In our experience serving 600+ cannabis clients throughout the US, we’ve observed that only 3 out of 10 dispensaries do an adequate job of bookkeeping and reporting.
The thing is, we understand why. Cannabis entrepreneurs and operators are rarely accounting and finance-focused. They are instead, rightfully, focused on the day-to-day demands of growing their business in a market with slim margins and fierce competition.
Unfortunately, in the current regulatory climate of the cannabis industry, there is a near 100% chance that a cannabis business will get audited at some point in the business’ lifecycle.
And the bad news just grows from there… because once you’ve been audited (and the regulators find any issue) you are more likely to get audited again in the future. That’s why, preparing our clients for an audit is at the very core of all the services we provide.
In today’s post-COVID-19 environment, we are seeing more and more audit activity, not just from the IRS, but also from state and local regulators as well. With widespread shutdowns limiting tax revenue for most of 2020, regulators are looking for “low-hanging fruit” to refill the public coffers. And as our previous reporting on how and why the IRS audits cannabis shows, we understand exactly why regulators target cannabis… not nearly enough companies are adequately performing basic bookkeeping and reporting activities.
In the past several months, we’ve experienced a surge in new clients coming to us for audit preparation and assurance services after being served with an audit.
Knowing this is a rising concern for operators across the country, in the following we share an overview of some of the shortcomings and trends our team notices in retail bookkeeping practices. We also provide some helpful solutions and recommendations for businesses in the prevention, preparation, or response phases of an audit.
Common Issues with Bookkeeping in Cannabis Dispensaries
In reviewing our clients’ bookkeeping and records, our CPA team noticed some recurring patterns common among dispensary operators.
Classifying Adult-use vs. Medical Cannabis Sales
One of the most common failures in cannabis retail bookkeeping procedures is that many sales reports and data do not delineate between medical cannabis sales and adult-use cannabis sales.
Something that may not be common knowledge to consumers, as well as many cannabis retail or dispensary operations, is that there’s a different tax basis for medical cannabis sales vs. adult use sales.
In a recent instance regarding dispensaries in Los Angeles, CA, adult-use and medical cannabis tax rates for customers are as follows…
Adult-Use Cannabis Tax Rates in the City of Los Angeles
- City Tax: 10%
- Excise Tax: 15%
- Sales Tax: 9.5%
- Grand total tax rate: 34.5%
Medical Marijuana Recommendation from your Doctor:
- City Tax: 5%
- Excise Tax: 15%
- Sales Tax: 9.5%
- Grand total tax rate: 29.5%
Medical Cannabis Tax Rates in the City of Los Angeles with an MMIC Card
- City Tax: 5%
- Excise Tax: 15%
- Sales Tax: 0%
- Grand total tax rate: 20%
The issue we found with our clients’ bookkeeping processes is that their reporting didn’t readily and clearly attribute sales as adult-use cannabis vs. medical cannabis. With that, we also found that some of these clients weren’t properly gathering and/or storing the proper medical documentation from their customers (proof MMIC cards, doctor’s orders, etc.) in order to provide evidence of a medical sale to the city tax board.
Tracking Accessory and Apparel Sales vs. Cannabis Sales
Just as there’s a different tax basis for medical cannabis vs. adult-use, apparel and accessories are a totally different ballgame as well.
It is common practice in the industry that cannabis dispensaries and retail operations sell accessories and apparel to brand their business and supplement their core-business sales:
- Accessories: Non-cannabis-containing products involved in the consumption of cannabis. Can include pipes, papers, rolling machines, vaporizer pens, etc.
- Apparel: Branded and/or wearable promotional materials that are not involved in cannabis consumption such as t-shirts, hats, books, magazines, and stickers.
Each of these categories is subject to different tax laws, in comparison to dispensary products that are cannabis or contain it. Sales of these “cannabis accessories” are subject to sales tax, but are not subject to the 15% cannabis excise tax, associated with cannabis-containing products.
Reporting and Bookkeeping Recommendations for Cannabis Dispensaries
After providing audit preparation services and serving as the liaison between the city tax board and our clients, our team identified various tracking, reporting, data management, and procedural improvements our clients could implement to improve their reporting, in the event of a future audit.
Categorize Sales and Bookkeeping Data
Whether you do this manually or automatically, you need to make sure you and your staff are diligent about classifying and reporting the types of sales you are making (medical, adult-use, apparel, accessories). Ideally, use a POS system that can track this information and data automatically, along with software that makes it easy to organize and interpret.
With this group of clients, we were able to help them navigate and organize their sales data in a way that we could distinguish between medical-use, adult-use cannabis, apparel, and accessory sales. In most cases, this resulted in alleviating client stress and produced more favorable tax rates, fees, penalties, etc. for the clients in this analysis. In the future, this will make for smoother and more transparent reporting for the benefit of businesses, as well as federal, state, and local tax authorities.
Back-up All of your Bookkeeping Records and Sales Data
With any dispensary or cannabis retail business, there’s a high probability of getting audited. As such, we recommend our clients not only standardize and streamline their bookkeeping, tracking, and sales reporting but also that they create multiple back-ups of all relevant data.
Our cannabis CPAs recommend making multiple back-ups of all of your sales data using:
- Point-of-sale (POS) servers
- Cloud storage
- Cold storage, like a zip drive or external hard drive
Having multiple back-ups of your sales reports and bookkeeping data is one of the best ways to protect your cannabis retail business, in the event of an audit. This is also critical in the event of migrating POS systems or software, in order to prevent data loss and fragmentation.
Keep Your Data as Long as Possible
Not only do you want to diligently back up all of your sales data and reporting, for the cannabis industry, but it’s also in your best interest that you keep these records as long as possible.
Even though the IRS can audit your business’s filings within the past three years of the time they conduct the audit, if they do find substantial errors, they can go back further. For that reason, our team recommends keeping your records for at least 7 years, and longer if possible.
Be sure that you have all of your sales data organized and categorized. Also, make sure you keep backups of any and all customer information and proof that verifies medical sales.
Always File and Pay Your Taxes on Time
We cannot emphasize enough that you should always pay your taxes on time. Even if you need to work with a qualified cannabis CPA to help you file an extension, you should always pay your tax liabilities, schedule, fees, and penalties before their deadlines. This will help you avoid further fees, interest, and penalties while helping to potentially lower the likelihood that your cannabis retail operation will get audited.
Other Recommendations: Dispensary Audit Preparation and Assurance
You should always stay on top of your reporting and data. To make your life easier, find ways to streamline, automate, and fool-proof as many of those processes as possible. With the access we have to advanced software, technology, cloud computing, and POS systems, there’s no reason you should not be tracking, saving, and backing up all relevant data for your business.
In addition, you should always be preparing your financials as if you were going to be audited, every single year. If you need assistance with audit preparation, internal auditing, or audit assurance service, contact our team at GreenGrowth CPAs on our website, or call us at +1-800-674-9050.