As the cannabis industry continues to grow, IRS auditors will be taking aim at cannabis business operators due to their lack of understanding around cannabis business taxes and cannabis compliance regulations.
In this episode, Jim will cover topics that help you prepare and get your cannabis accounting in order including:
- What draws attention from authorities
- How audits typically proceed
- How to prep for an IRS tax audit
- SOPs to avoid gross negligence
If you need help with your cannabis taxes or IRS tax audits, then please reach out to us at https://greengrowthcpas.com/get-started or call 800-674-9050.
Hey there. Thank you again for joining our webinar this afternoon. My name is Jim Breese from GreenGrowth CPAs, and today’s topic is minimizing your cannabis company. Tax audit risks is a buzz word. You’re hearing it more and more often as the industry matures. You know, we didn’t in the black market for a while starting to come out of that shadow and move into this licensed legal market here and now more people are taking notice, not just business operators, but every level of the government is starting to take notice as to how much money is being pumped into this industry, which then increases the risk for audits. So hopefully today we can add some color and context to how audits go, how you can prepare yourself and what to look for in the future. A little bit about GreenGrowth CPAs, we are a cannabis only tax and compliance firm.
Anything cash and cannabis we can help out with. Starting off, you know, we’ve prepared over 1200 annual tax returns for cannabis business operators in all verticals, from dispensary’s, distribution, cultivation, manufacturing, delivery and testing. So we can speak intelligently about all different parts of the supply chain for cannabis in the financials around that. And we have over 400 cannabis business clients. We see everything from big, large public companies all the way down to the small individual operator just doing their small little shop across that wide spectrum. We have a lot of experience. We’re in 12 different States from California, Oregon, Washington, Colorado, Hawaii, Montana, Florida, all different States, Oklahoma as well. And outside of just tax returns, we’ve done 17 audit related or valuation projects for 2018 and 2019 M and a is heating up and people need a deeper dive on their financials and on their analytics either on the buyer’s side or the seller side, especially if you have investors, investors want to know what’s going on with the business.
Can we take the CEOs of the CFO’s word truthfully, let’s get a third party to come look. And that’s what we do. We help create confidence within your business, around the money. And further we have a deep and thorough understanding of tax compliance and assurance related requirements for the cannabis industry. So before we get started with today’s presentation, I need to let you know that the information contained in this webinar presentation is meant for guidance purposes only and not as professional legal or tax advice. And further, it does not provide any personalized legal tax investment or any business advice in general. So with that out of the way, let’s hop right into today’s agenda. So today we’re going to talk about a lot of things. So first we’re going to start off with recent news and context about IRS tax audits for cannabis companies. And then we’re going to talk about what draws attention from the authorities and then how audits typically proceed.
We’ll discuss the two types of audits, which are correspondence audits and in-person audits. And then we’ll go into the documentation that you need to have, things you need to hold on to throughout the entire life of your business. Then what happens if you actually have to pay, there’s a judgment against you. How does that work out? How does that shake out? And then I think the most important part of this presentation is how to prepare for an IRS audit. It’s not just, Oh, you get something in the mail and now let’s prepare. It’s a process you do from day one going forward. Right? Prepare that this will happen at some point and if it doesn’t, great. But if it does, you’re ready. So some quick news about IRS audits. This article came out last week on October 16th about IRS tax audits and pretty much what it’s saying is that these attorneys that have worked to defend against IRS audits in other parts of the country, they’re seeing, you know, there’s going to be a tsunami of audits for many reasons and these are very thoughtful considerations they’re giving here.
It’s like the two 80 E tax code interpretation is very, very much misunderstood as Ken, as business operators, as some inexperienced CPA firms out there may not have the experience. No, we’re a cannabis CPA firm. We only work with cannabis. So we are very intimate with the two 80 E tax code interpretation. Someone who’s maybe just a generalist CPA firm may start to take expenses and deductions that you’re not really allowed to take as a cannabis company or not using a reasonable methodology. And the IRS is banking on your limited experience as an operator to not really know how to file your taxes properly. Especially if this is your first business watch out. The IRS is very, very well versed. Obviously they wrote the rules to the game. They know what to look for. You may not, they’re banking on that. They also know that cannabis is a cash heavy business, so if you’re taking in big payments of cash, $10,000 or more, are you filing your form 83 hundreds I you doing the due diligence to making sure that your team and your staff is following the standard operating procedures for large cash handling so they understand that as a cash heavy business you will probably make mistakes and there’s already precedent set with many cases out there.
