In the Cannabis Industry we hear IRC 280e continuously. Many owners know the history of this messy tax code, but the understanding of it STOPS there. If you have ever sat down and really read some of the multiple articles regarding IRC 280e, you will understand why it’s hard to understand. The IRS wants business owners to know it exists and it governs cannabis owners, but for the average individual who knows little to no bookkeeping it is extremely complex.
First, let’s define what IRC 280e is and why it is important. This federal statute states that a business who participates in the trafficking of a Schedule I or II controlled substance is banned from taking tax deductions or credits. Therefore, because cannabis is a Schedule I drug, cannabis business owners must pay taxes on all their revenue. Thus, removing the benefit of being able to use business expenses to reduce their taxable income. The IRS added an exclusion to 280e that allows the deduction of cost of goods sold with an extremely restricted definition of what can and cannot be included. Summed up, this means because you are trafficking a schedule I drug you are not treated like an everyday business.
Now that you know what it is and why it is important, let’s go further. In every one of my conversations with local business owners here in Oklahoma the topic of “cost of goods sold” or “COGS” is discussed. It is important to keep in mind that what a cannabis business can allocate to cost of goods sold is going to vary by what their role is in the industry. A grower will have more to allocate to cost of goods sold than a dispensary will. According to IRC 280e ONLY costs directly related to cannabis inventory can be allocated to COGS. These costs are made up of both direct and indirect costs pertaining to cannabis inventory. Broken down this way it would appear anyone could handle this job. To accurately determine COGS for a cannabis business a few things need to happen.
First and foremost, EVERYTHING needs to be accounted for. All receipts, invoices, utility bills, etc., need to be documented, categorized and noted. All income and expenses need to be tracked. No stone should go unturned in this area. Accurate records in this industry are extremely important. If records are not kept accurately or categorized correctly, deductions could lose their credibility as being a deduction. Accurate financial records are extremely important when the IRS decides to audit. If you are aware of Champ V. Commissioner, you will understand exactly how important precise record keeping is. Cannabis business owners are 30% more likely to be audited than any other business. That statement alone should send up a red flag on how extremely import this procedure is.
Second and extremely important, be descriptive in your business. Develop a blueprint of your building and break it down into cannabis and non-cannabis inventory and measure. These measurements will be used to determine what percentage of your building is cannabis inventory related. When developing your floor plan, maximize the space used for cannabis inventory and production. Construct descriptive job descriptions for each employee. Consider a biometric thumbprint system that will report your employees’ time in different areas of your business. This will determine what part if any of the employee wages can be allocated toward COGS. It is important to determine a documented system and do not deviate from it.
Realize that categorizing and reporting deductions incorrectly even for a short time could result in considerable expenses down the road. These expenses can vary from penalties, interest and increased tax liabilities. It is important that you understand what direct and indirect costs consist of. This will allow you to maximize what can be allocated to COGS and capitalize on them. This is important to lessen your tax burden. When the IRS audits, you are going to have to PROVE to them how you determined a cost could be allocated to COGS. This takes organization, documentation and a great deal of knowledge. The IRS would love to put you out of business and they will if you are negligent in your cannabis business books. It’s also important to keep in mind that you CAN NOT file bankruptcy on a cannabis business. You are STILL drug trafficking and the bankruptcy system is not going to protect you.
Lastly, DO NOT assume the average CPA or Bookkeeper for that matter knows what IRC 280e is or how to manage your books. Many of these professionals have no more knowledge of this federal statute than you do. As a business owner in this industry, it’s your job to ask these professionals questions about their knowledge before you hire them. Cannabis accounting takes a great deal of organization and knowledge. This area of accounting and bookkeeping is specialized and consists of a great deal of education not acquired easily. With that being said UNDERSTAND if an average CPA or bookkeeper does not know how to handle cannabis books…..it is extremely likely you do not either and are going to lose a ton of money and your business. As a cannabis bookkeeper, I expand my knowledge daily on this topic. I am aware of just how much work cost accounting is and the consequences a business owner will suffer over neglect and mistakes. Cannabis bookkeeping involves a very specific Cannabis Chart of Accounts to categorize expenses correctly. Analyzing costs one by one is extremely important and knowing what to do after analyzed is imperative. Start your cannabis books early, preferably from day one. Oklahoma cannabis business owners have to ability to start off on the right foot.