Cannabis Business Accounting Guidelines
Cannabis Business Accounting Guidelines- Requirements for Books of Account, Transaction Recording, Method of Accounting and Record Retention for Federal Income Tax and California Cannabis Regulatory Requirements
Cannabis dispensaries are cash businesses. [You can read more about accounting for entities that do business in cash here.] Most lack adequate internal accounting controls over cash. The books and records which are the financial record-keeping systems for the businesses have been historically weak. Those cannabis dispensaries with systems of internal accounting controls and financial record-keeping systems typically have lapses in the enforcement and maintenance of those systems. The IRS provides taxpayers with detailed suggestions for the types of records.
The setup and maintenance of proper accounting records, a system of internal accounting controls and the hiring, training and retention of competent accounting staff is perhaps the single most difficult task for cannabis businesses that are seeking to “go legal”. Our view is that the identification and retention of a competent firm of certified public accountants [“CPAs”] with cannabis industry experience is probably the single most important decision that new cannabis business needs to make. Once the CPA is retained, they will usually be able to assist the business owners in identifying, prioritizing and securing and solving every other service and compliance issue that they have.
The IRS provides guidance with respect to which records a business is required to keep. The IRS further describes how records should be maintained and how long the records must be retained This may well change in the near future as there are a couple of United States Tax Court cases pending decision that is likely to provide significant guidance on the application of IRC Sec.280E to cannabis dispensaries.
Finally, the agencies within the State of California with primary responsibility for oversight of the cannabis industry for regulatory compliance, which are the Bureau of Cannabis Control [“BCC”] for Retail [Dispensaries, Offsite Event and Distribution licensees, the California Department of Food and Agriculture’s [“CDFA”] CalCannabis Unit for Cultivation licensees, the California Department of Public Health’s [“CDPH”] Manufactured Cannabis Safety Bureau [“MCSB”] for Manufacturing, Extraction and Testing Laboratories and the California Department of Tax and Fee Administration [“CDTFA”], have issued a significant number of administrative pronouncements, regulations and Special Notices that expand upon the IRS’s requirements for financial records, recordkeeping, document formats, retention requirements and audit guidelines. The creation of a seed to sale “Track and Trace system, known as METRC is particularly onerous and detailed.
The application of Sec.280E to dispensaries is, however, the tip of the iceberg. IRC Sec.280E applies to “any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances…”. The unequivocal language of IRC Sec.280E, however, is equally applicable to cultivators, processors, manufacturers, distributors and cannabis delivery-services.
There may be some limits to the application of IRC Sec.280E to the cannabis industry. It appears unlikely the IRS will stretch IRC Sec.280E to apply its disallowance to a service business, such as marketing or representation businesses, or professional services such as attorneys, certified public accountants, that does not actually “touch the cannabis”. The use of the word “trafficking” suggests that IRC Sec.280E is solely applicable to in-line businesses that are directly involved in the series of activities that move an agricultural material from cultivation to the sale of the material to a consumer.
 The IRS provides guidance about the purposes of records, uses of records, and outlines their expectations about the types of records that they expect taxpayers to maintain. We have provided an overview:
- Monitor the progress of your business. – You need good records to monitor the progress of your business. Records can show whether your business is improving, which items are selling, or what changes you need to make. Good records can increase the likelihood of business success.
- Prepare your financial statements. You need good records to prepare accurate financial statements. These include income (profit and loss) statements and balance sheets. These statements can help you in dealing with your bank or creditors and help you manage your business. An income statement shows the income and expenses of the business for a given period of time. A balance sheet shows the assets, liabilities, and your equity in the business on a given date. Identify the source of receipts. You will receive money or property from many sources. Your records can identify the source of your receipts. You need this information to separate business from nonbusiness receipts and taxable from nontaxable income.
- Keep track of deductible expenses. You may forget expenses when you prepare your tax return unless you record them when they occur.
- Prepare your tax returns. You need good records to prepare your tax returns. These records must support the income, expenses, and credits you report. These are the same records you use to monitor your business and prepare your financial statements.
- Support items reported on tax returns. You must keep your business records available at all times for inspection by the IRS. If the IRS examines any of your tax returns, you may be asked to explain the items reported. A complete set of records will speed up the examination.
- Electronic records. All requirements that apply to hard copy books and records also apply to electronic storage systems that maintain tax books and records. When you replace hard copy books and records, you must maintain the electronic storage systems for as long as they are material to the administration of tax law.
