Is Your Cannabis Tax Credit Worth a Higher Likelihood of Being Audited? 

November 28, 2023

Taking credits can raise flags with the IRS–and audits can be time-consuming and costly. Here’s what to consider before opting to save a little extra at tax time. 

Should you take a tax credit if it means your cannabis business will have a greater chance of being audited? 

“It depends,” says CJBS Partner Ryan Guedel, CPA. 

“My job is always to look out for my clients best interest. In this case, if there is a tax credit that we can potentially harvest, it’s my job to try to go harvest it. But if that is potentially going to create an issue down the road, you don’t want to do it.”

Strict Deduction Limitations and Increased IRS Audits 

In today’s cannabis business environment, high taxes are a major concern. Plant-touching operators must adhere to the IRS Code Section 280E, which generally prevents businesses from deducting anything except cost of goods sold–or COGS–when they file their taxes. On top of strict regulation and increased competition, these tax restrictions make profitability much more difficult within the cannabis industry. 

However, over the years as legislation and guidance has evolved, certain tax credits–such as the Research and Development (R&D) tax credit (for products and activities unrelated to THC), Secure 2.0 for employer-sponsored retirement plans, as well as other state-specific tax credits, like the Cannabis Equity Tax Credit in California–have been increasingly used by cannabis businesses to help lower their tax burden. 

At the same time, audits of cannabis businesses by the IRS have seen a significant uptick in recent years. 

When a cannabis business opts to use tax credits beyond COGS, it’s like putting a bullseye on your back for an audit, Guedel says. 

If your cannabis business has been deemed not to have used a tax credit appropriately by the IRS auditor, you will be obligated to pay that tax liability.  

Even if your cannabis business comes out of an audit unscathed because you’ve done everything by the book–an IRS audit can still be costly and time-consuming. It will cost thousands of dollars, as well as lead to many lost hours interacting with auditors and gathering appropriate documents. 

Proper Record-Keeping Is Essential for Compliance 

If your business weighs the pros and cons of implementing tax credits and would like to move forward with them, Guedel recommends employing meticulous contemporaneous record-keeping. 

When a business is being audited–the IRS is looking for documents that have been compiled before an audit takes place, such as proper allocation within payroll records, charitable donations, mileage, capital purchases, etc. 

These records cannot be generated after the fact. They must be produced at the outset in order to be compliant with auditors. 

Read More: Your Cannabis Business Tax Planning Checklist

Sometimes the cost savings can be worth it–other times, not so much. 

“Everyone has to take their own temperature relating to finance and the IRS,” Guedel says. 

This is why it’s important to work with a CPA who understands the cannabis industry intricately to help you weigh these options to determine what will be best for your business. 

If your cannabis business needs assistance with audit and assurance services, tax planning and compliance, and/or business solutions–the CJBS team is here to help. We are Cannabis CPAs Who Care, and our goal is to help you grow and scale your company in the cannabis industry, with all its potential and challenges.