Difference between revisions of "Journal:Accounting and the US cannabis industry: Federal financial regulations and the perspectives of certified public accountants and cannabis businesses owners"

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==Methods==
==Methods==
Qualitative research is particularly well-suited for the “early stages of research” as in the case of a young industry such as cannabis.<ref name="BelottoData18">{{cite journal |title=Data Analysis Methods for Qualitative Research: Managing the Challenges of Coding, Interrater Reliability, and Thematic Analysis |journal=The Qualitative Report |author=Belotto, M.J. |volume=23 |issue=11 |pages=2622-2633 |year=2018 |url=https://nsuworks.nova.edu/tqr/vol23/iss11/2}}</ref> The grounded theory approach to qualitative research utilizes “systematical methodological procedures” to identify theories as they “emerge from the data.”<ref name="AstalinQual13">{{cite journal |title=Qualitative Research Designs: A Conceptual Framework |journal=International Journal of Social Sciences & Interdisciplinary Research |author=Astalin, P.K. |volume=2 |issue=1 |pages=118–24 |year=2013 |url=http://www.i-scholar.in/index.php/ijssir/article/view/43645}}</ref> Grounded theory is particularly appropriate for research such as this study, which seeks to generate theory based upon the reported data from participants.<ref name="Savin-BadenQual13">{{cite book |title=Qualitative Research: The Essential Guide to Theory and Practice |author=Savin-Baden, M.; Major, C.H. |publisher=Routledge |year=2013 |isbn=9780415674782}}</ref> Grounded theory requires one to continuously compare and analyze data previously collected to the new data being collected to identify patterns and themes, and produce theories. Interviews of participants are often used as a method of data collection in grounded theory research.<ref name="AstalinQual13" /><ref name="Savin-BadenQual13" /><ref name="CooperBusi13">{{cite book |title=Business Research Methods |author=Cooper, D.R.; Schindler, P.S. |publisher=McGraw-Hill Education |edition=12th |year=2013 |isbn=9780073521503}}</ref>





Revision as of 23:22, 26 February 2021

Full article title Accounting and the US cannabis industry: Federal financial regulations and the perspectives
of certified public accountants and cannabis businesses owners
Journal Journal of Cannabis Research
Author(s) Owens-Ott, G. Suzanne
Author affiliation(s) Colorado Mesa University
Primary contact Email: Send online message
Year published 2020
Volume and issue 2
Article # 41
DOI 10.1186/s42238-020-00049-7
ISSN 2522-5782
Distribution license Creative Commons Attribution 4.0 International
Website https://jcannabisresearch.biomedcentral.com/articles/10.1186/s42238-020-00049-7
Download https://jcannabisresearch.biomedcentral.com/track/pdf/10.1186/s42238-020-00049-7.pdf (PDF)

Abstract

Background: Cannabis-related businesses (CRBs), in states where cannabis is legal, may be unable to obtain professional financial services such as banking, insurance, and accounting because of federal laws and regulations. This qualitative study investigated the following research questions.

1. Why are some certified public accountants (CPAs) unwilling to provide services to cannabis-related businesses?
2. How do CRBs compensate for lack of CPA services?
3. What does a CPA need to know about the cannabis industry prior to engaging to provide services to CRBs?

Methods: Data for this grounded-theory qualitative study was gathered from twenty-three semi-structured phone and face-to-face interviews. Ten cannabis-related business owners were recruited from a convenience sample after attempting a broad recruiting effort. Thirteen CPAs with active licenses in Colorado or Washington State participated from firms of varying size and willingness to serve the cannabis industry. The individual interviews, which lasted from twenty minutes to more than an hour, focused on the participants’ perceptions of the complexities of accounting and tax compliance for cannabis businesses.

Results: Eight of the thirteen CPAs interviewed would not provide services to the cannabis industry with the primary reason given that cannabis is federally illegal. All ten of the cannabis business owners interviewed indicated they engage a CPA to provide tax services. Seven out of ten CRB participants and ten of the thirteen CPA participants indicated that extensive industry knowledge is needed for an accountant to competently provide services to a CRB.

Conclusions: CRB owners need to carefully consider the industry knowledge and experience of a potential CPA prior to engaging them. This study shows that U.S. CPAs should weigh the risk of federal prosecution and potential loss of the CPA license when deciding whether to serve a CRB client. The study also found that a CPA must commit to acquiring and maintaining substantial specialized knowledge related to tax Code Section 280E, internal controls for a cash-only or cash-intensive business, and the workings of the cannabis industry under the current regulatory conditions.