An electronic storage system is any system for preparing or keeping your records either by electronic imaging or by transfer to an electronic storage media. The electronic storage system must index, store, preserve, retrieve, and reproduce the electronically stored books and records in a legible format. All electronic storage systems must provide a complete and accurate record of your data that is accessible to the IRS.
Electronic storage systems are also subject to the same controls and retention guidelines as those imposed on your original hard copy books and records. The original hard copy books and records may be destroyed provided that the electronic storage system has been tested to establish that the hard copy books and records are being reproduced in compliance with IRS requirements for an electronic storage system and procedures are established to ensure continued compliance with all applicable rules and regulations. You still have the responsibility of retaining any other books and records that are required to be retained.
The IRS may test your electronic storage system, including the equipment used, indexing methodology, software and retrieval capabilities. This test is not considered an examination and the results must be shared with you. If your electronic storage system meets the requirements mentioned earlier, you will comply. If not, you may be subject to penalties for non-compliance, unless you continue to maintain your original hard copy books and records in a manner that allows you and the IRS to determine your correct tax. For details on electronic storage system requirements, See Revenue Procedure 97-22.
- Specific Records to Keep – Purchases, sales, payroll, and other transactions you have in your business generate supporting documents. Supporting documents include sales slips, paid bills, invoices, receipts, deposit slips, and canceled checks. These documents contain information you need to record in your books. It is important to keep these documents because they support the entries in your books and on your tax return. Keep them in an orderly fashion and in a safe place.
- Gross Receipts. Gross receipts are the income you receive from your business. You should keep supporting documents that show the amounts and sources of your gross receipts. Documents that show gross receipts include the following. Cash register tapes. Bank deposit slips. Receipt books. Invoices. Credit card charge slips. Forms 1099-MISC.
- Inventory is any item you buy and resell to customers. If you are a manufacturer or producer, this includes the cost of all raw materials or parts purchased for manufacture into finished products. Your supporting documents should show the amount paid and that the amount was for inventory. Documents reporting the cost of inventory include the following. Canceled checks. Cash register tape receipts. Credit card sales slip. Invoices. These records will help you determine the value of your inventory at the end of the year.
- Expenses are the costs you incur (other than the cost of inventory) to carry on your business. Your supporting documents should show the amount paid and that the amount was for a business expense. Documents for expenses include the following. Canceled checks. Cash register tapes. Account statements. Credit card sales slip. Invoices. Petty cash slips for small cash payments.
 Recording Business Transactions, A good recordkeeping system includes a summary of your business transactions. (Your business transactions are shown on the supporting documents just discussed.) Business transactions are ordinarily summarized in books called journals and ledgers. You can buy them at your local stationery or office supply store. A journal is a book where you record each business transaction shown on your supporting documents. You may have to keep separate journals for transactions that occur frequently. A ledger is a book that contains the totals from all of your journals. It is organized into different accounts.
Whether you keep journals and ledgers and how you keep them depends on the type of business you are in. For example, a recordkeeping system for a small business might include the following items. Business checkbook. Daily summary of cash receipts. Monthly summary of cash receipts. Check disbursements journal. Depreciation worksheet. Employee compensation record.
 You must keep your records as long as they may be needed for the administration of any provision of the Internal Revenue Code. This means you must keep records that support an item of income or deduction on a return until the period of limitations for that return runs out. The period of limitations is the period of time in which you can amend your return to claim a credit or refund, or the IRS can assess additional tax.
The following table provides a basic summary of record retention requirements:
|IF YOU||THEN THE RETENTION PERIOD IS|
|1. Owe additional tax and situations (2), (3), and (4), below, do not apply||3 Years|
|2. Do not report income that you should report, and it is more than 25% of the gross income shown on the return||6 Years|
|3. File a fraudulent return||Not Limited|
|4. Do not file a return||Not Limited|
|5. File a claim for credit or refund after you filed your return||Later of: 3 years or 2 years after tax was paid|
|6. File a claim for a loss from worthless securities or a bad debt deduction||7 Years|
The length of time you should keep a document depends on the action, expense, or event which the document records. Generally, you must keep your records that support an item of income, deduction or credit shown on your tax return until the period of limitations for that tax return runs out. For most taxpayers, the general recommendation is to retain copies of tax returns and supporting documents at least three years. Some documents should be kept up to seven years in case a taxpayer needs to file an amended return or if questions arise. Taxpayers should retain records relating to real estate for at least seven years after disposing of the property.