If you look up the Harborside case, there was an issue around two 80 E saying that if it’s a state business, it’s legal in this state, we shouldn’t be held to the 280E regulation. Well that was not upheld and they had to pay. Then you look at alternative healthcare, they thought, okay, well if we have a management company operating the dispensary, we won’t be liable. And all these different interpretations and people try to misconstrue it, they end up having to pay as well. So understand that there is a lot of stuff, not say working against you, but there is a lot of things out there that you need to consider as a cannabis business operator. That this is not just fluff, this is not just something you see in the movies. This is real life and it could happen to your business. So let’s also dig into a little piece of information here.
I just want to look at the left side of this graph, and this is a little bit older, 2014 but the information it contains is very much true today as it was five years ago. And so what this pie chart on the left says you’ve got marijuana businesses at the top level and then all businesses at the bottom level. And what this is is a self reporting of marijuana businesses saying, have they been subject to an audit? 6.3% say yes. Whereas ordinary businesses are all other businesses saying 1.4% have been audited. What that’s showing is that cannabis business operators are being audited at a higher rate three to four times more frequently than ordinary businesses. So again, this was just showing another piece of information. I don’t want to hold on to one.in this other dot. And you know, hold my hat on that I’m trying to create for you is align a trend.
Tell a story about why this could be something you will be experiencing. It’s not just one point of data. There are many articles, there are many instances, there are many court cases, there are many stories from the field that this could happen at a higher rate for cannabis companies. Then an ordinary business. So moving on, let’s just give you some context about IRS audits and cannabis businesses. Okay, so I’m going to build on this here is that there’s anecdotal evidence from legal partners that we have out in Colorado that one in five cannabis businesses will experience an audit at some level of the government. And again, Colorado, they’ve been legal for five, six years now. They are a preview of what’s to come for every other state, for every other operator across the entire country. Because they were the first movers. The IRS just moved their watch glass over to Colorado and said, let’s start digging here and next the IRS and other tax authorities again are banking on your inexperience and they know that you’re going to slip up on some compliance items.
Running a business, any kind of business is a lot of work. There’s a lot of moving parts, but in cannabis is a lot more regulation and they know that you’re going to potentially slip up and miss on some of those regulations and reporting requirements. And you look at federal regulations like the Cole memorandum, make it difficult for cannabis businesses to get access to the banking so they know that we deal in a lot of cash. So bringing that back and tying it all into a few slides earlier, this makes cannabis operators prime targets for a business audit for just a simple reason. Are you filing your form 83 hundreds and if you have not heard that term form 8,300 and you’re dealing in hundreds of thousands or even millions of dollars in cash, you need to really read up on that. We did a video a week ago, two weeks ago maybe on that, really dig deep into all these compliance items and if you don’t want to take care of it, get a CPA that will help you take care of this so you can focus on building your business.
Then further city governments are going to get hip to all the money that they’re missing out on. Since this isn’t all self-reporting business with income taxes, you are reporting with your due diligence and your assurance that Hey, this is truthfully what we made and this is truthfully what our expenses are in cities. They are starting to make estimates. I saw that California, the whole state was banking on $1 billion in tax revenue. They only got like $370 million. So you see that there’s like a huge differential and what they expected and what they actually got. They may start to Institute regulations around required audits. Who knows? We don’t know. This is very uncharted territory, but we could see that coming in. And lastly, two 80 East still applies to CBD related products and services. In the only case where businesses might be able to claim deductions is if they can claim improve at the CBD came from industrial hemp that is legal per state and federal laws.
