Due to its illegal status at the federal level and as the business is growing fast with various emerging sub-industries, cannabis companies face more complex issues than ever. These issues are unique to the industry and require their operators to be extra careful when keeping their books accurate and organized. Hence, following best practices are crucial for businesses in this field.
In this article, we cover everything you ought to know about bookkeeping for the cannabis industry in the U.S.!
Not many federally regulated financial institutions welcome cannabis businesses, as it is still classified as an illegal drug in many states. This lack of banking options subjects cannabis businesses to multiple issues, including internal and external theft, misallocation of funds, payroll, and insurance paid in cash.
However, you may still be able to find a bank that can work with your cannabis business. Be ready to deal with application procedures in which regular financial statements must go through reviews. Banks often do this quarterly, but monthly financial records should be ready for submission at any time.
Banks will also pay attention to fluctuations in your report, and you don’t want your account to be shut down because you can’t account for such inconsistencies, so keep that in mind as you proceed.
Cash flow control
Cash-only businesses can be challenging to manage, and those in the cannabis business are no exception. Cash transactions can become a mess without a proper tracking system. In the case of cannabis, a federally controlled substance, every piece of inventory matters. Any suspicious activity may lead to loss of licenses or even criminal charges against concerned individuals.
To prevent money laundering, marijuana companies must meet strict requirements regarding accounting and keeping records of every activity and transaction during the business, “from seed to sales” and from suppliers, distributors, and retailers to customers.
Moreover, for any transaction or a series of transactions that total $10,000 or more in cash, cannabis businesses have to prepare Form 8300 for tax purposes, the filing of which can be confusing with errors resulting in serious fines and audits.
According to Internal Revenue Code Section 280E, “No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances (within the meaning of Schedule I and II of the Controlled Substances Act) which is prohibited by federal law or the law of any state in which such trade or business is conducted.”
In compliance with this, cannabis-related businesses follow strict limitations when reporting taxable income, with the cost of goods sold being the only deductible expense. Accounting processes, as a result, must implement complete record-keeping to ensure a compliant inventory environment.
Related article: What Is the Supreme Court Cannabis Tax Ruling?
Cannabis businesses and accountants working in the industry do not often talk about seed-to-sale tracking with much enthusiasm. Every state has its seed-to-sale system to monitor the production and distribution of cannabis plants, causing a great deal of confusion for growers, distributors, and other stakeholders involved who need to adhere to changing rules of each local government.
Specifically, depending on its preference, each state may require a different software system to trace and monitor the plants and finished products from inventory to the point of sale. However, the three popular seed-to-sale software, Biotrack, MJ Freeway, and METRC, tend to have unreliable reporting. It cannot be easy to integrate them with existing accounting systems.
Bookkeeping for the cannabis business: fundamentals
With all the federal and state regulations that make accounting for cannabis extremely complex, anyone who deals with keeping the books must do it right.
In particular, bookkeepers should know the ins and outs of Section 280E in the tax code because of its major implications on the business’s income and profit. Unlike those working for most small-to-medium-sized businesses, accountants and bookkeepers in cannabis companies must get used to concepts such as cost accounting, accrual accounting, generally accepted accounting principles (GAAP), and absorption accounting.
Since many of these principles are not required for everyday small business accounting, a generalist accountant may not be familiar with them. Therefore, finding a person with the necessary skill set to keep good records for your cannabis business is important in several ways.
Whether outsourcing professional bookkeeping services or hiring an internal bookkeeper, cannabis businesses benefit greatly from having their books handled by people who have experience in the industry.
Get your accounting system set up and organize your expenses before opening your doors. Without proper tracking of day-to-day expenditure and transactions, your bookkeeping logs might become a nightmare with a higher tendency for errors. Even for pre-revenue companies, having a comprehensive bookkeeping system in place is essential at the beginning of your journey, when you will need to know how much was spent on what.
Related article: What Are The Differences Between A Bookkeeper And An Accountant?
Cash-intensive businesses like cannabis companies rely on fundraising for initial startup costs. Not to mention the difficulty of finding investors who understand the possible pitfalls of the industry, there are a host of components that business owners can’t overlook if they would like to attract investors to their business.