Keywords: cannabis, marijuana, accounting, business, certified public accountants, financial regulation, Colorado, Washington State

Background

There are a growing number of cannabis-related businesses (CRBs) in the United States, as many states have legalized cannabis for medical and/or recreational use even though it remains illegal at the federal level under the Controlled Substances Act (CSA). Thirty-three states plus the District of Columbia, Puerto Rico, the U.S. Virgin Islands, and Guam have legalized medical cannabis, while eleven states plus the District of Columbia and the Northern Mariana Islands have also legalized recreational cannabis usage as of September 2020.[1] Table 1 shows the legalized states by category. Cannabis has been listed as a Schedule I drug since 1970.[2] Regardless of state laws, cannabis is a Schedule I drug according to the federal government, and those found trafficking in cannabis could face criminal prosecution.[3] The Rohrabacher-Blumenauer amendment prohibits the use of federal funds to prosecute a cannabis-related business activity that operates within “States that have legalized the use of medical marijuana,” and was most recently extended to the 2019–2020 fiscal year in the 2020 Consolidated Appropriations Act.[4]

Table 1. States in which cannabis is legal for medical and/or recreational use. Abbreviations are standard US Postal Service abbreviations.[1]
States in which cannabis is legal only for medical use States in which cannabis is legal for medical and recreational use States in which only CBD (low THC) cannabis is allowed States in which cannabis remains illegal
AR, AZ, CT, DC, DE, FL, HI, LA, MD, MN, MO, MT, ND, NH, NJ, NM, NY, OH, OK, PA, RI, UT, and WV AK, CA, CO, IL, MA, ME, MI, NV, OR, VT, and WA AL, GA, IA, IN, KY, MS, NC, SC, TN, TX, VA, WI, and WY ID, KS, NE, SD

Cannabis and hemp are both varieties of the cannabis plant but with different tetrahydrocannabinol (THC) content. Hemp products became federally legal with the passage of the Agriculture Improvement Act of 2018.[5] The bill “removed hemp, defined as cannabis (Cannabis sativa L.) and derivatives of cannabis with extremely low concentrations of the psychoactive compound delta-9-tetrahydrocannabinol (THC) (no more than 0.3 percent THC on a dry weight basis), from the definition of marijuana in the Controlled Substances Act (CSA).”[6] Cannabis remains federally illegal and is the topic of this study.

This conflict between federal and state laws is problematic because cannabis-related businesses and ancillary businesses operating in legalized states and complying with all state laws are unable to fully comply with federal laws. Many cannabis businesses in states where cannabis is legal are facing difficulties in obtaining professional financial services because cannabis is still a controlled substance at the federal level.[7] For example, CRBs face difficulty obtaining banking services such as checking, credit cards, electronic transfers, and loans, which results in cash-only or cash-intensive business operation.[7] As such, many certified public accountants (CPAs) may be unwilling to provide their accounting and tax services to CRBs due to increased risks associated with the industry.[7][8][9]

Because cannabis is a Schedule I drug, a cannabis business is subject to Internal Revenue Service (IRS) Code Section 280E, which disallows the deduction of ordinary business expenses in arriving at taxable income.[10] As such, Code Section 280E results in significantly higher effective tax rates for cannabis businesses than for other businesses.[11][12] The Racketeer Influenced and Corrupt Organizations Act (RICO) of 1970 provides for federal criminal prosecution of individuals involved with criminal activities, including drug trafficking.[13] One does not have to be directly involved with the criminal enterprise to be prosecuted under RICO, as it applies to others associated with the criminal enterprise, include those providing professional services such as accountants, lawyers, and bankers.[14][15]

Cannabis businesses are also greatly affected by the Bank Secrecy Act (BSA) and anti-money laundering regulations that are designed to help identify and report money laundering activity.[16] The Financial Crimes Enforcement Network (FinCEN), a bureau of the U.S. Department of the Treasury, exists to “safeguard the financial system from illicit use and combat money laundering.”[17] In practical terms, FinCEN guidance stated that providing banking services to cannabis businesses was illegal and required banks to self-report this federally illegal activity.[18][19] Due to the BSA risks and FinCEN reporting requirements, most large banks will not provide accounts for cannabis-related businesses.[20] However, there is evidence that some banks and credit unions are serving the industry. According to FinCEN, as of June 2020, 695 financial institutions in the U.S. are reportedly serving the cannabis industry; this is down from a high of 747 institutions in November 2019.[21]