Okay, so just because you’re only in CBD, you have to understand where did that CBD come from? Did it come from a plant, had THC in it above that point, 3% THC. So if it’s from industrial hemp, you may be on the right side of the law. But really ask your accountant, ask your suppliers, where did this come from? What should we do from here? So now that you have some news, some color and context around IRS audits, let’s really jump into what draws attention from the authorities, right? What are the red flags? What are the orange flags, the yellow flags that come up, draw the attention and puts you under the microscope. So first let’s just start out. If you’re a business that earns more than $200,000 a year, you have a higher likelihood of being audited for a few reasons. Number one, you’re making a good amount of money that’s in that top 10% of income earners.
All right, well then the IRS knows that you probably have some tax liability that they can actually get back, right? If you’re making a little bit of money, it’s not worth their effort. It’s the same amount of effort for one audit as it is for another audit. Why not go after the bigger fish where they can get potentially larger taxes on that income. And secondly, if you’re making this kind of money, you probably have to spend more money to make that money, which means you potentially are misclassifying certain expenses in line items may be out of sync. Then what other businesses are on that lower tier now also having no form 8,300 filings and being in the cannabis industry, they know that you’re in the cannabis industry. It’s very easy. This is public information. They can find that. Okay, in California, everyone registered with the BCC.
This is all of them and this is all their [inaudible]. Let’s go and just see how many form 8300 they filed and what their income level is and let’s see what the pattern is there. It’s very easy to run these reports. This is not hidden information from the government. The government has purview too, a lot more information than the general public does, but they can jive that public and private information together to find potential targets for audits. Now, another thing here is that if you’ve had an audit in prior years, it’s kind of unspoken that you’re still under the magnifying glass at least for the next three to four years. If you’ve made a mistake once they know that you are likely to make a mistake again in next. If you run at a loss or a low profit margin that is not in sync or consistent with other successful businesses in your industry, that is another orange flag, yellow flag that jumps out to the IRS and says, all right, well maybe we should go take a look at this.
Also, if you have bank balances that increase or debt balances that decrease while profits remain flat. So how are you able to hold more money or pay off debts while your profits remained flat? Maybe you have certain expenses that are coming down which allow you to, you know, increase your bank balance or pay off your debts. But if they start to see certain line items are flat as well, that may trigger an audit. Next, they may see a lifestyle that doesn’t appear to be supported by your reported profits. So if you’re out here taking huge vacations, driving very expensive cars, taking big balances on loans, and you know you’re showing that you don’t make a lot of money to the IRS, they’re going to say, well, how are you affording this particular lifestyle? Another yellow flag or red flag orange flag is low sales. If your business is not successful and not growing, they’re going to want to look into why that is.
Maybe it’s that you’re just claiming low sales for six, seven years and you just really are bad at business, or is it that you’re taking a lot of cash in and not reporting on it. And then lastly, the one that grabs most here is that sometimes it’s just random. The IRS is, we’ll get into later, has a lot of data, has a lot of information, is a lot of algorithms that could just randomly pull things. They could see some of these data points that we just talked about or they’re just going to start saying, well, let’s just randomly pick some of these different entities or individuals to do audits and understand that. I said this earlier, cannabis businesses are on some type of list that the general public can see. So surely the governments can see this. And again, once cities start to see how much they’re losing out on, they will start doing audits.
You know, someone’s going to do a study, some kind of watchdog organization. They’re going to point out the fact that these numbers should be a little bit higher because of all this self reporting. And then with all this need for tax dollars for infrastructure projects or new programs, you may see audits happening more frequently at all levels of the government. And it could even be part of regulations in some markets, right? So be prepared, right? There’s not always a rhyme or reason why these happen to you as an individual or a business, but if you’re prepared, it’s not going to be as big of a problem as you think it is. So people always ask, well, how do audits typically proceed? What is it like to go through an audit? Well, just understand you’re not going to get a letter in the mail or a share for federal agent’s going to show up at your door and just take you away for money laundering.
If you made some mistake on your taxes or the calculation for your taxes, there is a process. So let’s dive deeper into that process. So first, some type of tax return has to be filed, right? You’re going to submit a personal in a business return and then that’s going to go to the IRS or to the state government. And there are algorithms at the IRS that go through their databases and nobody knows what they are. No one can say, Oh, if you do this or that, right? And all those things I told you before that draw attention from the authorities. Those are just some things out there that people have conjectured and thought about and say, well, these are common themes that we see in people that do get audited. There’s no steadfast rule, right? There are some algorithms out there and sometimes some things in some line items fall out of quote unquote range show.
