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IRS Audit Preparation

   Cannabis businesses are 4x more likely to be audited than a regular business. The restrictions of IRC 280e cause many cannabis businesses to misappropriate expenses and will likely trigger an audit by the IRS. Misappropriating expenses without supporting documentation could lead the IRS to penalize a cannabis business by not allowing the company to deduct any expenses under 280e as well as additional fines.

   The IRS continues to expand the large scale audit program targeting the cannabis industry called Compliance Initiative Project.


   The IRS created an algorithm specifically to analyze all cannabis tax returns and detect tax returns with a higher probability error using a DIF score (Discriminate Inventory Function). No one knows the exact information used in the algorithm but at Cash Grows CPAs, we have cutting edge indicators that all cannabis businesses should have in their tool box.

Why is it important?

   The U.S. Treasury Inspector General for Tax Administration published a report recently from March 2020 titled "The Growth of the Marijuana Industry Warrants Increased Tax Compliance Efforts and Additional Guidance". The report examined commercial cannabis businesses in California, Oregon and Washington. The data found approximately 59% of cannabis companies underpaid the IRS under section 280E, estimating $48.5 million dollars were owed to the IRS. Considering the data sample was only from three states, this suggests that hundreds of millions of dollars, if not billions, are owed by commercial cannabis businesses in states where medical cannabis and/or recreational cannabis is legal. Click here to see the U.S. Treasury Inspector General for Tax Administration report on cannabis.  


   The information in the report confirms the preparedness of the IRS to increase cannabis industry audits in all states that cannabis is legal in some form. Cannabis industry tax and legal experts have been warning about a tsunami of cannabis industry audits for years. The IRS is closely watching the cannabis industry, targeting cannabis companies that have failed to pay their federal tax obligations. In other words, the IRS plans to collect those taxes. The IRS has always placed the burden of proof on the taxpayer. Since a defendant is not considered innocent until proven guilty, supporting documentation is required for every transaction and/or event. 


   However, the current code states as long as a cannabis business has reasonable records that prove the amount in their tax return, and if they have been cooperative with the IRS requests for documents, meetings, etc. Only then is it up to the IRS to disprove the taxpayer’s numbers. If an audit is contested in U.S. Tax Court, the burden of proof is stricter on the taxpayer and they will add additional penalties, fees and interest.

Our Solution

   We can help your cannabis business be as prepared as possible by providing the best accounting and bookkeeping services as well as evaluating internal controls and SOP's. We can also help your cannabis business navigate through an IRS Audit. Document retention and organization is key. Businesses need to hang on to supporting documentation for at least 7 years.

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