New Jersey Update on Recreational Cannabis: The First Set of Rules

The State of New Jersey has adopted rules that move the Garden State one step closer to clearing a path for the legal cultivation and sale of cannabis for recreational use.

A regulatory framework passed on August 19, 2021 provides the list of critical rules that budding entrepreneurs will need to follow in the new marketplace, though additional clarification is expected on precisely when the State’s Cannabis Regulatory Commission (“CRC”) will begin accepting applications for licensure. Nonetheless, these regulations provide a general outline stressing what the CRC will look for in potential licensees as well as those receiving priority in the process.

The CRC has given priority to three characteristics of businesses: 1) Social Equity Businesses, owned by those who reside in economically disadvantaged areas or have past cannabis offense convictions; 2) Diversely Owned Businesses, which are minority, woman, or disabled veteran owned; and 3) Impact Zone Businesses, owned by individuals who are from or who employ residents of areas with a large population, high unemployment, or a high number of crime arrests for marijuana. Applications for cannabis business licenses will be reviewed as received on a continuous rolling-basis with priority given to applicants that fulfill any of these three categories. The CRC’s framework was further crafted to keep barriers to entry low, even maintaining licensing fees in two different categories for entrepreneurs who aim to be involved on a smaller scale.

Both initial application and annual license fees for “microbusinesses” are one-half of the standard business fees (starting at $100) and application requirements are slightly less to attract small business entrepreneurs to the industry. Once approved, microbusiness applicants will have 120 days to find an appropriate site, secure municipal approval, and apply for conversion to an annual license. To remain compliant as a microbusiness however, owners can have no more than 10 employees on the premises and occupy space no larger than 2,500 square feet. Beyond microbusinesses, there are options for entrepreneurs who intend to operate on a larger scale. Annual license fees are structured on a tiered scale from Tier I to Tier VI ranging up to 150,000 square foot cultivation capacity facilities

The new framework also outlines an often-overlooked inherent risk associated with newcomers. Predatory lenders and management companies may target these potential license holders, so rules and guidelines now exist to deter unfair and unreasonable contract terms while allowing companies to obtain financing and contractors to help facilitate their business. The framework requires that all terms of management agreements including interest rates, returns, and fees be commercially reasonable and bargained in an arms-length transaction. Management service providers are also prohibited from gaining a security or ownership interest in companies they work with except in situations where they cease operations as a service provider to become a passive owner or investor. The CRC may determine whether a term is commercially reasonable or consistent with fair market value by comparing to similar services rendered in the medical or personal use cannabis market in New Jersey or in other states with adult-use markets.

Another topic that remains to be clarified is how the CRC will enforce the state’s track-and-trace system for commercial cannabis activity (often referred to as “seed-to-sale”). Most states require single systems implemented by all businesses operating within the state to ensure inventory is legally grown, harvested, and packaged. Software, the likes of Metrc and BioTrackTHC, are likely choices as they have been required by previous adult-use states. Unfortunately, these systems alone will not be enough for a new business to stay on top of its inventory costs as these platforms do not consider other material inputs for growing or packaging. Inventory management is crucial not only for compliance but a lack of controls over inventory will burn up profits under IRS Code Section 280E which disallows non-cost of goods sold deductions for cannabis entities. Withum’s team of professionals have helped cannabis companies implement systems to optimize their inventory costs for tax savings and continue to work with growing cannabis businesses to be on the cutting edge of this industry.

Authors: Jeff DeLuca, CPA, MPA and Kevin Verbosky