Say you’re an individual and you have an AGI adjusted gross income of $50,000 but your charitable contributions are $25,000 that completely falls out of the algorithm’s range. Why is someone giving away half of their small income to a charitable organization? It is typically a lower percentage, so that might flag an audit or at least spur a notice out to the taxpayer and let’s kind of have a conversation from there. And the same thing happens for businesses, not just for individuals. Maybe it’s some particular type of expense, maybe it’s travel. And it’s huge relative to the business and the business classification. Maybe you are making $100,000 a year, but your travel expenses is $70,000 okay, what’s going on here? Why is this like that? But again, a lot of the times it’s just random. So once you get that tax return filed and there is some type of notice being put out there, there are two types of audits, a correspondence audit and an in-person audit.
So let’s first walk through what a correspondence audit looks like for you as a taxpayer or the business. So these are the easiest type of audits. Pretty much the IRS says, Hey, we have your tax return, can you give us some more info on this particular line item? Okay, don’t freak out if you get a notice. It’s not, you know, saying that you’re guilty, they just need more information to feel comfortable around the number that you reported in. Most people are honest and they can prove their expenses and there may be a little bit of an adjustment. Not a big deal. They’re just not looking to go charge you more money. It’s not like they’re trying to find pennies, okay? They just want more clarification. Just because a certain expense, looks off and you have 30 days to respond to that letter. You can either call or respond in writing.
Just don’t ignore this letter. It will not go away just because you throw it in the trashcan or bury it deep in the drawer. It’s not going to go away because if you do ignore this, they will assess you. The tax at whatever they say they’re going to in potentially assess fines and penalties and interests. Okay, so do not ignore these letters. Again, this not admitting that you’re guilty if you respond to the letter, it’s just giving them more color and context of your situation. So to defend against this, you’re able to furnish the IRS with some documentation and copies of invoices that pertain to that specific line item and canceled checks or proof of payment because even though you may have received an invoice that doesn’t prove that you ABC business or you ABC person made that payment. Okay. If someone else did that for you or another business, pay that invoice and the IRS starts to think, okay, well are there income issues that you didn’t report?
If someone is paying your bills or maybe another business is paying for it, another entity, maybe it’s rent, right? A big expense for all businesses is rent. If someone’s paying that for you, that could potentially be considered compensation that is unclaimed by you or the business, so to sum it up you need to prove that the expense is real and that you, the individual or the business did pay for it by using receipts, credit card statements, canceled checks, things of that nature, right? Especially receipts if you’re doing it all cash business or primarily cash heavy business and it’s really up to the auditor and their discretion. They look at very specific numbers and they’re going to just try to dig into that one line item and depending on what they do or don’t find, they can open it up further to other line items or even to prior years of tax returns.
It’s not just limited in scope, finite li, it can increase in scope as they find certain things or do not find certain things. And that in a nutshell is a correspondence audit. Just being in contact with the IRS and walking them through your methodology for taking those particular expenses that fall under that line. But now let’s explore what an in-person audit looks like for you and your business. So typically you’re going to be going out to them at their regional or local offices. They have a lot of offices and in-person audit is generally not going to be for a personal return. It’s going to be more for business returns because there’s a lot more documentation that you’re going to need to provide and you’ll need to explain some things that we walked through in the correspondence audit, right? That you got the invoice and that you are the actual one that paid for that.
But the focus is more on are these ordinary and necessary expenses to actually run your business. Okay. You can have all types of expenses as a business, rent, SGNA, insurance and Papa, Papa POS, so many other expenses. But sometimes you’ll notice that some operators run their personal expenses through their business. So don’t claim personal stuff on your business taxes because when you go for this in-person audit walkthrough, you will need to bring in all the documentation to reconstruct your expenses in that you or the business paid those expenses specifically. Okay. And with 280e don’t try to move any indirect costs into cogs without some type of reasonable methodology. If you are familiar or at least know of 280e, you know that what it does is that it limits people that deal in a schedule one controlled substance, which cannabis still is a limits what expenses that they can take, which is pretty much only cost of goods sold and in each different part of the cannabis supply chain, right?
