Bookkeeping, Tax Filing, and Compliance Guide for Cannabis & CBD/Hemp Businesses

Otterz is a Proud Member of the National Cannabis Industry Association

In this Article:

1. Introduction

Cannabis and CBD/Hemp businesses face unique challenges in bookkeeping, tax filing, and compliance due to a complex and often conflicting regulatory landscape. Unlike traditional businesses, these companies must navigate the dichotomy between federal illegality and state legality, complicating their operational and financial activities. One of the most significant hurdles is the impact of Section 280E of the Internal Revenue Code, which prohibits the deduction of ordinary business expenses for businesses involved in the trafficking of controlled substances. This restriction limits allowable deductions to the cost of goods sold (COGS), significantly increasing taxable income. Understanding and complying with both federal and state regulations is crucial for maintaining compliance and ensuring the financial viability of cannabis and CBD/Hemp businesses.

2. Differences Between Normal Bookkeeping and Cannabis Bookkeeping

3.  Key Elements of Bookkeeping for Cannabis and CBD/Hemp Businesses

Effective bookkeeping for cannabis and CBD/Hemp businesses involves several key elements tailored to the unique needs and regulatory requirements of the industry.

Chart of Accounts: Creating a comprehensive chart of accounts is essential for accurate financial tracking and reporting. For cannabis businesses, it's important to categorize income from various sources distinctly:

• Medical Sales: Revenue from sales to patients using cannabis for medicinal purposes.
• Recreational Sales: Revenue from sales to consumers using cannabis for recreational purposes.
• Wholesale Sales: Income from selling products in bulk to other businesses.
• Retail Sales: Income from direct sales to consumers.

Additionally, non-COGS expenses must be detailed carefully, noting that most of these are non-deductible under Section 280E. These expenses might include administrative costs, marketing expenses, and general operational costs.

Cash Handling and Internal Controls: Due to banking restrictions, many cannabis businesses handle significant amounts of cash, necessitating stringent internal controls:

• Daily Cash Counts: Perform daily reconciliations of cash on hand with sales records to ensure accuracy.
• Segregation of Duties: Separate cash handling duties among different employees to reduce the risk of theft and fraud.
• Secure Storage: Use safes and other secure storage solutions to protect cash, and restrict access to authorized personnel only.

Inventory Management: Effective inventory management is critical due to regulatory requirements for seed-to-sale tracking:

• Seed-to-Sale Tracking: Implement comprehensive tracking systems to monitor inventory from cultivation through sale. This ensures compliance with state regulations and helps prevent diversion.
• Regular Physical Audits: Conduct frequent physical inventory counts to verify records and maintain accuracy.

Transaction Recording: Accurate transaction recording is vital for compliance and financial integrity:

• Detailed Receipts: Issue detailed receipts for every transaction, documenting the date, time, items sold, and amounts.
• Comprehensive Transaction Logs: Maintain logs of all transactions, including cash sales, to ensure traceability and transparency.

Tax Compliance and Reporting: Adhering to tax regulations is particularly complex for cannabis businesses due to restrictions like Section 280E:

• Accurate Documentation of COGS: Since ordinary business expenses are non-deductible, it is crucial to accurately document all COGS for allowable deductions. This includes costs directly associated with production, such as raw materials and labor.
• Sales and Excise Taxes: Collect, remit, and document all applicable sales and excise taxes meticulously. Each state may have different tax rates and reporting requirements, so it’s essential to stay informed and compliant with local laws.

By focusing on these key elements, cannabis and CBD/Hemp businesses can ensure their bookkeeping practices are robust, compliant, and capable of supporting the unique demands of the industry. Proper financial management not only helps in meeting regulatory requirements but also contributes to the overall success and sustainability of the business.

4. Proving Authenticity of Transactions

Ensuring the authenticity of transactions is critical for cannabis and CBD/Hemp businesses due to the regulatory scrutiny and high risk of fraud. Implementing robust measures to validate transactions can help maintain compliance and financial integrity.

Cannabis-Specific POS Systems: Using cannabis-specific point-of-sale (POS) systems is essential for maintaining detailed and accurate transaction records. These systems are designed to handle the unique requirements of the cannabis industry, including:

• Comprehensive Transaction Tracking: Record every sale with detailed information, such as product type, quantity, price, date, and time.
• Inventory Integration: Sync with seed-to-sale tracking systems to update inventory levels in real-time, ensuring precise stock management.
• Compliance Reporting: Generate reports required by state regulators, simplifying compliance with reporting obligations.

Video Surveillance: Implementing video surveillance in key areas, especially where cash handling and transactions occur, enhances security and transaction authenticity:

• Monitoring Cash Handling: Cameras should be placed in areas where cash is counted, stored, and transacted to deter theft and ensure accountability.
• Retention of Footage: Retain video footage as required by state regulations to provide a visual record of transactions and cash handling activities.
• Compliance Verification: Use surveillance footage to verify compliance with internal cash handling procedures and external regulatory requirements.