These components include providing organized books and accurate financial reports that show effective internal controls and accounting policies. For marijuana businesses that wish to access capital, it is expected that they will be capable of good bookkeeping practices.
Taxes and deductibles
As mentioned earlier, under IRC 280E, cannabis companies cannot deduct business expenses such as rent, vehicle, and marketing like other companies because their business is related to a controlled substance. Despite this tax limitation, professional accountants can help to legally reduce taxable income by allocating costs to inventory and the cost of goods sold, which is mandated by IRC 471.
Besides the IRC 280E, there are other tax requirements that cannabis businesses must fulfill to maintain their license and stay out of trouble with the IRS.
GST/HST and provincial sales tax
Once a proper accounting system is set up with organized bookkeeping practices, cannabis companies can be at ease paying the correct sales tax they are supposed to. Moreover, based on the tax collected, it will be easier for them to plan, using the expected tax refunds for business operations.
You must keep track of the duty rates and report the higher duty payable transaction-by-transaction basis. Those who own a business in the industry must have a good grasp of the rules and regulations of the excise duty framework to know how to calculate duties or have a reliable accounting team to do this painstaking task. Plus, they should do it early on before all the transaction receipts pile up or go missing!
Bookkeeping for the cannabis industry: best practices
Know the rules
Whether for medical use or adult purchases, businesses associated with marijuana are restricted by countless written and unwritten rules, the sheer number of which may repel anyone wishing to be engaged in this space.
Both federal and state laws have their specifications regarding cannabis businesses, and bookkeepers must know them like the back of their hands to stay compliant.
As the foundation of good accounting and financial management, bookkeeping is all about being organized. You may have heard about digitized receipt services such as Shoeboxed that help keep your documents safe online and offline. Still, there are more advantages of applying technology in bookkeeping than you might imagine.
With brilliant features, including verified data that is audit-ready and easily located, customized expense reports, and integrations with various accounting systems, Shoeboxed offers an actionable data tool.
Accurate records and transparent accounting procedures are what a cannabis business needs to track its finance and enhance its credibility with financial institutions and potential investors.
Other things you can do with the Shoeboxed app:
- How to Track Mileage for Tax Deductions with the Shoeboxed App
- How to Scan Receipts With the Shoeboxed App: A Step-By-Step Guide
- 4 Easy Ways To Upload Your Receipt Images To Shoeboxed
- 5 Best Ways to Store Your Business Cards
A cannabis company is a complicated entity that involves several sub-industries (farming, chemical manufacturing, food production, and retail). Each requires various reporting under the many legislations at the state and federal levels.
Another big headache for cannabis bookkeepers and accountants is the buggy seed-to-sale software requested by local regulations. Unfortunately, cannabis accounting platform software designed to assist this complicated process is still lacking and doesn’t work well with widely used accounting systems.
While looking for more plausible solutions, specialists in the field suggest we use current software, combining their functions to serve our needs. Quickbooks and Xero are popular choices for accounting, although some attempts must be made to create charts of accounts for each business stage.
Excel is a basic-but-good tool for cost accounting, reconciliations, consolidations, and so on. If one realizes its versatility and puts decent effort into utilizing its functions, preparing monthly reports or creating accounting templates can become much easier. Doing what we have seems to be the right strategy, at least for now.
Checks and balances
Problems with bookkeeping in cannabis businesses are mostly due to the huge amount of cash being collected, which may lead to undesirable consequences ranging from careless mistakes to inaccuracies in bookkeeping to fraud. However, many can be prevented by consistently implementing checks and balances during operations.
For example, daily and weekly cash counts can help identify discrepancies between actual cash on hand and the records in the books. Likewise, sale receipts must be kept carefully compared to those listed regularly. It is also a good idea to have two people do the cash collection and reconciliation separately to lower the chance of theft. This way, professional bookkeepers and accountants are good for a reliable internal control system.
Frequently asked questions
Understanding the difference between cannabidiol (CBD) and tetrahydrocannabinol (THC) and the tax credit differences applicable to cannabis accounting is important.
