Since Proposition 64 legalized the personal use and cultivation of marijuana in California in 2016, many business owners have been able to take advantage of the legal cannabis market. However, there are a variety of laws and regulations that apply to these businesses, and it is important for business owners to keep abreast of changes to the laws that may affect them. One change that recently went into effect involves the cannabis excise tax. California cannabis businesses will need to make sure they are following the correct procedures to avoid potential tax penalties while addressing any other small business tax issues that they may encounter.

What Is the Cannabis Excise Tax?

Excise taxes are levied on specific products, services, or activities. There are multiple types of federal and state excise taxes that apply to products such as gasoline, cigarettes, or alcohol. The state of California levies a 15 percent excise tax on cannabis businesses and microbusinesses.

Changes to the Cannabis Excise Tax for 2023

Previously, the cannabis excise tax applied to marijuana and marijuana products sold by distributors to retailers. Distributors were required to collect excise taxes from retailers, and these taxes were calculated based on the average market price of cannabis and cannabis products.

Small business owners need to address a variety of small business tax issues, and it is important to comply with all requirements put in place by the IRS and California's Employment Development Department (EDD). Worker misclassification is one issue that has received increasing scrutiny in recent years, and businesses that improperly classify workers as independent contractors instead of employees may face a variety of tax penalties. Recently, the IRS and the federal Department of Labor (DOL) announced that they will be working together to identify tax compliance issues related to worker misclassification This may result in tax audits and penalties for businesses that have failed to follow the proper procedures.

Understanding the Joint Worker Misclassification Initiative

On December 14, 2022, the IRS and the DOL issued a Memorandum of Understanding for Employment Tax Referrals, and this document stated that the agencies will be working together to improve compliance with laws related to worker classification. The Department of Labor's Wage and Hour Division regularly investigates complaints related to the misclassification of workers. Under this initiative, the WHD may refer information related to investigations about alleged worker misclassification to the IRS's Small Business/Self-Employed Specialty Employment Tax unit. The IRS will then evaluate these referrals to determine whether to conduct audits and assess penalties against noncompliant employers.

The Memorandum of Understanding detailed certain requirements that must be met before cases can be referred to the IRS. A business must still be in operation at the time of the referral, and the IRS will typically only investigate businesses that did not have a good-faith basis for misclassifying workers. Referrals will only be made in cases where a business had an annual dollar volume of at least $500,000. That is, the business's gross earnings over a period of 12 months must be $500,000 or more.

If you are a small business owner, you may be aware that there are multiple different types of taxes that you need to pay. Self-employment taxes are the combined Social Security and Medicare taxes that sole proprietors, independent contractors, and other types of business owners must pay. Understanding the self-employment taxes that may apply to you can help you make sure you stay compliant with the law and will not be required to pay penalties or fees. 

Understanding Self-Employment Tax

You will generally be required to pay the self-employment tax (also known as SE tax) if you have net earnings of at least $400 from self-employment in a tax year. The SE tax rate is currently 15.3 percent, which consists of 12.4 percent for Social Security taxes and 2.9 percent for Medicare taxes. In 2022, the Social Security portion of the self-employment tax will apply to the first $147,000 of your net earnings, including wages or tips. All combined earnings will be subject to the Medicare portion of the self-employment tax.

Self-Employment Tax Vs. Income Taxes 

In addition to paying SE tax, small business owners also have the obligation of paying income taxes. These taxes will apply to the salary you pay yourself through your business. For businesses that are classified as pass-through entities, including S corporations or LLCs, the profits earned by the business will be "passed through" to the owner, and they will be subject to income taxes. If your business is a sole proprietorship, it will not be separate from the salary you pay yourself, and you will be required to pay income taxes on all business earnings.

The Criminal Investigation (CI) division of the IRS regularly investigates taxpayers who are suspected of tax evasion, tax fraud, and other offenses. These investigations may be related to tax audits, or they may be performed independently. Those who are accused of committing tax-related offenses may not only face penalties for non-payment of taxes or failure to submit the proper information to the IRS, but they may also be subject to criminal prosecution. In recent years, offenses related to cryptocurrency have been a significant concern for the IRS. Agency officials have stated that hundreds of cases involving virtual currency and tax evasion or other offenses are likely to be prosecuted within the next year.

The IRS's Increased Focus on Cryptocurrency

As more and more people invest in cryptocurrency, use virtual currencies to make payments and purchases, and receive digital assets as income, the IRS has begun to scrutinize these transactions and enforce compliance with tax laws. It has also been able to prosecute some major cases involving tax fraud and other related offenses. In just one example, the founders of Bitqyck, a cryptocurrency investment company, were convicted of tax evasion after defrauding investors of around $24 million. The defendants in this case had failed to file corporate tax returns, and they had underreported their income to the IRS, resulting in tax losses of more than $1.6 million. In addition to being sentenced to prison, the defendants were required to pay a civil penalty of $8.3 million to the U.S. Securities and Exchange Commission.

While high-profile cases prosecuted by the IRS that involve millions of dollars may receive the most attention in the news, the hundreds of cryptocurrency investigations that are currently being performed are likely to involve smaller amounts. Currently, the IRS is using "John Doe" summonses to gather information about cryptocurrency transactions, and in many cases, these summonses involve transactions of $20,000 or more. These summonses may be served on third parties, such as cryptocurrency exchanges, in order to identify virtual currency owners and determine whether they have violated tax laws. Summonses may be used to identify "off-ramping" transactions in which cryptocurrency is exchanged for legal currency issued by the U.S. or other countries, as well as virtual currency that was received as income and was not properly reported to the IRS.

Businesses that operate in the United States must meet a variety of legal requirements, including disclosing information to the government. In addition to submitting the proper information to the IRS when filing tax returns and other required forms, other types of disclosures need to be made to government agencies. This now includes reports required under the Corporate Transparency Act (CTA). This law was passed in 2019, and the final rule regarding reporting requirements was released in September 2022. Businesses will need to make sure to file the proper reports to avoid potential civil and criminal penalties.

What Is the Corporate Transparency Act?

Congress passed the CTA with the intent of preventing money laundering by people and organizations involved in drug trafficking, fraud, and other illegal activities. These activities often involve the creation of shell companies that conceal the identities of the owners and allow criminals to access and use assets in the United States. To combat these activities, the CTA requires companies to submit reports detailing their beneficial ownership information (BOI).

What Are the CTA's Reporting Requirements?

The new rule that was issued by the Financial Crimes Enforcement Network (FinCEN) goes into effect on January 1, 2024, and it states that "reporting companies" are required to file reports identifying a company's beneficial owners, as well as people who are considered "company applicants." Beneficial owners include any individuals who either exercise substantial control over how a company operates or who own or control at least 25 percent of a company's ownership interests. Company applicants include the individuals who file the documents that establish a company as a legal entity or those who direct or control applications filed by other parties.