Is Your Cannabis Business Ready for an IRS Audit?
The risk takers and money makers of the cannabis industry may be in different states but they all share one thing in common – marijuana industry bias in federal tax laws. That’s right, Uncle Sam wants your money just like any other taxpayer. The only problem is that you are more likely to be audited than the average business owner if you handle cannabis.
According to a 2021 report from Marijuana Business Daily, (https://mjbizdaily.com/chart-of-the-week-irs-audit-rate-for-existing-marijuana-businesses/), more than 6% of operational cannabis companies were audited. This is a much larger percentage than businesses overall, which are audited at a less than 2% rate in a typical year. This means that cannabis businesses need to be extra vigilant in how they report their income and fill out their tax forms.
In this blog post we’ll look at IRS audits and what cannabis entrepreneurs need to be aware of to avoid penalties or, even worse, jail time.
What Is An Audit?
So what is an audit? An IRS audit is a review or examination of an individual's or organization's accounts and financial information to ensure that it is being reported accurately on the tax return. The audit is conducted by the Internal Revenue Service (IRS), the federal agency responsible for enforcing the tax laws in the United States.
The audit process typically involves the IRS reviewing the taxpayer's records, such as receipts and bank statements, to verify that the information reported on the tax return is correct. If the IRS finds any discrepancies or errors, the taxpayer may be required to pay additional taxes or penalties. The audit may be conducted in person at the taxpayer's place of business or residence, or it may be done through the mail.
Why Are Cannabusinesses More Likely To Get Audited?
First of all, the industry is lucrative, or at the very least is perceived in that way by the IRS. But another key reason is marijuana’s designation as a Schedule I substance. Due to its illegality at the federal level and the persistent “war on drugs”, special tax codes that were meant to account for revenue derived from illegal sources affect legal state operated cannabis businesses that are stuck in a grey area.
Two of the biggest issues that trigger audits are IRC Section 280E and failing to fill out or improperly filling out Form 8300. Section 280E limits the business expenses that can be claimed by businesses or persons who sell a controlled substance. That’s right folks, a section of the tax code meant to curtail drug traffickers gets used against legally operating cannabis businesses as long as marijuana remains a controlled substance or until the tax code is repealed. Form 8300, Report of Cash Payments Over $10,000 Received in a Trade or Business, must be filed with the IRS any time there is a cash transaction of $10,000 or more. In the cannabis industry, we all know those kinds of transactions are quite frequent. That is a lot of paperwork to make sure is 100% accurate and never forgotten.
What Are The Different Types Of IRS Audits?
What does it look like when Uncle Sam comes knocking at your door to check your books? The audit process commences when you receive a letter in the mail informing you that you are the subject of an audit for a specific period or tax year. Audits are conducted either by mail or in person. The IRS will never email or call taxpayer to inform them of an audit, only scammers do this. When the tax man cometh they will ask that you present certain documents that support the income, credits, or deductions that were claimed on a submitted return. The notice will inform you of when and how to present your records. The request should not require you to create anything new.
There are three types of audits the IRS performs: correspondence, office exam, or the field audit. Correspondence audits are conducted through the mail, while office exams require you to go to the IRS office. The field exam, which is a comprehensive and thorough audit, often involves multiple years and issues. Field audits are the most common for cannabis businesses. Due to the nature of the “all cash business” of the cannabis industry, the IRS has taken notice and audited retail dispensaries and other marijuana operations across the nation.
Why Do Cannabis Businesses Get Audited?
Is an audit in your future? Likely. An audit can be triggered by improperly filled out or missing forms, like the 8300 form for transactions over $10,000. Keywords like MJ, cannabis, etc. and some descriptions used in your return can also cause the IRS to flag your returns for greater scrutiny. A 280E adjustment and its presentation on the tax return as well as certain NAICS codes also clue the IRS that your business is a marijuana venture.
If you find yourself facing an audit handle the situation with care and have a tax attorney ready. Noted cannabis attorney Henry Wykowski suggested in a 2013 interview (MMJ Audit Advice: Avoid Responding to IRS Yourself, Handle it ‘Like Nitroglycerine’ https://mjbizdaily.com/mmj-audit-advice-avoid-responding-to-irs-yourself-handle-it-like-nitroglycerine/) to “Never respond to an audit yourself” because “IRS agents know how to ask questions and get you talking, and before you know it, you’ve made mistakes.” These mistakes could range from fines to jail time.
Tips For Cannabis Companies On How To Handle An IRS Audit
Here are some tips to help guide you through the audit process. Stay focused, organized, and let a cooler head prevail, being angry or unorganized won’t make this go any faster. Use all of time the IRS allows you, getting it done fast doesn’t always mean it’s done right. Don’t be afraid to ask questions. Don’t forget that even though the IRS has a job do, you still have legal rights during an audit which your attorney should make you aware of so you know where you stand. Do not give out information that isn’t asked for, they will know what they need from you. Honesty isn’t just the best policy, it’s the law so no attempts to bribe the auditor or lying. Make sure to keep it professional so don’t invite auditors to your home unless it is part of the audit.
So are you ready for an audit? Follow these tips to be sure you are. Make certain your CPA or other tax professional knows the unique challenges cannabis businesses face. It’s best to find someone who specializes in representing cannabis businesses. This is because they will have experience with industry issues and will be knowledgeable about how to address them during an audit. No matter who our CPA or other tax professional is they will tell you to document everything!
Keep every single receipt, keep notes on why an expense occurred and why it was critical to your business. You may have expenses that qualify as COGS (Cost of Goods Sold), which are the only eligible deductions available to cannabusinesses. Also, you never want to give the IRS a reason to question where money is coming or going, they will suspect fraud. This is important because this form triggers a lot of audits, complete Form 8300 every time you have a cash transaction of $10,000 or more. Finally, file all tax returns on time with accurate information.
Handle Your IRS Audit With Indiva Advisors
Some of these tips may sound like common sense and they should, others may come as a surprise. The benefit of hiring knowledgeable professionals is the guidance they can offer throughout the year to keep your business on the straight and narrow with the IRS. You may be a risk-taking, money-making cannabis business rockstar but the smartest bet is to never underestimate the IRS and never go it alone in an audit.
Indiva Advisors can help a cannabis business prepare for and navigate the audit process in several ways:
Gathering and organizing documentation: we can help your business gather and organize all the necessary documentation, such as receipts, bank statements, and other records that may be requested by the IRS during the audit.
Reviewing tax returns: we can review the business's tax returns before they are filed to ensure that they are complete and accurate. This can help reduce the risk of being selected for audit or help identify and correct any errors before the return is filed.
Representing your business during an audit: we can act as a representative of the business during the audit and communicate with the IRS on behalf of your business. This can help to ensure that the audit is conducted fairly and efficiently.
Providing advice: Our accountants can provide guidance and advice on how to respond to any findings or issues that may arise during the audit and how to avoid similar issues in the future.
Overall, Indiva Advisors can be a valuable resource for a business during an IRS audit, helping to minimize the stress and burden of the process and ensure that your cannabis business is in compliance with federal and state tax laws.