Speaker: Cannabis Industry Ramping Up, with Major Opportunities for CPA Firms

By:
Ruth Singleton
Published Date:
Dec 12, 2018

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The cannabis industry could reach sales of $35 billion by 2022, creating significant opportunities for CPA firms to expand their practices in bookkeeping, auditing and tax. That was the message of Matthew Karnes, founder and managing partner of GreenWave Advisors, LLC, who presented an overview of the cannabis industry at the Foundation for Accounting Education’s Cannabis Conference on Dec. 11.

Karnes noted that there are currently 33 states permitting medical cannabis and 10 states plus Washington, D.C, that allow for recreational use. By 2022, he predicted, cannabis will be legal for one or both uses in every state. “We’ll be seeing a big ramp up in 2022,” he said, noting that, by that time, New York, New Jersey and Michigan will likely have legalized recreational use.

The opportunities for CPA firms will be numerous, he said, explaining that the cannabis business is mostly cash, and the people working in it are often right out of college or otherwise inexperienced. And so, the “biggest opportunity is getting books ready for an audit,” he said. On the tax preparation side, CPAs can help clients comply with Section 280E of the Tax Code, which disallows credits and deductions for Schedule 1 drugs other than costs of goods sold.

Karnes said that there has been a gradual shift from illicit to legal markets, although it is difficult to report reliably on the size of the shift  because of the scarcity of credible sources for compiling figures from the illicit market. Estimates for illicit sales are often based on plant confiscations by the Drug Enforcement Agency (DEA) and the Department of Homeland Security. The plants are converted into pounds and then estimates are based on the average price per pound. That information has been tracked since 2012, he said.

Karnes cited several recent positive developments for the industry, including the legalization of cannabis in Canada as of Oct. 17, and the tremendous amount of capital entering the industry.  In addition, the 2018 Farm Bill, will allow for cultivation of industrial hemp and the sale of CBD (cannabidiol) in all 50 states. (The Senate passed the Farm Bill on the day of the conference, and it now heads to the House of Representatives.)

Karnes also cited the following positive developments for the industry:

• The Trump administration has announced that it will allow each state to make a determination about legality. “If they were going to shut it down, they would have done it already,” he said.

• Former Speaker of the House John Boehner and former Massachusetts Governor William Weld have joined the board of directors of Acreage Holdings, a cannabis investment company

• Canadian cannabis company Canopy Growth is now listed on the New York Stock Exchange.

• Canadian cannabis companies Tilray and Cronos have direct listings on the Nasdaq.

• Alcoholic beverage company Constellation Brands has increased its stake in Canopy Growth to 38 percent after buying shares worth 5 million Canadian dollars

• The Food and Drug Administration (FDA) has  approval the epilepsy drug Epidiolex, which is significant because it’s based on CBD from the cannabis plant.

• Altria, which owns tobacco company Phillip Morris, has taken a 45 percent stake in Cronos after buying shares worth 2.4 million Canadian dollars

With regard to investment opportunities, he said they are divided between plant-touching operations and ancillary operations. Plant-touching operations include cultivation, processing, manufacturing and retail. Ancillary operations include lab testing, data analytics, delivery, agriculture technology, and professional services (such as accounting and legal services.)

Karnes said the infused product market, which includes edibles, is gaining significant market share and now represents 30-50 percent of the market, as smoking has grown more unpopular because of health concerns.

Still, Karnes acknowledged that the industry faces many challenges as long as marijuana remains a Schedule 1 drug on the federal level, the same classification as heroin or LSD.

"I have never spoken at a heroin or LSD conference," Karnes said.  "[That's how] how ridiculous that law is."

He noted that the Section 380E tax burden can yield an effective tax rate as high as 80 percent, which is why cannabis companies need to maximize what they can claim as cost of goods sold. (In a separate session, Peter Matz provided details about complying with 280E.)

Banking also remains an obstacle for the industry, said Karnes. There are currently 111 credit unions that work with cannabis businesses, and there are 496 financial institutions, up from 412 at the end of 2017. In Colorado, he said, one credit union, Partner Colorado Credit union (PCCU), maintains 32 percent of all marijuana deposits. But there have also been 15,363 account terminations in the past year, which occur when banks discover that accounts are being used for the cannabis industry. He said, frequently, that as one account opens, another closes.

Only 14 percent of marijuana businesses have bank accounts, he said, and lot of them conceal the nature of their business, a practice he strongly advised against.

Karnes said that notable trends include a continued disruption to medical use sales as the recreational use market comes into play. In Colorado, he said, patient counts have been coming down since recreational cannabis became legal, as have revenues. He has seen the same trends in Nevada, Oregon and Alaska. Most states with recreational use have been merging the two markets, but Colorado still maintains a bifurcated market. He also said it has become more difficult to become a cultivator because of the growing costs and the declining wholesale price of the flower.

Using Colorado as a case study, he said that the industry took five years to reach maturation. While sales increased over that period, and the state benefited from “cannatourism," sales have flattened in 2018, he said.

Karnes then turned to New York state, where medical marijuana was legalized in 2015. He said the program started slowly, with limited products, limited licenses and qualifying conditions. There hasn’t been a lot of doctor participation in the program, he said, and there are only about 83,000 patient card holders, who represent about 3.4 percent of the addressable market. He noted that recreational use has a good chance of passing next year. (New York State Assembly Member Richard N. Gottfried discussed those prospects in a separate session.)

During a question-and-answer session following his presentation, Karnes discussed, among other topics, research into medical cannabis. For many years, he said, the University of Mississippi was the only university authorized to conduct research. “Only small amounts were tested,” he said, and “it went nowhere.” But slowly, the federal government “started to open up the gates," he said. Last year, it expanded the number of universities that can apply for a grant, and there are now about 19 universities that have applied to conduct research.

“There is clearly an opportunity and a need for the research,” he said.

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