Each different vertical, certain things can and cannot be claimed as cost of goods sold. So a dispensary will have less leeway than a manufacturing facility, then maybe a delivery and all across the board. So you need to have a good tax strategy in a reasonable methodology to take certain things as cost of goods sold. So we really, really recommend that you have a CPA who can help you reconstruct those records in those logs to prove out your methodology. If you just do this Willy nilly, you’re going to run into a lot of issues later, especially if you have not been saving for taxes. It’s very, very difficult to come up with 400 grand once you get some kind of assessment against your business or some kind of judgment against your business. So always having a repository or some kind of holdings for taxes just in case this happens, having that rainy day fund is a really good idea.
So that is really what an in-person audit is. But let’s just break down and go a little bit deeper into what do you really need to bring with you when you start to go in, you know, reconstruct all of these different expenses for this audit. So there’s a few things here. Let’s just dive into them right away. You’re gonna need tax return data. So likely you’re going to need to submit previous year’s tax returns information in addition to the current year. Yes, the IRS has them, but they want you to bring them in as well because the IRS will be looking for a point of comparison and you may also be asked to bring in returns for other businesses that you are an operator of. So lots of tax return information. So save your tax data. Don’t just throw it away, archive it, save it digitally, save it in hard copies, whatever you need to do.
Then they’re going to ask about the reliability of taxpayer’s information. So if you have unexplained gaps in your records, the IRS will want to understand why your records are incomplete. They usually assume the worst, right? So to be prepared, be able to justify what’s missing and why, and how to back up your receipts with certain things, right? If there’s gaps in the documentation, have a reason to explain why that is. So next, there’s this thing called the minimum income probe in this tool is usually used to identify deposits that may be taxable income or sources of taxable income. Now otherwise disclose by the taxpayer. So they start seeing the positives come into your accounts and you’re not claiming this as income. What’s going on? They’re going to look at that. They’re going to ask what is this and tell me about it. They’re also going to ask for your cash accounting methodology, which may include things for inventory items, the way the employees handle these transactions.
Okay. As soapies for records of transactions and accounts, cash deposit locations and procedures for cash deposits. Also other cash handling procedures. What’s happening in your store? Who is depositing the money into the safe and who’s actually going through the safe log? Is there a division of duties to prevent theft and diversion? They’re going to ask you for all of your bank account information. Other personal financial information as well. Let me just really open the scope up here is that state cannabis regulators are permitted to ask for a range of records to inspect. You know, anything they can inspect your physical location. So the list on this page is just an illustrative example of what you may be asked to provide. And then cannabis regulatory authorities can pretty much ask you to turn over anything and everything. Even the IRS agents, their federal agents, and they’ll pull all the strings they need to to get the information that they desire.
So don’t hide anything, right? Focus on gathering the documents by the deadline that they’ve set for you and be a good partner in your IRS audit. Always be operating in good faith. So now that you understand how audits proceed, the types of audits and what kind of information you need to bring with you. If you go for an in-person audit, let’s ask, all right, do these initial audits lead to onsite audits? You know, you see in the movies, there’s a whole group of people that come in and like it’s a bunch of agents and they just kind of lock everything down and they go through all your documents. You know, do these initial audits lead to something like that? Not typically, but don’t rule it out. The IRS is getting budget cuts and there’s not always enough agents to go to every business to check on things, and it happens less often that someone will actually show up and say, Hey, show me your home office, or let me see how many plants you have in your hydroponic system.
Or let me see your standard operating procedures in action. Look, the IRS agents and the whole agency is overworked, right? It’s a thankless job by the government, right? We need taxes to take care of infrastructure projects. Everyone seems to try to pay the least amount of taxes. These IRS agents are overworked and then business owners and people individually, they get scared when they get these notices or they get told they’re being audited, but you just need to relax. Okay? Like I said, they’re not out here to try find more money. They just need more clarification. So don’t treat these agents mean IRS agents are people too, just like you and I, they have families to go home to. They have their own set of problems and worries, right? They’re reasonable people here. For example, they may not give you one expense, but they’ll give you another expense.