Health care information statements should be kept with other tax records. Taxpayers do not need to send these forms to IRS as proof of health coverage. The records taxpayers should keep include records of any employer-provided coverage, premiums paid, advance payments of the premium tax credit received and type of coverage. Taxpayers should keep these — as they do other tax records — generally for three years after they file their tax returns.
Whether stored on paper or kept electronically, taxpayers are urged to keep tax records safe and secure, especially any documents bearing Social Security numbers. Consider scanning paper tax and financial records into a format that can be encrypted and stored securely on a flash drive, CD or DVD with photos or videos of valuables.
Now is a good time to set up a system to keep tax records safe and easy to find when filing next year, applying for a home loan or financial aid. Tax records must support the income, deductions and credits claimed on returns. Taxpayers need to keep these records if the IRS asks questions about a tax return or to file an amended return.
Keep tax, financial and health records safe and secure whether stored on paper or kept electronically. When records are no longer needed for tax purposes, ensure the data is properly destroyed to prevent the information from being used by identity thieves.
The period of limitations is the period of time in which you can amend your tax return to claim a credit or refund, or the IRS can assess additional tax. Unless otherwise stated, the years refer to the period after the income tax return was filed. Returns filed before the due date are treated as filed on the due date. Filed tax returns can be helpful in preparing future tax returns and making computations if you file an amended return.
Period of Limitations that generally apply to income tax returns:
- Keep records for 3 years, if situations (4) and (5) below do not apply to you.
- Keep records for 3 years from the date you filed your original return or 2 years from the date you paid the tax, whichever is later if you file a claim for credit or refund after you file your return.
- Keep records for 7 years if you file a claim for a loss from worthless securities or bad debt deduction.
- Keep records of gross income for 6 years, which is the statute of limitations for assessment where a return omits more than 25% of gross income or 25% of gross receipts of a trade or business. Examples, where this can occur, is a reclassification of a related-party loan as income, constructive dividends, failure to report alimony, failure to report a discharge of debt income, and failure to report income from a pass-through entity.
- Keep records indefinitely if have not filed a return.
- Keep employment tax records for at least 4 years after the date that the tax becomes due or is paid, whichever is later.
The following questions should be applied to each record as you decide whether to keep a document or throw it away.
Are the records connected to property? Generally, keep records relating to property until the period of limitations expires for the year in which you dispose of the property. You must keep these records to figure any depreciation, amortization, or depletion deduction and to figure the gain or loss when you sell or otherwise dispose of the property.
If you received property in a nontaxable exchange, your basis in that property is the same as the basis of the property you gave up, increased by any money you paid. You must keep the records on the old property, as well as on the new property until the period of limitations expires for the year in which you dispose of the new property.
What should I do with my records for nontax purposes? When your records are no longer needed for tax purposes, do not discard them until you check to see if you have to keep them longer for other purposes. For example, your insurance company or creditors may require you to keep them longer than the IRS does.
Cannabis Business Accounting Guidelines
Sec. 8400. Record Retention. – For the purposes of this chapter, the term record includes all records, applications, reports or other supporting documents required by the department.
(a) Each licensee shall keep and maintain the records listed in subsection (d) for at least seven (7) years from the date the document was created.
(b) Records shall be kept in a manner that allows the records to be provided at the licensed premises or delivered to the department, upon request.
(c) All records are subject to review by the department during standard business hours or at any other reasonable time as mutually agreed to by the department and the licensee. For the purposes of this section, standard business hours are deemed to be 8:00 am – 5:00 pm (Pacific Standard Time). Prior notice by the department to review records is not required.
(d) Each licensee shall maintain all of the following records on the licensed premises, including but not limited to:
- Department issued cultivation license(s);
- Cultivation plan;
- All records evidencing compliance with the environmental protection measures pursuant to sections 8304, 8305, 8306 and 8307 of this chapter;
- All supporting documentation for data or information input into the track-and-trace system;
- All UIDs assigned to a product in inventory and all unassigned UIDs. UIDs associated with a product that has been retired from the track-and-trace system must be retained for six (6) months after the date the tags were retired;
- Financial records related to the licensed commercial cannabis activity, including but not limited to, bank statements, tax records, sales invoices, and sales receipts;
- Personnel records, including each employee’s full name, social security, or individual taxpayer identification number, date of beginning employment, and date of termination of employment if applicable
- Records related to employee training for the track-and-track system or other requirements of this chapter. Records shall include, but are not limited to, the date(s) training occurred, description of the training provided, and the names of the employees that received the training;
- Contracts with other state-licensed cannabis businesses;
- Permits, licenses, and other local authorizations to conduct the licensee’s commercial cannabis activity;
- Records associated with composting or disposal of cannabis waste.
