In the Cannabis Industry, it is not a question of IF a company will be audited but WHEN. Due to the high revenue expectation and the newness of an industry that is demanding compliance, all agencies are interested in auditing tax returns.
Major Areas of Audit
Local
It is expected that a cannabis business in most California localities will be audited every year. One municipality has it written into the local licenses that each retail license holder will be audited two times a year. You have to be “audit-ready” at all times. All tax authorities share information. Generally, the local auditors will have all of the information of the state tax returns for the business entity, which allows for a check and balance between the state and local reporting.
State
State auditing in California is not as aggressive as the local auditing. This is not unexpected; California is still focusing on other areas of the Cannabis industry. Also, just remember that the state has several years open on its statute of limitations, so time is on the side of the state. Each cannabis business must still be “audit-ready” each quarter that they file returns.
Based on the structure of the government of California, audits will come from two departments within the CDTFA, one for sales tax and one for cultivation and distribution excise tax.
METRC
METRC is the other agency that is a factor for audits. METRC reports quantities of product moving through the cannabis system “seed-to-sale.” All cannabis companies with permanent licenses will have to report all product movement.
The additional audit concern is that METRC and CDTFA will share information and develop audit plans to identify inconsistencies.
Income Tax
For the state of California, the auditing will be performed through the Franchise Tax Board. It is expected that the auditing will be a factor at the state level for the Cannabis industry.
For the federal income tax system, the expectation is to have increased auditing. With 280e being in the mix, there will be an ongoing concern about a higher tax burden for cannabis taxpayers. In 2018, there were several Tax Court cases which have long-range impact on the industry.
The other issue to keep in mind is that 280e is expected to be a temporary condition. As soon as cannabis is rescheduled or de-scheduled, 280e may no longer be a consideration for cannabis companies. Audits may be conducted based upon prevailing tax law. It will be important to track and know what the tax was at each yearly filing, as the audits may differ year to year.
We at Cannabis CPA Tax have years of experience in financial institution, municipal, and commercial auditing, as well as many years of experience performing municipal, state, and federal tax audits. Let us help on this audit journey.