Maybe they can’t give you the ability to write off a private jet expense, but they will go and give you first-class fees at Delta airlines and that’s what they can reasonably claim for you. So you don’t work with these people. Don’t try to skirt the law. Don’t try to be a jerk to them. You know, they’re not here to ruin your life. They’re there to do their job. Okay, so what if you go through an audit and now you need to pay, okay, what now? Well, if it’s just something minor, couple hundred dollars, you know, a few thousand dollars a minor is actually relative. Cause if you don’t have a few thousand dollars as an individual, I get it. It could be a problem, but usually it’s something on that level, a couple of weeks to pay. But if it’s a huge mistake, $10,000 $50,000 $500,000 then you can typically set up a payment plan with the IRS.
One thing to note about these payment plans is that you need to always be in communication with the IRS about your ability to pay. And if that changes, because you do not want to miss a payment. If you do, they will go into your bank account, take your money, they will put a lien against your assets, like your home or your car or your business. Uncle Sam always gets his money, okay, so don’t try to run away from this obligation. This is something real. This is something you’re going to need to deal with and work with. So if you get a payment plan, make sure you pay those payments and if you can’t speak with the IRS and try to figure something out, maybe lowering that payment, extending the time for that payment, whatever that’s going to be, but always be in communication and do not avoid that.
Now let’s talk about the most important stuff. How to be proactive and prepare for an audit. Okay, so don’t let audits be an afterthought. This is something that like we talked about in the beginning of this, experts are predicting that there’s going to be a tsunami of audits coming. Cannabis is just getting bigger. The cat’s out of the bag. More and more people are getting into this industry more and more people are operating and probably doing things that they don’t even know are wrong and so the IRS is going to take advantage of that opportunity and audits are not a problem if you’re ready for them as well as if you are truthful and honest in your business and your tax returns. So let’s go into some ways to prepare for an audit. So first document, document, document, document, document, document, document. I can’t say it enough in the unlikely but possible event of an audit.
Have your stuff available, have information to back up. What you’re saying is true is actually true. This pertains not just to financial data. Yes, it can be financial data, but it includes sales stuff, inventory management, purchases, taxes. You paid hiring an employee agreements, environmental compliance stuff and pretty much any paper or information piece that has to deal with your business, you need to have that and what we suggest is creating a data room on Dropbox or your favorite cloud storage thing and keep everything in there. Try to keep it organized in files and folders, but if you just want to quickly dump it into one Dropbox folder, do that and make sure that these records are detailed and thorough and depending on what state you’re operating in, there are different requirements for how long records must be maintained, but keep it as long as you can because digital space is very much available and consider keeping hard copies as well.
But just a steadfast rule, a minimum of seven years is how long you need to hold on to this stuff and why document. It makes it so much easier for you and your CPA to reconstruct all of these expenses during an audit. If you have no documentation, you’re going to be sitting out there twiddling your thumbs and like, I don’t know how we got to this number. You know you really need to prove that it’s not just on that you can say, and they’re going to take your word. They want documentation and this is really, really important around the cost of goods sold. So really, really be thoughtful about how you’re claiming cost of goods sold in dancing with two 80 E in mitigating that tax impact. And another reason why documentation you need to hold onto it for a long time is that audits can take a while to trigger.
What that means is that say you’re starting to go through an audit, maybe it’s, you know, they’re auditing your 2019 stuff and they find some issues there that are material. They may go back two, three, four, five years. They’re doing a deeper dive on these in-person audits or on these business audits and they say, all right, well we’ve got some disallowed expenses in these years. Let’s go back. And they started to dig deeper in those prior years and if they find that you did anything wrong in those prior years, you’re likely going to have less documentation because you are younger business. You weren’t thinking about this at that time. It’s all I’m telling you now. If you are a younger business, make it a standard operating procedure to create documentation of everything that you are doing, every expense you’re taking and why and who and how much and then you’ll have the information to do that reconstruction because if they go back they find, okay, well you don’t have any documentation for 2017 we’re just going to disallow all these expenses and add on penalties, fees and interest.