- Documentation associated with loss of access to the track-and-trace system prepared pursuant to section 8402(d) of this chapter.
(e) All required records shall be prepared and retained in accordance with the following conditions:
(1) Records shall be legible; and
(2) Records shall be stored in a secured area where the records are protected from debris, moisture, contamination, hazardous waste, fire and theft.
Sec. 8401. Sales Invoice or Receipt Requirements. The licensee shall prepare a sales invoice or receipt for every sale, transport, or transfer of cannabis or nonmanufactured cannabis product to another licensee. Sales invoices and receipts may be retained electronically but must be readily accessible for examination by the department, other state licensing authorities, any state or local law enforcement authority, and the California Department of Tax and Fee Administration. Each sales invoice or receipt shall include all the following:
- Name, business address, and department issued license number of the seller;
(b) Name, business address, and department issued license number of the purchaser;
(c) Date of sale or transfer (month, day and year). The date of any sale or transfer of cannabis and nonmanufactured cannabis products shall be the date of transfer to the licensee receiving it;
(d) Invoice or receipt number;
(e) Weight or quantity of cannabis and nonmanufactured cannabis products sold;
- For the purposes of this section, a licensee must use wet weight or net weight. Wet weight and net weight shall be measured, recorded and reported in U.S. customary units (e.g., ounce or pound); or International System of Units (e.g., kilograms, grams, or milligrams).
- Weighing Devices. A licensee shall follow weighing device requirements pursuant to section 8213 of this chapter.
(3) Count. For the purposes of this section, “count” means the numerical count of the individual plants or units.
(f) The cost to the purchaser, including any discount applied to the total price, shall be recorded on the invoice.
(g) Description for each item including strain or cultivar, and all of the applicable information below:
- Kief; and
(h) Signature of the seller, or designated representative of the seller, acknowledging the accuracy of the cannabis and nonmanufactured cannabis products being shipped.
(i) Signature of the purchaser, or designated representative of the purchaser, acknowledging receipt or rejection of the cannabis or nonmanufactured cannabis products.
Sec. 8408. Inventory Audits. The department may perform an audit of the physical inventory and inventory as reported in the track-and-trace system of any licensee at the department’s discretion. Audits of the licensee shall be conducted during standard business hours or at other reasonable times as mutually agreed to by the department and the licensee. For the purposes of this section standard business hours are 8:00 am – 5:00 pm (Pacific Standard Time). Prior notice of audit is not required.
Sec. 8501. Inspections, Investigations and Audits. The department shall conduct inspections, investigations and audits of licensees including, but not limited to, a review of any books, records, accounts, inventory, or onsite operations specific to the license.
(a) The department may conduct an inspection, investigation or audit for any of the following purposes:
- To determine the accuracy and completeness of the application prior to issuing a license;
- To determine compliance with license requirements including, but not limited to, the cultivation plan;
- To audit or inspect any records outlined in section 8400 of this chapter;
- To respond to a complaint(s) received by the department regarding the licensee;
- To inspect incoming or outgoing shipments of cannabis and nonmanufactured cannabis products; and
(6) As deemed necessary by the department.
(b) All inspections, investigations, and audits of the licensed premises shall be conducted during standard business hours or at other reasonable times as mutually agreed to by the department and the licensee. For the purposes of this section, standard business hours are 8:00 am – 5:00 pm (Pacific Standard Time). Prior notice of inspection, investigation or audit is not required.
(c) No applicant, licensee, its agent or employees shall interfere with, obstruct or impede the department’s inspection, investigation or audit
This includes, but is not limited to, the following actions:
- Denying the department access to the licensed premises;
- Providing false or misleading statements;
- Providing false, falsified, fraudulent or misleading documents and records; and
(4) Failing to provide records, reports, and other supporting documents.
(d) Upon completion of an inspection, investigation or audit, the department shall notify the applicant or licensee of any violation(s) and/or action(s) the department is taking.
Cannabis Business Accounting Guidelines