Retirement Plans, Tax Benefits and Empowered Employees: Unlocking the Potential of Cannabis Companies with an ESOP

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While cannabis remains classified as a controlled substance at the federal level, many states have legalized recreational use of cannabis, paving the way for businesses to succeed in a challenging regulatory environment. The cannabis industry operates under a complex network of laws and regulations that vary across jurisdictions. Navigating licensing, compliance, and regulatory requirements can be complex and costly.

Due to the federal illegality of cannabis, many large financial institutions are hesitant to provide banking services to cannabis businesses. This leads to limited access to basic financial services such as banking, loans, lines of credit, and merchant services. Moreover, many 401(k) and retirement plan providers are not willing to risk violating federal anti-money laundering laws and the Bank Secrecy Act. While the SAFE Act, legislation that would make access to financial institutions easier for cannabis companies, stalls in Washington, cannabis companies continue to operate in a challenging environment.

Cannabis businesses also face unique tax challenges. Section 280E of the Internal Revenue Code disallows ordinary business expense deductions for businesses engaged in the sale of controlled substances, including cannabis. This results in significantly higher effective tax rates and limited ability to deduct expenses like marketing, research and development, and general business overhead.

An employee stock ownership plan (“ESOP”) is a qualified retirement plan that invests primarily in the employer’s stock. An ESOP enables employees to receive shares of their employer’s company. These shares are held in a trust on behalf of the employees, and they can accumulate ownership over time, usually through allocations made by the employer. ESOPs are designed to provide retirement benefits to employees. As employees accumulate ownership in the ESOP, they can benefit from the appreciation of the company’s stock value over time. Upon retirement or separation from the company, employees can cash out or sell their vested ESOP shares.

Significant tax benefits are available to ESOPs that hold 100% of an S corporation. As a qualified retirement plan, any pass-through income is not subject to federal taxes [1]. This benefit significantly mitigates the negative tax implications of Section 280E on cannabis companies. As a 100% ESOP-owned S corporation, more capital would be available for the company to fund growth, which is essential for companies in the cannabis industry.

In addition, while 401(k) options are limited for companies in the cannabis industry, an ESOP provides a retirement benefit that aligns employee and company interests, helps to retain and attract talent, and can enhance company culture.

Implementing and operating an ESOP requires careful planning, compliance with regulatory requirements, and proper execution. Consulting with legal, financial, and tax professionals with expertise in ESOPs is crucial to ensure successful implementation of the plan. Greenwich Capital Group has the expertise to assist business owners in the cannabis industry that are considering an ESOP. Contact us today to discuss options available to companies operating in the cannabis industry.

[1] Certain income taxes may still be applicable depending on the location and nexus of the Company.

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