Like many other federal agencies, the IRS put much of its routine work on the back burner and demonstrated more leniency during the COVID-19 pandemic. Experts are saying that this means for this year’s tax season, cannabis-related business (CRB) owners should brace up for a new wave of IRS audits, which had been tabled at the height of the pandemic.
If you’re a cannabis business owner, statistically, you’re likely to face at least one IRS audit in your career. That’s why preparing ahead, maintaining compliance records, and documenting every transaction is critical to your business. Don’t wait until you receive an IRS audit notice to get started – in this post, you’ll learn how to prepare for when the IRS comes calling.
On average, the IRS annually performs audits on around 1-3% of businesses. However, CRB owners face a higher rate of IRS audits than any other comparable industry – much higher, in fact. Highlights from a recent survey conducted by MJBiz Daily include the following:
The purpose of an audit isn’t to help business owners correct mistakes – audits are performed with auditors specifically looking for “reasonable indication” that payment is owed.
A standard IRS audit of non-cannabis businesses is centered on itemizations that are prone to misstatement by business owners – think travel and entertainment expenses, purchases of assets, or loan payments. IRS audits of cannabis taxpayers focus on the business representation of gross profit and the flow of cash within the business.
Due to the federal disconnect that leaves the cannabis industry underbanked, the IRS assumes that cannabis businesses are hoarding, hiding, or concealing large sums of cash. Essentially, CRBs are audited more because of lingering stereotypes about the industry.
IRS auditors are looking for any misstatement, error, or oversight related to gross sale receipts. Auditors are closely inspecting all issues relating to the deduction of expenses while simultaneously considering the disallowance of retail related cannabis expenses.
The list of things IRS auditors are looking for during an audit of a cannabis business include, but are not limited to:
There are two core methods used by the IRS to conduct an audit. The direct method involves the review of SOPs, business-related documentation and records, like bank accounts, finance, and utility statements. Auditors will also expect an in-depth review of how cash transactions are handled, ATM transactions, and records of cash deposits. They may also evaluate the cash registers, count the amount of cash on the premises, and review business practices for transferring excess cash from the premises.
The indirect method is employed by auditors when it’s suspected that the CRB is underreporting, but there is no way to substantiate the suspicion via the direct method. Per IRS language, “…if the method of accounting used by the business owner does not clearly reflect income,” there is a legal precedent to use indirect methodology. This approach includes establishing the net worth of the CRB owner, comparing records related to income sources with expenditure records, and interviews with individuals unaffiliated with the business.
The unfortunate result of most IRS audits of cannabis businesses ends with the CRB owner held liable for unpaid taxes. With that in mind, it’s smart to go into an audit of your business with the goal of minimizing the financial impact.
The key to preparing for an IRS audit is doing it before you’re facing one. Here’s how you can stay audit ready, year-round.
With over a decade of experience serving the needs of the cannabis industry, Accountabis financial advisors understand the unique needs of your cannabusiness. We’re ready to use our expert accounting strategies to usher your cannabis business into a new era, and to make sure that if you’re facing an IRS audit, you’re not alone, and can go into it with confidence and peace of mind.
If you’re ready for a partner to help grow your business and ensure it remains in compliance with all the complicated tax laws and regulations, we’d love to help. All you need to do to start is book a call to discuss your cannabis business and how Accountabis can help with your cannabis tax, bookkeeping and accounting needs.
