Choosing the Right Business Structure: A New York CPA’s Guide for Cannabis Entrepreneurs

The cannabis industry in New York is both challenging and rewarding. Startup costs can be high, but choosing the proper business structure strategically can be the key to maximizing profitability, reducing your tax burden, and streamlining operations. In this guide, we’ll explore what cannabis entrepreneurs and their financial teams need to know about structuring a business for success in New York State.

New York Cannabis Legal Business Entities

Choosing a legal business entity is often the first step when forming a new cannabis business. This decision lays the foundation for the company’s future growth, so it’s critical to weigh the pros and cons based on your partners, investors, the type of cannabis business you’re launching (manufacturer, dispensary, lab, delivery service, etc.), and your long-range vision.

In New York, the main entity options for cannabis startups include limited liability companies (LLCs), corporations, and partnerships. Let’s examine each structure and how it measures up.

LLC (Limited Liability Company)

An LLC is a popular choice for many small businesses, including cannabis startups, because it offers a mix of flexibility and protection. LLC owners are called members (not shareholders), and they can manage the business directly.

Pros of an LLC:

·        Limited liability protection: Members’ personal assets are shielded from the company’s debts and legal liabilities. Creditors typically cannot go after your personal property (home, car, bank accounts) to satisfy business obligations.

·        Simple and flexible setup: LLCs are relatively easy to form and maintain, with fewer formal requirements than a corporation. The company can be managed by the members or by appointed managers, allowing flexibility in how you run the business.

·        Pass-through taxation by default: By default, an LLC’s profits (or losses) pass through to the owners’ personal tax returns, and the LLC itself does not pay federal income tax.

·        Optional tax elections: An LLC can elect to be taxed as a corporation (even opting for S-corporation status if it meets the criteria). This means you have the flexibility to choose a tax treatment that best suits the owners’ financial situation.

Cons of an LLC:

·        Limited attraction for investors: LLCs cannot issue stock, and ownership interests (membership units) are less straightforward to transfer than corporate shares. Bringing in outside investors or transferring ownership often requires more legal work and the approval of other members.

·        Section 280E tax burden on owners: Because an LLC is a pass-through entity, its owners bear the tax impact of IRC 280E on their personal returns. If your cannabis business generates income that can’t be offset by deductions, you could face a very high tax bill personally. In other words, an LLC doesn’t shield its owners from the tax disadvantages imposed by 280E.

·        New York publication requirement: New York State requires new LLCs (and LLPs) to publish a notice of formation in two newspapers for six consecutive weeks and then file proof of publication with the state. This process can cost several hundred to a few thousand dollars and is an extra startup hassle to be aware of.

Corporation

Forming a corporation is more complex than forming an LLC, but it can be beneficial for cannabis companies that plan to scale, raise significant capital, or mitigate certain tax issues. A corporation is owned by shareholders and managed by a board of directors and officers. There are two main types of corporations: C corporations and S corporations. A C-corp is the default form (taxed separately from its owners), while an S-corp is a corporation that elects pass-through taxation (avoiding federal corporate tax). Each has pros and cons in the cannabis context.

Corporation pros:

·       Limited liability. Like LLCs, corporations provide strong personal liability protection. Shareholders are not personally liable for the corporation’s debts or legal obligations, so their personal assets are protected

·       Raising capital and attracting investors may be easier

·       Unlike an LLC, ownership is transferrable through sale of shares.

·       The corporation will exist in perpetuity, regardless of any changes in management or ownership.

Corporation cons:

·       More regulation and upkeep: Corporations are subject to stricter reporting, record-keeping, and compliance requirements. They must adopt bylaws, hold regular board and shareholder meetings, keep detailed records (minutes, stock ledgers, etc.), and file separate corporate tax returns. In the heavily regulated cannabis industry, these additional corporate formalities can be burdensome for a startup.

·       C-corporations are taxed twice: at the corporate level and again when dividends are distributed to shareholders. However, C-Corp is one of our favorite type of the entity for tax purposes!

·       A state franchise tax applies to all corporations in New York.

Partnership

Smaller cannabis startups may find it simpler to establish a partnership as part of their business structure. While this decision is undoubtedly a more expedient and less costly way to get the company up and running, it is also riskier as the partners are personally liable for the company’s debts and legal issues.

