By Ben Condon, CPA
Executive Summary
Ben Condon,
CPA, Founding Partner of BC Consulting discusses the background of California taxation of cannabis companies walks through the steps of converting a
California Nonprofit Mutual Benefit Corporation (MBC) to a For-profit General
Stock Corporation and the resulting tax entity flexibility.
Law Prior to 2018 - Non-Profit MBCs Ruled
Although
these medicinal cannabis businesses formally are incorporated as nonprofit
mutual benefit corporations, they do not meet the
requirements for income tax exemption described in Internal Revenue
Code (IRC) Section 501(c) or California Revenue and Taxation
Code (R&TC) Section 23701, Meaning they must file Form
1120, U.S. Corporation Income Tax Return and Form
100, California Corporation Franchise or Income Tax
Return. Additionally, IRC Section 280E applies to
these business, which can severely limit the ability to deduct expenses
resulting in a higher effective tax rate. However, they can deduct ordinary and
necessary business expenses for California purposes.
Nonprofit
mutual benefit corporations are limited by their inability to pay dividends and
be sold as there is no stock to sell. Members generally secure their returns via
wages and through liquidation of any assets on dissolution.
Current Law - Total Legal
Entity Freedom and Flexibility
The Adult
Use of Marijuana Act (Proposition 64) passed with 57% voter approval
and became law on November 9, 2016. The Medicinal and Adult-Use Cannabis
Regulation and Safety Act (MAUCRSA), SB 94, passed on June 27, 2017. It
established a comprehensive system to control and regulate the cultivation,
distribution, transport, storage, manufacturing, processing, and sale of
medicinal and adult-use cannabis, and related products.
Businesses
operating under these state licenses can choose any form of valid business
structure for their business. They are able to operate on a for-profit or
not-for-profit basis. They are not eligible for
California franchise and income tax exemption, as they do not meet the
requirements as described in IRC Section 501(c) or California R&TC Section
23701. This means California cannabis business now have
the flexibility to choose from a variety of legal entities to best suit the
needs and tax profiles of their owners. These entities include, but are
not limited to Limited Liability Companies (tax as: Disregarded Single-Member
LLC, Partnerships,& C-Corporation), C-Corporation, S-Corporations, and
Limited Partnerships.
Converting a Nonprofit Mutual Benefit
Corporation to a Stock Corporation
California
allows for the conversion of an Mutual Benefit Corporation (MBC) to a general
stock corporation by Restating the articles of incorporation of the
nonprofit MBC. There is a $30 associated filing fee. The
restated articles must include:
1. The name of the Corporation.
2. The following general stock purpose statement: The purpose of the corporation is to engage in any lawful act or activity for which a corporation may be organized under the General Corporation Law of California other than the banking business, the trust company business or the practice of a profession permitted to be incorporated by the California Corporations Code.
3. The number of shares of stock the corporation is allowed to issue.
4. If there are outstanding membership interest, the articles must include a statement of the effect of the restatement on those interests.
Within 90 days of filing the amended articles of incorporation, a Form SI-550 Statement of Information must be filed with the Secretary of State. This form is free to file if filing to meet the 90 day requirement otherwise it is $25 initially and annually thereafter. If this is the initial SI-550 then the Service of Process information must be included within the amended articles of incorporation in the previous step.
2. The following general stock purpose statement: The purpose of the corporation is to engage in any lawful act or activity for which a corporation may be organized under the General Corporation Law of California other than the banking business, the trust company business or the practice of a profession permitted to be incorporated by the California Corporations Code.
3. The number of shares of stock the corporation is allowed to issue.
4. If there are outstanding membership interest, the articles must include a statement of the effect of the restatement on those interests.
Within 90 days of filing the amended articles of incorporation, a Form SI-550 Statement of Information must be filed with the Secretary of State. This form is free to file if filing to meet the 90 day requirement otherwise it is $25 initially and annually thereafter. If this is the initial SI-550 then the Service of Process information must be included within the amended articles of incorporation in the previous step.
That's it! Your corporation is now a general for-profit stock corporation which allows for dividends and buying and selling of company stock and allow for more sophisticated legal tax structuring.
Converting
to anything other than a C-Corporation
In order to convert to another legal entity type such as an LLC or LP,
the MBC first must convert to a general stock corporation and then convert from
there. This is because the conversion of the MBC to a general stock corporation
was technically not a conversion, but merely a restatement of its purpose
statement and issuance of stock, as it was already a corporation from the
beginning, however now with its newly attained for profit status it can convert
from corporation to a multitude of other forms. The California Secretary of
state website has a large listing of various legal conversion forms.
Additionally, tax only elections can be made with the IRS via Form 2553 and/or Form 8832 which allow the corporation to be taxed as an S-Corporation, Partnership, or disregarded entity depending on the fact pattern without further legal conversions at the state level.
Please note that the above is provided for illustrative purposes only. For more information, reach out to us at info@b-cconsulting.com
