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Net Operating Losses (NOL), Intercompany Transactions, Consolidated Tax Return

Net Operating Losses (NOLs)

US Code Section 172, which governs the net operating loss (NOL) deduction, has gone through some changes over the past few years due to the passage of the Tax Cuts and Jobs Act (TCJA) in 2017 and the CARES Act in 2020. 

Changes timeline

Where does the NOL stand today?

  • Starting 2021, losses arising from operation can be carried forward indefinitely to help off-set future gains. 
  • The amount of NOL that can be used in a given year is limited to 80% of taxable income.

How does a cannabis business report its NOL on a federal tax return?
Since cannabis is considered an illegal business at the federal level, it is bound by the requirements of US Code Section 280E which limits taxable income to gross profit (net revenue less COGS). Therefore, your business may be operating at a loss, but have to pay federal income tax. At the state level, you can take advantage of the entire NOL.  

Maintaining support for the NOL
The IRS requires you to keep records for any tax year that generates an NOL for 3 years after you have used the carryback/carryforward or 3 years after the carryforward expires. 
What is most important for cannabis business is having proper support for inventory and COGS. 

Schedule a free call if you want to discuss the rules and how you can maximize the NOL. 

 

Intercompany Transactions

Intercompany (IC) accounting is the process of recording transactions that take place between the different legal entities and subsidiaries under the companies that owns them. A few of the most common types of IC transactions affecting cannabis businesses are the purchase of goods and services between subsidiaries, royalty, financing and leasing activities, cash management, dividends, and cost allocations. 

Tips to consider:

  • The accounting process for IC transactions can be cumbersome if done manually. If your business has become complex and the general ledger is kept in Quickbooks or a similar software, consider moving to a more sophisticated accounting software.
  • An IC transaction requires two journal entries. One, record the liability (due to) and expense on one company, two, record the receivable (due from) and revenue to the other. Alternatively, only make balance sheet entries initially and post to the income statement when there’s a transaction with a third-party.
    • Illustrative example: Parent transfers cash to its subsidiary to pay rent to a landlord

                       Parent entry would be as follows
                            Dr. Intercompany
                            Cr. Cash
                      Subsidiary entry would be as follows
                             Dr. Cash
                             Cr. Intercompany
                      Once the sub pays rent
                             Dr. Rent Expense
                             Cr. Cash

  • No gain or loss on sale transactions is recognized by the internal entities until the sales is made to a third-party.
  • Upon consolidation the IC should net to zero.

Manual accounting processes lead to bottlenecks, confusion, and the chance of error. If your IC accounting is manual, Schedule a call with us to help automate and develop an efficient process.

 

Consolidated Tax Return

To consolidate or not consolidate, that is the question?

The IRS allows affiliate corporations with a common parent to file consolidated tax returns. The subs need to meet the 80% ownership test and each needs to file consent form 1122 with the IRS.

Consolidation has it advantages
  • Off-setting of one affiliate’s income with another’s loss,
  • Off-setting of capital gains from one and capital losses from another.
  • Simplified tax filing as there is a single corporate return being filed.
However, cannabis businesses need to be aware that if you consolidate plant touching businesses that are subject to 280E with non-plant touching businesses, this will result in the exclusion of certain allowable deductions.

For example, you may have a non-plant touching ancillary business which can deduct its marketing costs in it’s tax returns. However, once it joins the affiliated group and agrees to consolidate, those marketing costs become a disallowed deduction in accordance with 280E. The strategy here may be to create an organization structure to isolate the plant touching business in its own reporting line and file a consolidated return for its “plant-touching” affiliated group.
The election to file a consolidated tax return is difficult to revoke once made. The choice remains binding on all subsequent tax years until the group terminates.

Before you elect to consolidate schedule time to discuss to consider all pros and cons, as only the IRS can grant permission to discontinue the election.