There are different types of partnerships to consider as well. Partners engaged in a general partnership agreement are equally liable for the business’s debts.

A limited partnership includes partners that have no direct involvement with the day-to-day running of the business. Their liability is limited to the amount of their contributions.

A limited liability partnership (LLP) means that all partners have limited liability and are subject to pass-through taxation.

IRC 280E and Business Entity Implications

IRC 280E should and must be a consideration before making any hard and fast decisions regarding business structures.

Under 280E, cannabis businesses may only deduct expenses attributable to cost of goods sold (COGS), which can include expenses related to cultivation, manufacturing, packaging, transportation, and storage. Other deductions are disallowed, resulting in over-inflated taxable income and an audit-heavy tax environment.

For these reasons, C-corporations are recommended for most cannabis businesses to avoid passing the tax burden on to owners. Cultivators tend to be in a more favorable position than retail operations as they can attribute more expenses to COGS and are less likely to amass a huge tax bill.

Working with a qualified cannabis tax professional280 is essential at the startup stage, as they can provide the expertise needed to determine the best business entity structure to suit your needs now and in the future.

New York has decoupled from 280E at the state level, meaning that cannabis operators in New York can claim these deductions on their state returns. Despite the apparent advantages, this adds yet another layer of recordkeeping complexity, which should factor into entity-forming decisions as it will require more oversight and New York state cannabis-specific expertise.

To see how entity choice and 280E can affect a cannabis startup, consider two hypothetical New York companies:

Green Leaf Dispensary – a retail cannabis storefront.

Sunshine Farms – a cannabis cultivation business.

Both businesses launch in the same year and achieve similar gross revenues. However, assume both initially chose to operate as pass-through entities (for example, LLCs taxed as S-corps). After year one, look at their tax situations:

Green Leaf Dispensary: Most of Green Leaf’s expenses (shop rent, budtender salaries, utilities, marketing, etc.) are operating costs that 280E does not allow as deductions. On its federal tax return, the dispensary can only deduct the cost of the cannabis products it purchased (its COGS). This leaves a large taxable profit on paper. When that income passes through to the owners’ personal returns, they each face a surprisingly high federal tax bill – even though the business itself might be short on cash after covering all those nondeductible expenses. In essence, the owners have to pay income tax on money the business had to spend on operating costs (a frustrating situation for any entrepreneur).

Sunshine Farms: A large portion of Sunshine’s expenses are related to production and are part of COGS (e.g. soil, nutrients, electricity for grow lights, wages for cultivation staff). Those costs remain deductible despite 280E. As a result, Sunshine Farms reports a much smaller taxable income relative to its total expenditures. The owners still pay tax on the profits that pass through to them, but those profits were reduced by the deductible growing costs – making the tax burden more manageable. In fact, Sunshine might even show a very small profit or a taxable loss once all its allowed deductions are applied, meaning little to no 280E impact on the owners.

In this scenario, Green Leaf’s owners realize that using a pass-through entity made their personal tax situation difficult. Had Green Leaf been set up as a C-corporation, the corporation would shoulder that big 280E-driven tax bill at the corporate tax rate, and the owners wouldn’t report the business’s profits on their personal returns unless those profits were distributed as dividends. By using a C-corp, the dispensary could potentially retain and reinvest earnings (paying corporate tax on them as required), rather than forcing profits out to owners just to cover a tax bill. In hindsight, the C-corporation structure would have helped contain the tax impact within the company, instead of hitting the owners individually.

The takeaway: Every cannabis business is different. Retail operations often suffer more under 280E and may benefit from a C-corp structure, whereas production-heavy businesses can sometimes thrive as pass-throughs because they can deduct more of their costs. It’s crucial to evaluate your specific financial projections and tax circumstances – ideally with a cannabis-savvy CPA – before deciding which entity is right for you.

The Bottom Line: What Business Structure is Right for Your NY Cannabis Operation?

The cannabis business in New York is booming. The entity you choose now can impact your ability to expand to new locations, take on investors, or even exit the business down the road. Savvy cannabis entrepreneurs in New York plan with these future milestones in mind, not just immediate convenience. Speak to the team at Growise today to gain access to New York state-specific expertise on establishing and structuring your cannabis startup.