Avoiding IRS Headaches: The Role of Accurate Record-Keeping in Tax Compliance
Cannabis businesses in the US face an uphill battle with profitability, largely because of restrictive tax laws gripping the nascent industry. Until the FDA reschedules, cannabis companies will be under a microscope. Accurate record-keeping is essential, not just to maintain compliance but also to enable more accurate business planning and attract investors.
So, while keeping up with federal and state cannabis tax regulations is a daunting task at the best of times, with some diligence and consistency, you can reduce tax and compliance stress and spend more time doing what you do best.
The Unfortunate Impact of Section 280E on Cannabis Companies
Perhaps the greatest tax challenge cannabis businesses face is Section 280E. This federal tax rule prevents any company engaged in manufacturing or selling “illegal” substances from deducting typical business expenses, like rent, payroll, insurance, advertising, etc.
While this rule may seem unfair, considering the legal status of cannabis in most states, it is still considered a Schedule 1 controlled drug in the Fed’s eyes. Though there is a push to reduce cannabis to Schedule III, it remains to be seen how quickly this will pass as the new administration has other priorities. Should rescheduling pass, cannabis companies will have the same rights and tax advantages as any other American business.
Cannabis companies can only deduct expenses related to the cost of goods sold (COGS), some of which can be attributed to inventory.
State and Local Cannabis Taxes
State regs vary. Some levy cultivation taxes, and many have sales and excise taxes on retail and wholesale transactions. Further complicating matters, the rules vary significantly between states as some products are taxed based on weight and price, others on potency, and there may be several layers of taxes to consider. Additionally, there may be taxes due at the local level.
How Accurate Record-Keeping Helps
Cannabis businesses are inordinately targeted for audits. Why? It’s simple. Cannabis is a huge money-maker for the government because they pay more taxes than the average business. Hence, auditors want to ensure everybody’s paying their share.
Additionally, cannabis businesses have a lot of cash transactions, which can easily be mismanaged.
Maintaining accurate financial records is a way to beat the IRS at their own game. If you keep impeccable books, you’ll be prepared for any level of scrutiny and will confidently breeze through an audit if (or when) it happens.
Audits can be stressful. They can also be costly, especially if the auditor finds any impropriety. If your books are disorganized, it will take more time to sort them out, and you’ll pay for the privilege of having them go through your books with a fine-tooth comb. Good times!
Tips to Improve Your Cannabis Business Record-Keeping
If bookkeeping isn’t one of your superpowers, don’t despair. We’ve got a few tips to get you in the groove.
Track all transactions meticulously.
Accurate record-keeping lays the groundwork for good accounting practices. Track all purchases, sales, and expenses, and retain receipts and invoices in a filing system. Include details like invoice numbers, dates, prices, taxes collected or paid, and payment method; essentially, every pertinent detail that can be recorded that relates to the transaction. Not only will you have clean books to present to the auditor, but your records will support accurate forecasting and cash flow analysis so you can make qualified business decisions.
Implement cannabis accounting software.
Having the right accounting software is essential to maintaining accurate records. Several solutions are purpose-made for the cannabis industry, with modules to help you track inventory, purchases, taxes, sales, and payroll hours and generate compliance reports. Look for cloud-based software that integrates with apps you already use. Strong integration capabilities allow you to save time and effort with automation.
Reconcile accounts regularly
Get in the habit of reconciling your records frequently—daily if possible. The more often you do it, the less work it will be. Set aside time in the morning before things get busy. Even if most of your transactions are automated, you still need to check them against your accounts periodically to ensure accuracy. Keeping tabs on your accounts helps you identify open invoices, uncleared checks, etc., providing a realistic view of your business finances. Cash transactions can easily be missed or mishandled if you’re not on top of things, which could lead to income reporting inaccuracy. Good bookkeeping habits simplify and streamline audits and reporting, easing the stress at tax time.
Stay on top of federal, state, and local regulatory frameworks.
As cannabis regulations and frameworks continue to evolve, staying on top of current legalities might seem like a monumental challenge. But since these changes relate directly to your livelihood, it’s a good idea to be informed in case you need to adapt your bookkeeping processes. Staying compliant is good for business. It will also save you a ton of money and headaches with your professional associations and the IRS. Adherence to best practices to the letter of the law—legally, financially, and otherwise—boosts trust with potential investors, reduces risk, and helps you stay competitive despite disruption.
Partner with a qualified cannabis CPA
Small firms are especially challenged to meet the stringent demands of cannabis financial reporting and compliance. We get it—you wear many hats and run a tight ship. Working with a qualified cannabis CPA like Growise helps you focus on growing your business and worry less about the labyrinthine maze of challenges on the regulatory end of things. From Form 8300 filings and compliance reporting to inventory accounting methods that will help you grow your bottom line, we provide proactive strategies, comprehensive tools, and all-around great financial advice to keep your business moving forward.
Set up a call today. We’d love to learn more about your business and show you how we can help you avoid IRS headaches and achieve your financial goals.