It is possible to extract CBD from hemp or marijuana. Cannabis plants classified as hemp have a THC content of less than 0.3 percent, whereas marijuana plants have greater THC levels.
THC, the central ingredient in marijuana, produces a high sensation. You can take it by smoking marijuana, extracting the THC, and putting it in an edible or topical delivery system.
The only true difference between the plants is in their chemistry, which makes it difficult to distinguish between them because they appear identical to the untrained eye.
Another notable distinction between hemp and THC is the availability of greater tax incentives under hemp, notably the R&D tax credit. For instance, you might create a cannabis strain with less than 0.3 THC that is extremely resistant to pests, drought, or other environmental factors comparable to conventional farming methods.
Growing hemp has numerous potential for advancements, but under Code 280E, you are not permitted to claim such credits.
A chart of accounts (COA) overviews an organization’s financial accounts. This index presents all financial transactions completed during a given accounting period in five main categories: assets, liabilities, equity, income/income, and expenses. Under each main category, transactions are further itemized into smaller categories.
The Chart of Accounts (COA) helps organize your finances, increases internal accountability, and gives investors, auditors and shareholders a clear view of your business finances. A COA can help marijuana businesses meet the tough reporting standards of the cannabis industry. Creating and submitting quarterly financial reports and your tax returns becomes much easier.
As a cannabis operator, the COA is especially important because 280E limits the number of business deductions you can take on your tax return. Hence, it would help to categorize expenses correctly to make the most of your limited deductions.
A COA for your cannabis operation will help you document your business and keep track of your expenses. The more details you provide for each transaction, the easier it will be for your accountant to have the time to achieve the more thoughtful assignment of CoGS concerning your taxes.
1. It’s not easy to open a business bank account or get a loan for your cannabis business, depending on your state.
2. Cannabis tax laws are complicated, and the IRS monitors cannabis businesses since marijuana is classified as a Schedule I substance. It’s recommended for business owners to work with cannabis professionals like accounts and lawyers to ensure they do not violate tax regulations.
3. Cannabis businesses are more likely to be inspected by the government.
4. Third-party bookkeepers and payroll professionals specializing in cannabis are limited.
5. Cannabis businesses risk losing inventory when not many banks let them open a business account.
6. IRS limits how cannabis businesses can apply for tax deductions for their products.
7. The cannabis industry has higher startup costs than normal.
• Cannabis Accounting Education and Training—Provides seminars, workshops, whitepapers, and templates guiding bookkeeping professionals and business owners in operating their cannabis businesses compliantly.
• CPA Academy—A leading organization that has a specific course for bookkeeping beginners who are working in the cannabis industry.
• CBM Network—Teaches accountants about cannabis accounting, cannabis taxes, and what to do as a cannabis bookkeeper, cannabis accountant, or cannabis business owner.
• My CPE—Provides a deep-dived webinar into everything a small business owner needs to know related to Cannabis, CBD, and Hemp Bookkeeping.
• National Association of Cannabis—Offers a complete guide on the day-to-day accounting requirements of working with cannabis companies for bookkeepers and accountants.
Final thoughts on bookkeeping for the cannabis industry
We have yet to know when the federal legalization of cannabis is coming and how it will change the bookkeeping practices in cannabis companies. Whatever may happen, keeping accurate and organized books will enable you to enjoy smooth business operations.
Bonus resources on bookkeeping for dispensaries
- Bookkeeping for Dispensaries blog
- Cannabis Accounting Services – Greenbooks CPA
- Cannabis Accounting Education and Training
You might also be interested in: U.S. Cannabis Market to be Worth $40.0 Billion by 2030: Grand View Research, Inc
Bonus infographic: The US cannabis market segmentation
You might be interested in:
- 5 Most Famous Tax Court Cases In IRS History
- What Is Receipt Paper Made Of? 3 Common Types of Receipt Paper
- The Ultimate Receipt Organization & Management Resource
- Financial Record Keeping: 6 Best Practices for Small Businesses
Originally published on September 2, 2021. Updated on August 17, 2022.
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