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Taxation and 280E for Dispensaries

280e 471 cannabis dispensaries Feb 22, 2022

The Challenges of Accounting for Cannabis Dispensaries

From cash control issues to inadequate reporting and POS software, accounting for Cannabis dispensaries is no easy feat and making the wrong move can land your client in serious legal trouble. 

Accounting professionals claiming to have Cannabis experiences are often misinterpreting tax codes in an effort to increase deductions dispensaries may not be allowed to take. This means that the CEOs 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 procedure under IRC 280E.

Professionals who are new to the Cannabis industry that have never worked with such large sums of cash are also 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 clients in compliance, you have to implement solid internal controls like paying bills timely, maintaining pristine records of each payment, daily cash counts, and segregation of duties.

The reason is simple: many accountants don’t realize how far behind they’ve gotten while accounting for a cash-based business, even when doing their usual quarterly financial reviews or monthly books until it’s too late.

More often than not, they’ve fallen so far behind that they’re setting themselves up for a string of all-nighters, at minimum, to catch up. The worst-case scenario? They end up increasing their client's risk of those hefty fines or being permanently shut down by not doing accounting and compliance correctly.

How can you ensure your clients are in compliance?

By now, you probably have an idea of what 280E is.

At the very least, you’re aware that it’s what stops Cannabis operations like dispensaries from getting tax deductions. But before we continue learning how to keep your Cannabis clients in compliance, let’s take a deeper look at IRC 280E.

According to the Legal Information Institute, 280E is described as:

 “No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances (within the meaning of schedule I and II of the Controlled Substances Act) which is prohibited by Federal law or the law of any State in which such trade or business is conducted.”

This is where things get tricky. Since Cannabis is classified as a Schedule 1 substance, any business that distributes or owns Cannabis products is technically trafficking it, regardless of the intent. 

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 IRC 471 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. 

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 are putting their foot down. 

The best way for you to guarantee success for your clients is by implementing annual, quarterly, monthly, weekly, and daily procedures for dispensary accounting to strictly adhere to both GAAP (Generally Accepted Accounting Principles) and IRC 280E so that the business can take advantage of correctly minimizing their taxes.

So, how exactly do you get deductions for dispensaries?

The answer lies within COGS and tax code 471. However, it varies from vertical to vertical within the Cannabis industry, making it even more difficult for dispensaries than say a farm or manufacturing type of business in this space.  

But before we go further, let’s go over the basics of 471. 

The general rule that applies for all Cannabis companies is:

“Whenever in the opinion of the Secretary the use of inventories is necessary in order clearly to determine the income of any taxpayer, inventories shall be taken by such taxpayer on such basis as the Secretary may prescribe as conforming as nearly as may be to the best accounting practice in the trade or business and as most clearly reflecting the income.”

In other words, the method used for inventory has to unquestionably reflect the company’s income and align with the way your client accounts for inventory in the financials.

For dispensaries specifically, we can look to 471-3, which states that:   

In the case of merchandise purchased since the beginning of the taxable year, the invoice price less trade or other discounts, except strictly cash discounts approximating a fair interest rate, which may be deducted or not at the option of the taxpayer, provided a consistent course is followed. To this net invoice price should be added transportation or other necessary charges incurred in acquiring possession of the goods.

Essentially allowing the dispensary taxable income to be lowered via COGS if the accountant is making sure to do 471-3 correctly. Because the IRS is so strict, it’s essential that, as a Cannabis accounting professional, you’re keeping track of your client’s inventory accounting if the client hopes to be able to successfully pass an IRS audit.

Poor bookkeeping is no joke, and the legal fines your client may have to pay can be over $70k, or more, just take a look at the Altermeds Case if you need a cautionary accounting tale. 

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. With state-mandated seed to sale, coupled with POS systems that integrate terribly and are hard to reconcile, there are a number of added headaches just because of the fact that you’re dealing with Cannabis.

Cash controls are a whole other issue since banking is pretty much non-existent in many states. When dealing with cash you now have to worry about money being stolen and daily cash counts are essential. And the local licensing authorities are holding owners responsible for having adequate security measures in place, so clients 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 workpapers so that you can do proper GAAP accounting if you plan to take any allowable deductions. The tools don’t exist and there isn’t much in terms of proper guidance, which is why DOPE CFO exists… to provide that guidance AND the tools for accounting professionals that are looking to support growing Cannabis companies and help them thrive.

Are you ready to better serve your Cannabis clients or get into the industry? Join our ever-growing community of over 500 Cannabis accounting, tax, and legal professionals who are actively involved in the industry. Get workpapers, tools, and guidance to help you successfully keep your clients in compliance.

To learn more about accounting and bookkeeping for Cannabis dispensaries, check out our webinar here.

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