Bills have been proposed that would change the federal landscape for the cannabis industry. For example, H.R. 1588, the Ending Federal Marijuana Prohibition Act of 2019[22], was introduced in the House of Representatives in March of 2019 and referred to the House Energy and Commerce and House Judiciary committees. There have been several attempts to pass legislation to ease the banking burden for the industry, including the Secure and Fair Enforcement (SAFE) Banking Act of 2019, which passed in the House of Representatives but has not yet passed the Senate.[23] There have been numerous cannabis-related bills introduced in the 116th Congress in 2019–2020, ranging from the MAPLE Act, which would remove cannabis from the list of crimes that would prevent an immigrant entrance into the U.S., to the MORE Act, which provides for the total decriminalization of cannabis and expungement of cannabis-related convictions. However, as of October 2020, none of these bills have passed both chambers.[24][25] Changes in federal legislation could potentially reduce, if not eliminate, the business problem studied herein. For example, if federal prohibition were eliminated, cannabis clients would be no different than any other client in a legal industry from the perspective of a CPA. Passage of a cannabis banking act would allow the industry to utilize regular banking services and eliminate some risk associated with a cash-intensive type of business.

Accounting and internal control

There are several unique accounting issues that affect the cannabis industry. Due to the state and local regulatory requirements, CRBs need to maintain effective accounting records. Tax Code Section 280E requires attention to inventory accounting while following the tax requirements.[26] Lack of banking availability requires special attention to internal controls to safeguard cash and maintain good accounting records of cash transactions. State regulations also require thorough accounting records as well as strong internal controls.[27][28][29]

Internal controls are also important to a cannabis business. These are the activities that an organization takes to provide reasonable assurance that the company can meet its goals.[30][31] Failure to comply with state, local, or tax regulations can result in penalties, fines, and potential revocation of the cannabis license.[32] For example, effective internal controls were missing in the Alterman v. Commissioner case in which a medical cannabis company failed to maintain adequate records and failed to understand how to comply with Tax Code Section 280E.[33] Due to complexities in accounting and regulation, cannabis businesses should be perpetually ready for a potential audit by regulators or the IRS.[32] Certified Public Accountants can provide small businesses, including cannabis businesses, with guidance to develop and implement effective internal controls.[34]

A cash-intensive business requires some unique internal controls to safeguard the asset and to maintain adequate records of cash transactions.[30] The IRS defines a cash-intensive business as one that receives most of its revenues in cash and/or pays many of its expenses in cash.[35] Cash may be stolen by employees and is most susceptible to theft when entering or exiting the business.[30] To maintain proper accounting records to support potential tax and other regulatory audits, a cash-intensive business should “document the flow of each receipt or revenue from the customer’s hands to the business, to the final end in the business bank account or as payment for a business expense.”[36]

Physical controls may be one of the most crucial internal controls, and security must be considered for areas “to include property, office buildings, warehouses, utility rooms … and vehicles as well as employees, contractors, and visitors.”[37] Physical controls over cash and cannabis inventory include keeping them in a safe or vault, video surveillance, and promptly depositing cash into a bank account if the cannabis business has one.[28][38][39] Physical controls should be tested frequently to ensure continuous safeguarding of assets.[37] Frequent physical inventory counts are needed, and differences between the actual count and inventory records should be examined right away.[34] Colorado, for examples, has regulations that require daily reconciliation of inventory on-hand to the inventory tracking system.[27][28]

CPA requirements and risks

CPAs must adhere to an extremely high standard of ethical conduct as provided by the American Institute of Certified Public Accountants (AICPA) Code of Professional Conduct, as well as any individual state codes of conduct.[40] Unlike many business professionals, CPAs obtain a license or permit to practice from the state(s) in which they provide services.[8] A violation of ethics or “lack of good moral character” could potentially result in a loss of the CPA license, and therefore the potential loss of the ability to earn a living.[8]

Most state boards of accountancy have provided somewhat unclear official guidance on the provision of services for the cannabis industry.[8] The Washington State Board of Accountancy (BOA) stated in 2014, and again in 2018, that a CPA’s provision of services to a cannabis-related business does not constitute a violation of the BOA’s rules. This statement followed the March 2018 signing of the Engrossed Substitute Senate Bill 5928, which states that the provision of services to a CRB by a CPA does not, by itself, constitute a crime.[41] The Washington BOA further recommended that CPAs consider the risks associated with serving the cannabis industry and that CPAs engage an attorney for counsel.[41] As for Colorado, their BOA issued a position statement on December 16, 2015 that indicated the provision of services by a Certified Public Accountant to a cannabis business is not “specifically prohibited by the Accountancy Act.”[42] The Colorado Board went on to caution CPAs that their position statement does not constitute an endorsement for CPAs to enter the industry.[42]

