Andrew Hunzicker is a CPA and CEO of DOPE CFO, which provides accounting and bookkeeping training programs for financial professionals in the cannabis industry. Views are the author's own.
Professionals, finance executives and accountants who are new to the cannabis sector and have never worked with large sums of cash are often finding themselves in a bind by relying on accounting controls from the past that likely won’t work in this industry.
The fact of the matter is that if you want to successfully keep your cannabis company or clients in compliance, you have to implement solid internal controls over paying bills in a timely manner and maintaining pristine records of each payment, daily cash counts and segregation of duties.
Accounting professionals and financial report preparers often misinterpret tax codes in an effort to increase deductions that dispensaries may not be allowed to take. This means that the CEOs and CFOs who are heavily relying on their accounting teams are unknowingly putting their company at risk of large fees, or worse, being shut down for not following the correct procedures.
How can you ensure your clients are in compliance?
One area of confusion for many is section 280e of the Internal Revenue Code (IRC), which is what stops cannabis operations like dispensaries from getting tax deductions. Because it remains classified as a Schedule 1 substance, any business that distributes or owns cannabis products is technically trafficking it, regardless of the intent. There are no cutting corners or loopholes to get around 280E and find deductions; the IRS is more than aware of the games being played and is putting its foot down.
Since cannabis companies can’t take deductions or credits like traditional companies, they don’t have many options when it comes to reducing tax liability; in fact, the only way to do so is by relying on section 471 of the IRC to determine which costs can be allocated via cost accounting to inventory and eventually to Cost of Goods Sold (COGS). This process is highly complex, even more so for dispensaries.
So, how exactly do you get deductions for dispensaries?
The answer lies within COGS and the IRC’s 471 section. However, the application of the tax rules vary from vertical to vertical within the cannabis industry, making it even more difficult for dispensaries than for a farm or manufacturing type of business in this space.
One general rule that applies for all cannabis companies is the use of inventories and the method used has to unquestionably reflect the company’s income and align with the way a company accounts for inventory in the financials.
For dispensaries specifically, regulations essentially allow a dispensary taxable income to be lowered via COGS if the accountant is making sure to do it correctly. Because the IRS is so strict, it’s essential that cannabis accounting professionals are keeping track of their client’s inventory accounting if the company hopes to be able to successfully pass an IRS audit.
Poor bookkeeping is no joke, and the legal fines a company may have to pay can be over $70,000, or more. Just take a look at the Alterman v. Commissioner case if you need a cautionary accounting tale. The 2018 Tax Court decision upheld a 20% tax penalty on the taxpayer for underpayment of the tax liability related to deductions taken, according to a June 15, 2018 report from the law firm Lowndes.
Still, success is more than possible when you follow the correct procedures and understand how to adhere to IRC 280E and 471.
Tools needed for proper dispensary accounting
One of the other unfortunate aspects of accounting for dispensaries is that there aren’t very many tools out there that can make an accounting professional’s life easier in the cannabis sector. With state-mandated seed to sale, coupled with POS systems that are poorly integrated and hard to reconcile, there are a number of added headaches around dealing with cannabis.
Cash controls are a whole other issue since banking is pretty much non-existent in many states. Local licensing authorities are holding owners responsible for having adequate security measures in place, so companies can’t use theft as an excuse for missing cash.
To add insult to injury, accounting software often isn’t cannabis friendly, so you’ll need a dispensary-specific chart of accounts and work papers so that you can do proper GAAP accounting if you plan to take any allowable deductions.
In short, the best way for a company in the cannabis sector to succeed is to implement annual, quarterly, monthly, weekly, and daily procedures for dispensary accounting and to strictly adhere to both GAAP and IRC 280E so that the business can correctly minimize taxes.