That’s where things get really, really scary because this could end up gutting your business. If you don’t have the cash to pay for that, it can become very expensive very quickly, so make sure that you have documentation. Now, some other ones here is that file on time and accurately for taxes at all levels of the government. Now that seems obvious you should file your returns on time, but you understand as an operator that it can be difficult to keep up with all the forms and the due dates for cannabis related businesses. Since the rules seen the kind of ebb and flow and changed throughout the year or throughout. As regulations mature and they grow. So have a qualified tax professional. Prepare your taxes for you. Keep an accounting calendar for you so you can stay on top of these legal requirements for your business. Next, comply with all state and local laws.
This again seems obvious, but some people are breaking laws, whether willingly or unknowingly. Make sure you’re following the laws and disclose all of your activities of your business to your lawyer and to your CPA. People think that CPAs are an extension of the IRS or the government. Look, we don’t work for the IRS. We work for you just like how lawyers don’t work for the judges, but your personal lawyer is not part of the court of law working against you. They’re working with you. So CPAs are very much on the other side of that IRS fence. We’re here to help you and create an offensive tax strategy, not a defensive tax strategy for your business. Next, to help prepare for an audit, create an implement standard operating procedures. Okay and don’t just write them and put them in a book on a shelf or put them in a document that gets buried deep into some kind of file tree in your computer system.
Really, really make sure that you’re training your people, especially on cash handling procedures in form 8,300 filings, right? Again, we talked about this in the beginning. Those are some particular red flags that may grab some attention. You’re making a lot of money not filing any form 83 hundreds in a cash heavy industry. The IRS to say, let’s take a little bit of a look here, and you may not purposely be avoiding taxes, but you may be liable for the taxes on diverted cash. So if you are grossly negligent in preventing diversion or theft of cash, you may still be liable for that income that comes through. Even though you don’t have the money on hand, you could be liable for those taxes. Now, next, set up a system of checks and balances, personal expenses and business expenses can easily get mixed up. When you’re dealing with a lot of cash, it’s understandable.
So we recommend creating an organizational system to track your tax information, your expenses, and even things you can’t deduct on your tax return. Right? Payroll is one of those areas of cannabis companies where you might get tripped up in some verticals. It’s very easy to claim that payroll is going into cogs or it can’t be, but you also get to the point where you’re dealing in cash and you may say, all right, well let’s start paying cash for these people because we don’t want to pay him digitally or we can’t pay them digitally. Well, how can you prove that you actually paid these people out? Right? Makes you have a receipt or a software system that prints off, alright, payroll was this much for each person and here’s a receipt that’s signed and that person ABC received that their payroll and now we can say, all right, this is how we can reconstruct this particular expense.
Just having a system of checks and balances also in cash handling, make sure the person that’s counting the cash and depositing it is not the same person. Okay? There has to be some kind of cash log. The person that counts it, then hands it off to somebody else who does a cash log, which creates a checks and balance for that particular item. Lastly, I would say work with a cannabis specific accounting firm. A good CPA firm can give you more than just basic feedback on your potential for fraud. There’s a lot of general CPA firms out there. They may want to get into the industry. They may create it as a practice area because they want exposure to that, but make sure that the firm you’re hiring has experience in working with cannabis regulations and tax compliance in your specific state and as well as in the national level as well on the IRS level.
Cause not every CPA firm is well versed in the limitations that are placed on cannabis businesses by two 80 E you don’t want to leave it up to non-industry specific professionals to learn about the industry at your expense. Okay. At GreenGrowth CPAs, we are not generalists. We are specialists. Cannabis is the only thing that we work on. It is not just one practice area for us. You’re not paying us to learn on your dime and yes, you may hit a generalist firm that may undercut us on price, but two things. You may save money in the short term, but in the longterm you’re going to have a weaker tax strategy that you will end up paying more and more taxes on and two, you will essentially be billed for more hours because they’re going to have to learn the nuances of that tax law and then they’ll be implementing it for you for the first time or the first few times for their business and with GreenGrowth CPA is what we’re doing for you in any other experience from that has got deep experience in this.