In January of 2019, the National Association of State Boards of Accountancy (NASBA), in conjunction with the AICPA, published a document entitled "Providing services to businesses in the marijuana industry: A sample of current board positions."[42] This paper summarized the board positions for Alaska, Arizona, Arkansas, Colorado, Connecticut, Florida, Iowa, Maryland, Massachusetts, Michigan, New Mexico, Nevada, Oregon, and Washington. This sample includes states in which cannabis is legal only for medical purposes, states in which cannabis is legal for recreational or medical usage, and a state in which cannabis remains prohibited. All state boards in the report, except New Mexico, indicated that the CPA would not face disciplinary action by the board for providing services to a cannabis business, assuming the CPA was in compliance with all state laws.[42] This was even the case for Iowa, where only low-THC, high-CBD (cannabidiol) cannabis is allowed; the Iowa BOA indicated that Iowa CPAs serving cannabis businesses in legalized states would not face disciplinary action.[42]

While providing services to cannabis businesses does not by itself necessarily constitute a violation of good moral character, other problems can result from a CPA serving the cannabis industry.[43] In some cases, a CPA may be found to have “aided and abetted” or been involved in a “conspiracy to violate” the federal Controlled Substances Act or racketeering laws.[43] A CPA may also be exposed to criminal investigation and/or prosecution as well as potential fines, penalties, and sanctions if he participates in “dishonest, fraudulent, or criminal acts” associated with the cannabis industry.[43]

Cannabis businesses have a higher likelihood of income tax audit than other businesses due to complexities of Tax Code Section 280E.[44] The large number of cash transactions may result in the absence of a clear paper trail, which increases the risk of tax evasion and makes cannabis businesses targets for federal tax audits.[16] Some state cannabis regulations—including those found in New Mexico, Minnesota, and Colorado—may require a financial statement audit of a cannabis business to be completed by a CPA.[8][28]

Additionally, CPAs may believe associating with the cannabis industry could damage their reputation in the business community with current or prospective clients. Devers et al. have shown that reputation of a firm can indeed be seen by outsiders as an indication of the firm’s quality of services.[45] CPA firms may also be viewed as less than legitimate based on their overall association with the somewhat controversial cannabis industry.[45] Core-stigmatized organizations are those for whom outsiders have a “perceived violation of social norms” and may be looked at unfavorably.[46] Current or prospective clients may avoid associating with a CPA firm who works in the cannabis industry because they worry that negative stigma may transfer to them.[47] However, some CPAs may determine that they are willing to accept such core stigma as part of their business strategy, as may be the case for CPA firms who specialize in cannabis clients.[46]

Lastly, professional standards require that a CPA only take on engagements for which he or she has the appropriate technical knowledge about the industry to complete the work competently.[42] The complexities of the cannabis industry make meeting this standard costly and not necessarily worth the risks to many CPAs.[8] In general, CPAs need to evaluate the many risks associated with providing services to the industry and may determine that the risks outweigh the benefits and choose to not take on cannabis clients.[48]

Purpose of this study

Given the previously discussed, this qualitative study investigated the following research questions:

1. Why are some certified public accountants (CPAs) unwilling to provide services to cannabis-related businesses?
2. How do CRBs compensate for lack of CPA services?
3. What does a CPA need to know about the cannabis industry prior to engaging to provide services to CRBs?

Methods

Qualitative research is particularly well-suited for the “early stages of research” as in the case of a young industry such as cannabis.[49] The grounded theory approach to qualitative research utilizes “systematical methodological procedures” to identify theories as they “emerge from the data.”[50] Grounded theory is particularly appropriate for research such as this study, which seeks to generate theory based upon the reported data from participants.[51] Grounded theory requires one to continuously compare and analyze data previously collected to the new data being collected to identify patterns and themes, and produce theories. Interviews of participants are often used as a method of data collection in grounded theory research.[50][51][52]



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Notes

This presentation is faithful to the original, with only a few minor changes to presentation. Some grammar and punctuation was cleaned up to improve readability. In some cases important information was missing from the references, and that information was added. The original article lists references in alphabetical order; this version lists them in order of appearance, by design. Two of the original references for AICPA CPA docs had broken URLs; what is presumed to be the same documents—although updated for 2019—were found elsewhere on the AICPA site and used for this version.