regulations do not follow this code.
Hemp farming businesses also do not follow §471 alone when accounting for their inventory costs like a marijuana business should. Instead, a hemp producer or reseller should follow §263A and apply uniform capitalization rules to its inventory costing.
Similar to §471, uniform capitalization rules under §263A require capitalization of direct and indirect costs in to inventory value. Additionally, service costs identified as indirect costs are also required to be capitalized to inventory value under §263A. Service costs include administrative expenses that support inventory related functions. Costs such as property taxes also require capitalization under §263A. Anyone familiar with marijuana accounting on the other hand knows that administrative expenses typically are not includible in marijuana inventory costs.
Corporations must follow §263A. However some corporations qualify for exemption from following §263A under certain circumstances. IRC §447, “Method of accounting for corporations engaged in farming”, requires that farming corporations adhere to accrual accounting (and follow §263A), unless the farm corporation is an S corporation. Additionally, all corporations that have less than $25 million in average gross receipts for the last three years are exempt from applying §263A, per IRC §448.
Farming businesses must review their application of §263A a step further as well. Under §263A-4, “Rules for property produced in a farming business”, an election is available for plant farmers to opt out of §263A, assuming there are no other provisions disallowing this exemption. In general, many hemp plant farmers meet the election requirements.
For hemp businesses required to capitalize costs under the uniform capitalization requirements of §263A, the Internal Revenue Code defines the costs includible in plant value. According to the code, “the costs of producing a plant typically required to be capitalized under section 263A include the costs incurred so that the plant’s growing process may begin (preparatory costs), such as the acquisition costs of the seed, seedling, or plant, and the costs of planting, cultivating, maintaining, or developing the plant during the pre-productive period. Pre-productive period costs include, but are not limited to, management, irrigation, pruning, soil and water conservation […], fertilizing […], frost protection, spraying, harvesting, storage and handling, upkeep, electricity, tax depreciation and repairs on buildings and equipment used in raising the plants, farm overhead, taxes (except state and Federal income taxes), and interest required to be capitalized under section 263A.”
Hemp businesses meeting the qualifications to elect out of §263A for inventory accounting may apply another acceptable accounting method for inventory costing. One of these methods includes the cash method, or accounting for costs as incurred, rather than capitalizing them.
Another accounting method used by some farm businesses is the annual accrual method of accounting. The annual accrual method of accounting is defined under IRC §447, and is a “method under which revenues, costs, and expenses are computed on an accrual method of accounting and the pre-productive period expenses incurred during the taxable year are charged to harvested crops or deducted in determining the taxable income for such years.” Hemp farmers generally grow their plants and complete harvest in one season. Consequently, many hemp farming businesses reasonably apply a modified accrual method of accounting.
Local Tax Incentives – Farmland and Open Space Preservation Program (Michigan)
Michigan hemp farmers operating under Michigan Department of Agriculture and Rural Development (MDARD) and US Department of Agriculture approved regulations may be able to qualify under the Farmland and Open Space Preservation Program for a tax credit based on their farm’s property taxes. “PA 116” commonly refers to this program. A Farmland Development Rights Agreement with the State of Michigan requires a farmer to agree that their land will be used only for agricultural purposes. In exchange, the farmer is eligible for certain exemptions from special tax assessments and a tax credit.
Farmland is eligible to qualify for the Farmland and Open Space Program, if one of the following requirements is met:
- it is 40 acres or more in size, and at least 51% of the land is in active agriculture.
- it is less than 40 acres in size but at least 5 acres in size, more than 51 % of the land is in active agriculture, and the agricultural land produces a gross annual income in excess of $200 per tillable acre.
- the farm has been designated as a specialty farm by the Michigan Department of Agriculture, is at least 15 acres in size, and has a gross annual income in excess of $2,000 per year.
In exchange for participating in the program, eligible farmers receive an income tax credit. This credit equals the amount the farm’s property taxes exceed 3.5% of income. Farm land qualifying and enrolled in the program also receives exemption from certain new special assessments. These assessments include for sanitary sewers, water, lights, or non-farm drainage. Assessments imposed prior to the farm’s farmland agreement do not qualify.
Federal Tax Incentives and Grants
With the federal prohibition on marijuana, these businesses can not take advantage of federal tax incentives and grants otherwise available. Hemp businesses on the other hand may qualify for these options similar to other farming and agricultural businesses.
Federal Opportunity Zones and Qualified Opportunity Funds
Newly available under the Tax Cuts and Jobs Act of 2017, investing in Opportunity Zones allows the ability to delay and reduce taxable gains. Defined by the IRS, “An Opportunity Zone is an economically-distressed community where new investments, under certain conditions, may be eligible for preferential tax treatment.” Hundreds of communities in Michigan received approval as an opportunity zone. Check out the list here.
In order to qualify, hemp farm entrepreneurs must first invest taxable gains into a Qualified Opportunity Fund (QOF). Before doing so, the entity must be structured properly with the correct tax election selected. Then, for any gains invested into the QOF, the taxes become deferred or reduced. After at least 5 years the taxable gain lowers, resulting in tax savings.
Farmers currently farming another crop (such as corn or soy beans) may also be able to utilize opportunity zone incentives. Converting their current farm into a hemp farm may qualify under opportunity fund rules.
Grants and loans available from the USDA
The US Department of Agriculture offers access to many different types of loans and grants available for farming businesses or not for profit entities. Through the Farm Service Agency, the USDA provides loans to beginning farmers who are unable to obtain commercial financing. Additionally, special loans and grants are available for rural business development and micro-entrepreneur assistance programs.
The 2018 Farm Bill also provides for additional opportunities, including crop insurance on eligible hemp production beginning in 2020. Many tools and informational resources are available via the USDA for beginning hemp farming businesses.
Eligibility as a not for profit entity
Marijuana businesses generally are not eligible to receive federal tax exempt status as a not for profit entity. There are no such restrictions for hemp businesses however operating under USDA approved regulations. Many grants and incentives offered by the USDA described above are available only through not for profit agricultural organizations.
Applying for tax exempt status with the Internal Revenue Service can be a complex process. However, it is no longer a wasted effort by hemp production or distribution focused entities. Organizations denied federal tax exempt status as charities incorporating cannabis may otherwise qualify as hemp only businesses. Several other criteria also apply for being eligible for tax exempt status. Check out the application form for applying for charitable tax exempt status under IRC §501(c)(3) here.
LC Solutions Michigan PLLC – We can help!
Our CPA firm places its focus on supporting complete and compliant accounting practices for both hemp and marijuana businesses. We understand the agricultural accounting considerations necessary for hemp farmers to incorporate into their business process. Our accounting professionals have helped hundreds of businesses manage their accounting needs operating in the regulated cannabis industry. From bookkeeping and CFO services to tax planning and traditional attestation services, our firm has the experience and knowledge to help your business implement and maintain a successful accounting environment.
Copyright by LC Solutions Michigan PLLC
October 29, 2019