Taxation, 280E, And The Challenges Of Accounting For Cannabis Dispensaries

Currently, too many accounting professionals are making big mistakes by misinterpreting the tax code in an attempt to increase the deductions dispensaries take.  This approach could trigger an IRS audit and put companies at risk of incurring hefty penalties, or being shut down for not following IRC 280E. This highly-regulated niche requires specific internal controls including immaculate records of all payments, daily cash counts, and the proper segregation of duties (SOD). 

How Can You Ensure Your Clients Are In Compliance?

You probably know 280e is the IRS’s internal revenue code that stops Cannabis dispensaries and other businesses from being able to take tax deductions. Keeping your Cannabis clients in compliance has everything to do with understanding 280E. Despite the green wave that’s sweeping the nation in which more and more states have legalized both the medical and recreational use of Cannabis, it is still classified as a Schedule 1 substance. As such, any business that distributes, owns, or processes Cannabis products is technically “trafficking” it, regardless of the intent. Therefore, the options for reducing tax liability are greatly reduced for Cannabis companies. 

While one tax code makes it impossible for Cannabis businesses to take deductions and credits the way traditional companies do, another IRC code serves as part of the solution. By relying on IRC 471, accountants can determine which costs can be allocated via cost accounting to inventory, and eventually, to Cost of Goods Sold (COGS). Is this process easy? No, it is not. It’s actually very complex, especially for Cannabis dispensaries that are also producing goods and can utilize 471-11. 

It is key for everyone in the licensed Cannabis space to know that there is no getting around 280E. The IRS is more aware now than ever of the games and tactics being used to try to circumnavigate it. The IRS has become adept at conducting audits of Cannabis businesses. Their adroitness has enabled them to collect many times more in unpaid taxes as they did from mainstream companies.

Providing your Cannabis business clients with real value requires implementing specific processes including annual, quarterly, monthly, and daily procedures for dispensary accounting that accord with 280E. In Cannabis accounting, the only way to correctly minimize tax liability is the hard way. There are no shortcuts and no magic formulas.

So, How Exactly Do You Minimize Tax Liability For Cannabis Dispensaries?

IRC 471 and COGS are key. Dispensaries have even more challenges than other verticals in the industry, such as cultivation and processing/manufacturing.  

The general code 471 applies for all Cannabis companies and is the method used for inventory which has to unquestionably reflect the company’s income, as well as align with the way your client accounts for inventory in the financials.

For dispensaries specifically, we can look to 471-3, which states the following:   

“In the case of merchandise purchased since the beginning of the taxable year, the invoice price less trade or other discounts, except strictly cash discounts approximating a fair interest rate, which may be deducted or not at the option of the taxpayer, provided a consistent course is followed. To this net invoice price should be added transportation or other necessary charges incurred in acquiring possession of the goods.”

If one is fastidiously adhering to 471-3, dispensary taxable income can essentially be lowered via COGS. The IRS is very strict. It is therefore paramount that any accounting professionals serving Cannabis businesses keep track of their clients’ inventories so that they will be in good standing to pass an IRS audit. This includes doing weekly cycle counts and reconciling to POS and seed to sale systems.

Tools Needed For Proper Cannabis Dispensary Accounting.

Another challenge facing Cannabis dispensaries and the accountants who work with them is a dearth of tools that make accounting for these businesses easier. There are notorious glitches that need to be worked out in the several state-mandated seed to sale systems. There are POS systems which integrate terribly and are hard to reconcile. 

Another big issue is cash controls. Taking the time and prioritizing setting effective controls and procedures in place is essential for Cannabis dispensaries. Banking options for Cannabis companies are essentially non-existent in many states (although this is slowly changing), and local licensing authorities hold the dispensary owners responsible for creating and maintaining adequate security measures, so theft is not an excuse for missing cash.  

From cash control and management issues to correct reporting, to seed to sale and POS software, providing quality accounting for Cannabis dispensaries is not easy. Furthermore, make the wrong move and you could incur large penalty fees for your client, land them in serious legal trouble, or both.