280E & Tax

The IRS Is Auditing Your Cannabis Business: What to Expect and How to Survive

Why cannabis businesses get examined

Cannabis returns combine three things the IRS finds interesting: large cash volumes, a statute (280E) that many preparers apply incorrectly, and an industry young enough that recordkeeping standards vary wildly. Examination rates in this industry run well above the general business population, and every operator should file as if their return will eventually be read by an examiner — because it may be.

What the audit is actually about

Nearly every cannabis examination centers on one question: were the costs you classified as cost of goods sold properly capitalizable under §471? The examiner will test your allocation methodology, ask for the contemporaneous records behind it, and reclassify anything unsupported into non-deductible expense — with tax, penalties, and interest on the difference.

Secondary areas follow a pattern too: cash receipts testing against deposits, inventory reconciliation against your state tracking system, and related-party transactions in multi-entity structures.

What to do when the notice arrives

Do not respond before someone qualified reviews it. Responses cannot be unsent, and the early framing of an examination genuinely shapes its outcome. Engage representation, assemble the documentation behind every material position, and communicate through your representative rather than directly.

If your documentation is thin, know that before the examiner does. Weaknesses identified early can sometimes be shored up with secondary evidence; weaknesses discovered mid-examination cannot.

The best defense is built years earlier

Audits are won at bookkeeping time, not at examination time. Contemporaneous labor allocations, seed-to-sale reconciliations that tie to the ledger, and a documented cost methodology are what make an examination boring — which is the goal. We build every client's position expecting the examination, so that when it arrives, the file already exists.

This article is general information, not tax advice. Cannabis tax outcomes depend on facts, documentation, and jurisdiction — talk to a qualified professional about your specific situation.