How to Prepare for a CDTFA Audit: Tips for SoCal Cannabis Retailers

The California Department of Tax and Fee Administration (CDTFA) oversees state-level taxation, licensing, reporting, and compliance for California cannabis businesses. Since cannabis companies are under extreme scrutiny at the best of times, it pays to keep your books in order, file and pay your taxes on time, and ensure your business licenses are up to date to avoid issues if and when an audit comes your way.

As cannabis is a high-grossing sector in California, the CDTFA operates at a heightened level to ensure all business are compliant with various cannabis taxes and regulations.

In any CDTFA audit, the auditor’s job is to determine whether you have reported and paid the correct amounts for all applicable taxes. To back up your filings, you must maintain accurate, detailed records of all transactions, including cash transactions. Without proper documentation, the CDTFA can estimate your liabilities and require you to pay taxes based on that estimate – not an outcome you want.

California Cannabis Tax Compliance: What the CDTFA Looks At

In addition to federal and state taxes, many jurisdictions in California have imposed a local cannabis tax. As these fees are often overlooked, failure to file and pay may trigger an audit. Staying up to date on all local tax obligations is essential as the financial implications can be significant.

The CDTFA examines three types of taxes for cannabis businesses:

Sales tax

Points to be verified include:

·       The business is using the correct tax rate in their district

·       Tax is being properly applied to sales

·       Major business equipment purchases are properly accounted for (for example, use tax is paid if sales tax was not collected at purchase

·       Any sales tax deductions or exemptions claimed (for nontaxable sales, resale certificates, etc.) are valid and accurately documented.

Excise tax

The state cannabis excise tax is a special 19% tax on retail sales of cannabis products. Auditors will verify that:

·       You accurately calculated and remitted the required excise tax on all cannabis product sales.

·       The total amounts of excise tax collected match what was reported to the state.

What Will Trigger a CDTFA Audit?

The CDTFA focuses only on California state and local cannabis taxes. Common audit triggers can include:

·       Not filing tax returns or paying on time

·       Not making sales tax prepayments

·       Reporting discrepancies. For example, sales figures in your sales tax returns not matching income tax reports.

·       Poor bookkeeping, missing invoices, or records that don’t reconcile can raise red flags.

·       Unusually low reported revenue (relative to industry averages or inventory purchases) might lead the CDTFA to suspect under-the-table sales.

CDTFA Audit Tips for SoCal Cannabis Businesses

So, will you get audited? Sooner or later, it’s bound to happen. Larger cannabis companies with high sales volumes are more frequent audit targets, but every cannabis operator should stay prepared.

Fortunately, there are plenty of things you can do to minimize the stress—and potential penalties. The CDFTA will typically provide notice of an upcoming audit, along with a list of records they want to see. However, surprise audits are possible if they suspect the business is being deliberately evasive.

Your best strategy is to maintain clean books and stay compliant with local, state, and federal taxation. If you’re challenged to do this, working with a qualified cannabis accountant will help!

Here are a few strategic tips to get you thinking.

·       Keep your cannabis business licenses current. Be aware of your renewal dates and prepare your submission well in advance to avoid service disruption.

·       Maintain detailed financial records for all financial transactions, including sales, invoices, purchase orders, inventory data, seed-to-sale data, payroll, vendor contracts, agreements, cash flow records, etc. If this data is stored electronically, ensure you have an efficient and reliable backup system.

·       If running multiple entities, separate finances for each. Separate bank accounts and financial records to avoid having them all assessed together.

·       Keep financial records for a minimum of 7 years, as required by law. CDFTA will generally only go back three years but best be prepared.

·       Understand state and local tax rules. Monitor changes in California and local tax laws to ensure compliance.

·       Separate excise tax on sales receipts as legally required. Specialized cannabis POS systems typically have this feature built in (plus they integrate with Metrc, so it makes life easier all around).

·       Report COGS expenses accurately to maximize allowable deductions. Any cost directly related to cultivation, processing, packaging, acquisition, and transportation are eligible.

·       Implement strict internal controls, especially for cash handling. Security and accountability are imperative when handling large amounts of cash. Smart safes, electronic surveillance systems, two-person transactions, and physical security are all recommended.

·       Use cannabis-specific software to track sales, streamline inventory, automate reporting, and improve compliance.

·       Conduct internal audits periodically to ensure everything is in order. Identifying anomalies before they become red-flag issues will help you keep things on track.

·       Create and maintain a compliance calendar with all relevant reporting, filing, and payment dates through the year.

What to Do If You Are Audited

Preparation is the best audit defense for SoCal cannabis operators. Since there is really no way to avoid an audit, proceed with the assumption that it will eventually happen—and when it does, you’ll be ready for it! Audits are a heck of lot less stressful when your records are organized, compliant with Metrc, and ready to call up in a couple of clicks.

What happens if you don’t comply? Beyond the financial penalties, which are 50% for late or inaccurate filing of excise taxes, plus the standard rate of 10% for late filing. You’ll also pay interest on unpaid taxes.

At the more extreme end of the scale, cannabis businesses in tax arrears may face suspension or revocation of their business license. Criminal charges are also possible, and the CDTFA is authorized to seize and auction off property to recover tax arrears.

Our best advice is to know the rules, apply the rules, and maintain precise documentation. These things are your best defense in an audit as they will facilitate a smooth process. Need help with this? Set up a call with Growise today, and let’s get you audit-ready!