Cannabis Bookkeeping for SoCal Dispensaries: Avoid Common Mistakes That Trigger Audits

Cannabis dispensaries in Southern California face numerous challenges. Although running a business can be profitable, state, local, and federal regulations create an incredibly complex landscape. Adding to that, you’re operating in a saturated and highly competitive market, where banking options are limited and costly, and just about every aspect of the business is high risk. The last thing you need is an IRS audit.

Unfortunately, in the big scheme of things, an audit is probably inevitable. The best strategy is to be prepared, keep your books in order, and understand the red flags and triggers that might put your business in the auditor’s crosshairs.

Cannabis businesses in general are prioritized for audits because they tend to be quite lucrative for the IRS. As such, all business models in the cannabis industry are likely targets, but dispensaries are of particular concern because of large volumes of cash transactions.

Types of Audits SoCal Cannabis Businesses Can Expect

There are four types of IRS audits SoCal dispensaries can expect, each varying in degrees of scrutiny.

·       Correspondence audits account for the majority of all IRS audits. Because it is conducted through the mail, it is usually simply resolved by responding to the questions contained in the letter. You might be asked to clarify specific deductions or provide information regarding parts of your tax return that don’t line up with IRS records. If your books are clean and up to date, the matter should be closed quickly.

·       Office audits are the next stage and are generally triggered by questions too complex to be answered via correspondence. It only takes a single issue to trigger an office audit, but it can quickly expand in scope if the auditor identifies other concerns. Historically, office audits were conducted in person, but nowadays, they are frequently held virtually.

·       Field audits involve an IRS agent coming to your place of business and are significantly more intensive than the previous two audit types. The process will involve a detailed review of all business financial records and may also include employee interviews and a facility tour.

·       Taxpayer Compliance Measurement Program (TCMP) audits are intensive, requiring every detail of a tax return to be substantiated with documentation. Businesses are selected at random for TCMP audits as the results are needed for IRS data analysis. Be meticulous about your documentation and recordkeeping, as there is a very good chance you might be on the receiving end of a TCMP audit one day.

Common Cannabis Dispensary Mistakes that Trigger Audits

Poor accounting practices and past tax non-compliance are among the top red flags that might trigger an audit. Here are a few more specific red flags that may draw the IRS’s attention to you.

·       Questionable deductions. While cannabis businesses in Southern California currently have the advantage of IRC 280E decoupling, many expenses eligible at the state level are not allowed for federal returns. Cannabis companies can only deduct costs related to COGS. The IRS knows what’s typical for dispensaries in California, so if you are reporting deductions above that threshold, it’s a big red flag. Be mindful of what you’re deducting and be sure to keep meticulous records to support every deduction you take.

·       Home office deductions. If your primary office is not in your home and you’re also taking a home office deduction, it’s a questionable situation in the eyes of the IRS. If you feel it’s warranted, be prepared to substantiate your claims. Ultimately, it’s probably not worth it, and you can almost certainly expect it to trigger an audit.

·       Underreported income. Even if you don’t receive a 1099 from a vendor, it doesn’t mean the IRS doesn’t know about it. If your reported income doesn’t match their records, an audit might be coming your way. Report all income from all sources and maintain detailed records and receipts, particularly where cash transactions are involved.

·       Inadequate Form 8300 filings. Form 8300 is mandatory for all cash transactions exceeding $10,000. In IRS parlance, this also includes cash equivalents, such as money orders and cashier’s checks. Manipulating transactions to avoid filing Form 8300 is a red flag as it indicates evasive measures and can lead to legal action, penalties, and audits.

·       Disproportionate losses. Consistently reporting losses from rental property associated with the business, for example, can draw the auditor’s attention. If the losses are bona fide, they must be documented and have reasonable explanations.

What Can Happen if You Get Audited?

If your dispensary is audited, the consequences can be severe if you’re unprepared. For example, if the auditor determines you have unreported income or did not comply with federal tax laws, you will be required to pay fines and penalties, which can be severe.

In more extreme cases, the dispensary may also lose its license to operate, a massively devastating result considering the time, effort, and resources required to establish the company in the first place.

On the extreme end of the scale, criminal charges might be forthcoming. Fraud, tax evasion, or money laundering are indictable offences that carry jail time and will result in irreparable damage to one’s professional reputation.

How SoCal Cannabis Dispensaries Can Avoid IRS Audits

Filing tax returns is mandatory. Even if you are reporting a loss or no income at all, you must file. If you can’t afford to pay what you owe, the IRS is generally amenable to setting up a payment plan.

Since everything is done electronically, there is no room for error. You must file and pay on time. Failure to do so is a definite audit trigger.

Here are a few additional tips to keep you on the right side of the auditor’s pencil.

·       Stay on top of changes in cannabis tax laws and regulations.

·       Report all expenses and income.

·       Comply with Form 8300 cash transaction reporting rules.

·       Substantiate all expenses and income with proper documentation.

IRS audits are a fact of life for cannabis dispensaries in SoCal, but preparation is your best defense. Working with a qualified cannabis accountant helps you stay ahead of the game and ensures you are prepared when an audit is forthcoming. Set up a call with the experts at Growise today, and let’s get your SoCal dispensary audit-ready!