Okay. What we’re doing for you is based on actions we’ve taken for 400 other clients and it’s backed by tax court cases and our experience, so have confidence when you’re investing in your CPA. Not just hope because either you do it right or you’re going to do it twice. Just a few other thoughts around audits. There are no guarantees at all that you will not be audited. You heard that word random throughout this presentation and it is just that for many cases, no matter how many precautions you take, there’s absolutely no guarantee that your businesses will not be audited by the IRS. However, using those tips that we talked about in preparing can lessen your chances that an audit will kill or crush your business, but you should still maintain thorough and well organized records. Just in case something happens to your business, you get audited.
Again, audits are not a problem if you are prepared for them. Yes, they can be a headache, they can be an energy suck in a time suck. But once you go through an audit and you come out clean on the other side, you have now walked away with even more confidence in your business and the team that you’ve assembled to help you take care of your business. And lastly, tax evasion territory. Some people say, I don’t want to get in trouble for evading taxes, then don’t evade taxes. That’s a very simple, okay, it’s obvious if you’re evading taxes, right? If you don’t show income that you received and that you know is income that you received, right? There’s some way you’ve acknowledged that that is egregious and you will get a fraudulent penalty, right? It’s a type of penalty that is much higher than other penalties.
It’s typically around 25% of that unreported income amount and you still have to pay taxes on that amount. So if you’re in those higher tax brackets, it can become very, very expensive to evade taxes. So don’t do that. As we talked about a little bit earlier in the presentation, once you get into that, Hey, tax evasion territory, you likely going to be under the magnifying glass for the next few years as well. So don’t create headaches for yourself. Do everything that you can to stay above board filing truthful and honest and reasonable tax filings in things should work out well in your favor. So we’ve talked about a lot, we’ve covered a lot of ground, opened your eyes potentially to a lot of different considerations. So let’s go over a few key takeaways. Audits are not problems. If you’re operating above the board and prepared with documentation, don’t let audits be an afterthought.
Prepare for this. Now that you’ve listened to this, you know that this could be an issue. Okay, so don’t get all upset later when it happens and you’re not ready for it. You have to have integrity. Now that you’ve listened to this presentation, you’ve gotten through this, we’ve been talking for, I dunno, 40 minutes here, 35 minutes. Make sure that you’re doing the documentation of your business. And then secondly, correspondence. Audits are the most common ones and it’s about clarification of certain line items. It’s not about, Hey, let’s peel into your business and find all the ways to screw you over it. Just need clarification on certain line items. So make sure you have a reasonable methodology for taking any specific expenses that fall into every line item. Next audits can increase in scope depending on what the auditor does and doesn’t find. So if they are looking for certain documentation and you have nothing, well maybe that opens up the scope cause they’re like, well this person is quite sloppy at maintaining their records.
Let’s dig a little bit deeper into this line item or this expense or this one or that one. And then once they start peeling back the layers of the onion, man, it can get really, really ugly at that point. And lastly, we highly suggest that you work with a seasoned, experienced lawyer and CPA to protect your company, especially in cannabis, since it’s a very regulated industry. This is not just like opening up a Cornerstore. This is like starting an airline, starting a liquor company, starting a pharmacy, starting a pharmaceutical brand. This is really, really big. It’s not small business. It’s not very easy. It takes a lot of money to start these businesses. And cannabis is a team sport. So make sure that you’re assembling the best superstar team to help your business be successful as you grow on this path. So I want to thank you for taking the time to listen and absorb this information.
Hopefully this presentation has brought you a ton of value. Again, opened your eyes up to certain nuances of IRS tax audits and given you some color and context and how you can prepare for those. But if you need help with audit preparation, being proactive about it, or audit defense for your cannabis business because you’ve gotten an IRS notice, then please get in contact with GreenGrowth CPAs by visiting our website at greengross, CPA’s dot com or giving us a call at (800) 674-9050 we’re here to help you want to help walk you through this process, make sure that you’re operating your business with confidence and that you’re prepared if this ever does come down to you. So again, if you need help with audit prep, audit defense, reach out to GreenGrowth CPAs via our website at greengrowthcpas.com or give us a call at (800) 674-9050 thank you again for your time today. We really appreciate you taking the time to listen and learn. Have a great day and we’ll talk to you soon.
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