There is no question that packaging can play a big role in the overall success of any cannabis business. From the look and feel of a product to its efficacy, packaging can make or break a business. But how can a business in the marijuana industry ensure that its packaging is a smart investment to help grow profit margins? Well, the answer is simple- by classifying packaging as Cost of Goods Sold (COGS). In this blog, Cannabis Business Owners: Packaging is Cost of Goods Sold-Learn How with Redbud Advisors to maximize your bottom line.
To make sure we get started on the right foot let's go over the Internal Revenue Code (IRC) 280E and what the Cost of Goods Sold actually means. If you already know this, you get to advance to the next section! If you don’t know this, read on and we will have a certificate of completion at the end for you. Just kidding, seriously though it's good information to know!
An example of COGS for a cannabis dispensary is inventory purchased and the associated shipping cost can be allocated to COGS.
What in The Heck is The IRC 280E?
Ok, we are going to give you the long and short of it but mostly just the short. If you need a more in-depth breakdown of IRC 280E you can check out this blog.
The IRC 280E states federally Illegal businesses, such as marijuana businesses, cannot deduct the same type of normal overhead expenses as other businesses if it involves trafficking schedule I or II substances (the sale of marijuana products).
Basically, this is a nice way of saying cannabis business owners, no matter what vertical, are not allowed to write off as many expenses as other “normal” businesses can. Which all really just means cannabis businesses end up paying more in taxes than regular non-cannabis business owners do.
Cost of Goods Sold Mean What Exactly?
Same situation here, we are giving you the TL;DR version of the cost of goods sold. If you need more information we have it, check out this blog for all the information.
The direct costs related to producing the goods being sold by your company, including the cost of materials and labor, is the cost of goods sold. An example of COGS for a cannabis dispensary is inventory purchased and the associated shipping cost can be allocated to COGS.
Businesses within the cannabis industry are treated differently, taxed at a significantly higher rate, and when it comes to being able to claim expenses as COGS you better call your cannabis accountant to double check. A dispensary may not be able to claim rent or utilities where other businesses can. There is another tax code we can dive into in a later blog to delve into that controversial topic.
The takeaway about COGS in the cannabis industry is business owners are left with many expenses on the table and no tax breaks in sight, shrinking their profit margin.
Alright, hopefully, that helped give some perspective on why being able to allocate even the smallest expense to COGS for cannabis businesses is important. You want to preserve that bottom line so you can keep doing what you love within the industry you love.
The Impact of Packaging on Your Cannabis Business
As a full-service cannabis accounting firm, we see so many missed opportunities to maximize COGS in the marijuana industry i.e. maximizing your profits. One of the areas we see this frequently is with packaging. We know it and you know it, the packaging is important.
The package is one of the first things that might catch a customer's eye. When someone doesn’t remember the name of a product they will more than likely remember the packaging. Some customers might choose a product solely based on its packaging. As a cannabis business owner, you want to have inviting packaging that entices the customer.
While flashy packaging does look appealing it may not be functional. A customer is going to keep coming back to your cannabis business if your product is fresh and reliable. Not all packaging is created equal and finding a balance between flashy and effectiveness is important. A good thing to remember, the cheapest option is not always the best option but this isn’t to say the most expensive option is the best either. We always recommend reading reviews and working with your manufacturer to find the best fit for your specific product. Asking for a sample is a good way to get the feel of it…pun intended.
Some argue packaging is not allocated to COGS on the dispensary side but we say it 100% is.
How Can I Allocate Packaging to COGS?
Packaging for your cannabis business that is included as part of the final product can be allocated as COGS.
As cannabis tax experts we see this so much with new clients. Reviewing their books we will notice they paid a graphic designer for a logo or other work and this is being allocated as non-COGS. Designers creating designs for the end user packaging should be allocated to COGS. Or in a dispensary packaging has not been allocated to COGS.
A state may have requirements in place for specific packaging. In general, the product is going in some type of packaging. This is a necessary business expense. Some argue packaging is not allocated to COGS on the dispensary side but we say it 100% is.
Packaging, in general, is considered COGS, Also, the designer of the art is sometimes a cost that is mis-accounted for as "marketing or advertising" but if the design is for the packaging the amount can be allotted to COGS.
Why is a designer able to be allocated to COGS? If the design is printed on the packaging it is ultimately part of the cost of the finished packaging product and should be allocated as COGS. Examples of packaging are mylar bags, exit bags, pop-tops, pre-roll tubes, cubes, boxes for carts, etc.
It’s also important to note that the Internal Revenue Code Section 471-11 says that these types of indirect costs can be allocated to COGS only if you’re creating recurring financial statements that are consistent with GAAP (Generally Accepted Accounting Principles). This is why we work with clients on a monthly basis, to ensure that they are able to maximize COGS legally.
That’s All She Wrote
The cannabis industry is harshly taxed at a higher rate and held to different standards than other businesses. At Redbud Advisors we want to keep more money in your pockets by educating cannabis business owners. Allocating final product packaging to COGS is another opportunity business owners have to maximize their profits. Unfortunately, some business owners are not aware of this opportunity in the cannabis industry.
To ensure your business is allocating expenses appropriately Redbud Advisors recommends getting an account for your cannabis business to assist with your accounting and tax needs. Even better if that person is an expert cannabis accountant.
We work with all verticals and ancillary businesses in this industry. Check out our client Sooner State Packing for all your packaging needs as well.
Why an expert? Because the experts in cannabis taxes and accounting spend more time than your average accountant understanding all aspects of the IRC 280E, how to allocate COGS within the cannabis industry, the best way to set up your business within this industry, plus their overall knowledge about the intricacies of the industry.
If you ever need support for your cannabis business, reach out to Redbud Advisors at 866-830-5144, we are happy to help.