Written by Abraham Finberg, CPA and Simon Menkes, CPA
Traditionally, deciding on the best entity for a business involves a comparison of the Corporation versus the LLC, with a few nods to Partnerships and Sole Proprietorships thrown in. However, if you decide to go into the cannabis business, choosing a corporation is a bit more complicated - as is everything else in this wild and wooly industry.
Moving on from the Mutual Benefit Structure
First, many of you may be starting with a Mutual Benefit Company (MBC), and are rushing to change it to a more "business friendly" entity. But is that necessarily the best decision? When a shareholder owns a regular corporation and the IRS decides the shareholder is taking money out of the corp, they'll declare the money removed a “deemed dividend” and insist the shareholder owes income tax on it on their individual return (so much for limited liability!). Usually no one owns an MBC, and there is no one to issue the dividend to. So there may be some tax protection to be had.
But then you ask, what about investors? How can investor invest in a nonprofit? Plus, there's this sophisticated buyer (read Canadian cannabis conglomerate or major international brewer) who I've been courting. I want my business to be easily purchased. So…
LLC, C Corp, S Corp - What are my Benefits?
You contact your attorney and let them know it's time to choose a more traditional business entity. Which do you opt for? Partnerships and Sole Props are generally less desirable due to their lack of limitation of liability, among other issues, so it really comes down to the LLC, the C Corp, or the S Corp. Let's take a look.
LLC Pros: Easy to allocate distributions as long as you don't take out more than you put in + profit. Plus, you can have a share in profits and losses without owning equity.
LLC Cons: You may potentially have to pay self-employment taxes on all profit. Also, you can't deduct operational expenses for California, similar to IRS.
C Corp Pros: You can deduct operational expenses on your California return. Additionally, income tax liability is mostly at the corporate level so the IRS cannot go after the owners as long as they don't treat money taken out of the company as a dividend. Plus, you don't have to pay self-employment tax on money you take out if you issue a dividend to yourself.
C Corp Cons: You are taxed if you take money out of the corporation unless you set up loan accounts per shareholder and track the interest (not too difficult, but you need to do it right, or the IRS will invalidate the loan, and you'll owe tax).
S Corp Pros: You can deduct operational expenses on your California return since it's a corporation. You don't have to pay self-employment tax on money you take out.
S Corp Cons: You have to have some salary to the active owners. Also, all distributions are based on share ownership percentages, unlike LLCs, in which one owner can take more money out than another, as long as the owners have a positive capital balance (this can be solved with shareholder loans, similar to the C Corp).
In conclusion, there's no perfect answer – whatever entity you choose will require you to keep a lot of financial balls in the air as perfectly as possible. A quick call to your CPA and attorney wouldn't be out of place here!