It’s the time of the year when businesses of every industry prepare for tax season. For the cannabis industry, seasoned plant-touching business owners and recent licensees alike will be required to meet stringent requirements where taxes are concerned. In fact, the cannabis industry faces unique challenges not applicable to other industries—namely Internal Revenue Service Code 280E (IRC 280E), a tax code that imposes restrictions on the deductions cannabis businesses can take. IRC 280E restricts companies that sell Schedule I or Schedule II substances from deducting ordinary business expenses other than the cost of goods sold (COGS). This means plant-touching businesses can allocate some of their operating expenses, like rent and utilities, into COGs as allowed in IRC 471. Understanding this code and organizing your accounting to comply is crucial, because the IRS has been auditing cannabis businesses actively to ensure they comply with IRC 280E. Not doing so could make your business vulnerable to compliance penalties and fines. However, with advanced planning, you can become compliant and withstand the scrutiny of an IRS audit.
Here’s a list of essential best practices to help you prepare right away.
Prepare a cannabis-specific Chart of Accounts
A cannabis Chart of Accounts (COA) can help plant-touching businesses ensure accurate accounting by tracking COGS and providing a clear picture of the revenues earned and expenses incurred. It is crucial for implementing IRC 280E-compliant accounting operations.
Determine the COGs
COGS are the costs a dispensary incurs to acquire products for resale or a grow/manufacturer incurs to produce inventory to sell. These costs will be easily identified on a cannabis COA. COGS should be calculated separately for each product and supported by documentation such as invoices, receipts, and other records. Accurately determining the COGs is important for reducing tax liability.
Review deductible expenses
It is essential to review all expenses incurred by the business to determine which ones can be allocated to COGs. These allocable expenses include rent, payroll, utilities, and costs allowed by IRC 471. The company should clearly understand which expenses are allocable and which are not so they can be prepared to provide the necessary documentation to the auditor.
Implement cash controls for unbanked businesses
If you do not have banking, then it is important to set up policies, procedures, and processes for how your business handles cash transactions. Cannabis businesses without banking are considered cash-intensive businesses and will be audited with more scrutiny than banked businesses. Implementing proper controls over cash receipts and disbursements and maintaining adequate documentation will ensure your cash-handling operations are audit-ready.
The IRS will use specific techniques to determine if you have accounted for cash sales to make sure you are not under-reporting revenue or gross receipts. If you are dealing with cash and receive over $10,000 in a cash transaction, you must submit Form 8300, Report of Cash Payments Over $10,000 in a Trade or Business (also known as the Bank Secrecy Act cash reporting form).
Set up an online document-storage system
An online document-storage system is a great way to file and keep track of important business documents, expenses, revenues (invoices), and accounting workpapers. As mentioned above, maintaining documentation is an important part of your business operations, and being able to substantiate transactions in your accounting system is important for being audit-ready.
Put policies and procedures in writing
Having well-documented policies, procedures, and business processes that identify internal controls will help IRS auditors, potential investors, or potential buyers audit or make decisions about your organization. In addition to having policies and procedures, you also must make sure they are communicated to your team.
Hire an accounting and tax professional
It’s critical to find a professional accountant who is familiar with IRC 280E compliance and has experience implementing policies, procedures, and processes to prepare for an audit. They can help the business prepare for the audit and ensure all necessary documentation is in order, while a tax professional can handle any questions or concerns that arise during the audit.
In conclusion, it’s worth the effort required of cannabis-business owners to manage their accounting practices according to code. Becoming IRC 280E-compliant is the first important step in avoiding or successfully getting through an audit.
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