How Cannabis Operators Should Prepare for 280E Audits

Cannabis businesses face complex tax obligations and need to be mindful of potential IRS audits. The complexities of IRS audits increase due to Section 280E of the Internal Revenue Code (IRC).

In a recent webinar, we addressed, “Why is the IRS Targeting Cannabis Businesses with 280E Audits? and What Cannabis Operators Need to Know to Prepare.” Here is an overview of what a cannabis operators need to know to prepare for a 280E audit.

What You Need to Know About Section 280E Tax Code

Section 280E of the IRC prohibits taxpayers engaged in trafficking Schedule 1 controlled substances from deducting usual business expenses linked with such activities. How does 280E affect the cannabis sector?

Since cannabis is still considered a Schedule 1 drug from the federal government’s perspective, THC trafficking businesses are subject to 280E. While costs of goods sold are an allowable reduction to gross receipts, businesses subject to 280E are allowed no deductions for the purposes of calculating taxable income.

Why the Sudden Surge of IRS Audits and Compliance Audits Targeting Cannabis Businesses?

Cannabis operators and businesses are more likely to face increased scrutiny from the IRS. Because perceived inconsistent compliance with 280E in the cannabis industry, the IRS believes that there is a need for this level of scrutiny.

Below are the two primary factors motivating the current situation involving the IRS targeting cannabis businesses with audits:

Complex Regulatory Landscape

Cannabis is currently legal in over 75% of all states. This is after a long struggle by cannabis operators to seek the legitimization of their operations. However, federal guidance remains unclear. The greatest cause of this confusion is the lack of alignment between federal, state, and local legislation. Cannabis remains federally illegal while individual states license and regulate its operations.

Section 280E

Unfortunately, the IRC doesn’t strictly differentiate between income generated via legal means and income generated through illegal activity. According to the IRC, all income is taxable and must be reported on tax returns. It’s almost challenging to figure out what you can and can’t write off. Unfortunately, the IRS guidelines appear counterintuitive.

What Cannabis Operators Can Do to Avoid IRS Audits: How to Prepare for IRS Audits

The thought of an IRS audit tends to cause panic in businesses. As a cannabis operator, your chances of getting audited increase over time. However, this is no time to get in trouble with the IRS.

As long as your tax return is prepared correctly and you have a record of all source documentation, you shouldn’t worry about avoiding an IRS audit.

Below are five tips for cannabis operators to prepare for an IRS audit:

  • Organize all your financial documentation and maintain good records
  • Partner with cannabis-specific tax and accounting professionals
  • Ensure all correspondence with the Internal Revenue Service is in writing
  • Do not ignore IRS notices
  • Prepare for interview questions and physical tours of your business operations

Adverse audit findings can result in strict fines and possible criminal penalties for cannabis businesses. Cannabis business owners who partner with financial teams of experts tend to be ahead of such audits. Furthermore, they are usually informed and updated on the current legislation and tax laws affecting the cannabis sector.

We Can Help

Bridge West CPAs & Advisors have been assisting cannabis businesses across the country since 2009. Our dedicated industry experts have assisted cannabis businesses and entrepreneurs throughout the country navigate complex local and federal accounting, tax, and regulatory issues. Bridge West can help your cannabis business scale growth and guide you through the challenging financial and operational requirements of our rapidly growing industry. Contact us to schedule an appointment and get started today.

“BGM” is the brand name under which BGM CPA, LLC and BGM Group, LLC provide professional services. BGM CPA, LLC and BGM Group, LLC practice as an alternative practice structure in accordance with the AICPA Code of Professional Conduct and applicable law, regulations, and professional standards. BGM CPA, LLC is a licensed independent CPA firm that provides attest services to its clients, and BGM Group, LLC and its subsidiary entities provide advisory, and business consulting services to their clients. BGM Group, LLC and its subsidiary entities are not licensed CPA firms. The entities falling under the BGM brand are independently owned and are not liable for the services provided by any other entity providing services under the BGM brand. Our use of the terms “our firm” and “we” and “us” and terms of similar import, denote the alternative practice structure conducted by BGM CPA, LLC and BGM Group, LLC.

BGM WEALTH: Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™, CFP® (with plaque design) and CFP® (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.