Regular Reconciliation: Regular reconciliation of cash on hand with sales and inventory records is vital to detect and prevent discrepancies:

• Daily Reconciliations: Perform daily checks to match cash receipts with sales records, identifying any variances promptly.
• Inventory Reconciliation: Regularly reconcile inventory records with physical stock to ensure accuracy and compliance with seed-to-sale tracking requirements.
• Discrepancy Investigation: Investigate and resolve any discrepancies immediately to maintain accurate financial records and prevent fraud.

Employee Training: Proper training for employees is crucial in ensuring effective cash handling and fraud prevention. Continuous training programs and regular updates are necessary to keep employees informed about new regulations and fraud prevention techniques. Key areas of training should include:

• Cash Handling Procedures: Train employees on standard cash handling practices, including counting, recording, and storing cash securely.
• Fraud Prevention Techniques: Educate staff on recognizing and preventing fraudulent activities, emphasizing the importance of vigilance and accuracy.
• Compliance Awareness: Ensure employees understand the regulatory requirements and the importance of adhering to internal controls and procedures.
• Ongoing Education: Regularly update training materials and conduct refresher courses to keep staff current with changes in regulations and best practices.

Regular External Audits: Conducting regular external audits is an essential practice to verify the authenticity of financial records and transactions:

• Independent Verification: Engage third-party auditors to review financial records, ensuring impartial validation of transaction authenticity.
• Audit Reports: Use audit findings to identify areas for improvement in internal controls and compliance practices.
• Continuous Improvement: Implement recommendations from audits to enhance financial practices and mitigate risks of fraud and non-compliance.

By focusing on these methods, cannabis and CBD/Hemp businesses can establish a robust framework for proving transaction authenticity. This not only helps in maintaining regulatory compliance but also strengthens overall financial management and trustworthiness within the industry.

A cannabis point-of-sale (POS) system is specifically designed to handle the unique needs of cannabis retailers and dispensaries, ensuring seamless inventory and sales management while maintaining compliance with strict industry regulations. These systems are essential for cannabis businesses as they automate the reporting of sales on a daily, weekly, or monthly basis, depending on state requirements. The leading cannabis POS systems focus on compliance and automation, which are crucial for preventing business interruptions and supporting growth despite the rigorous rules imposed on merchants. While these systems tend to be more expensive than traditional POS systems, their specialized features and compliance capabilities justify the investment.

Among the top cannabis POS systems, Blaze is recognized as the best overall all-in-one solution, offering comprehensive features like seed-to-sale tracking, integrated payment processing, and compatibility with both iOS and Android systems. Cova stands out for its ease of use, providing robust reporting and compliance features. Dutchie is praised for its all-in-one capabilities tailored for growing retailers, while Indica Online is the preferred choice for medical marijuana dispensaries due to its HIPAA compliance. Flowhub Maui is ideal for businesses operating in multiple states, and Vende offers a free option suitable for startups. Each of these systems provides unique advantages, ensuring that cannabis businesses can find a solution that meets their specific needs and supports their operational and regulatory requirements.

5. Differences Between Normal Tax Filing and Cannabis Tax Filing

Tax filing for cannabis and CBD/Hemp businesses involves unique challenges that distinguish it significantly from traditional business tax filing. Understanding these differences is crucial for maintaining compliance and optimizing tax strategies.

Restrictions on Deductions under Section 280E: One of the most significant differences in tax filing for cannabis businesses is the impact of Section 280E of the Internal Revenue Code. This section prohibits businesses involved in the trafficking of controlled substances, including cannabis, from deducting ordinary business expenses. As a result:

• Limited Deductions: Cannabis businesses cannot deduct typical operating expenses such as rent, salaries, and marketing costs.
• Cost of Goods Sold (COGS): The only allowable deductions are for the cost of goods sold. This includes expenses directly associated with the production of cannabis products, such as raw materials and direct labor. Accurate documentation of COGS is crucial to maximize deductions and minimize taxable income.

Additional Tax Filing Requirements: Cannabis businesses face additional tax filing requirements beyond those of normal businesses:

• State Compliance: Each state with legalized cannabis has its own specific tax rates, filing requirements, and deadlines, which can significantly differ and impact overall tax strategy and compliance. Businesses must file separate state tax returns and adhere to these state-specific tax forms and procedures. This often includes additional financial disclosures and compliance with unique state regulations. Staying informed and up-to-date on these varying requirements is crucial for maintaining compliance and optimizing tax strategies.
• Excise Taxes: Many states impose excise taxes on cannabis products, and the calculation method varies by state. These taxes can be calculated as a percentage of the sales price or a fixed amount per unit sold. It is essential for businesses to stay updated on these rates and methods to ensure accurate calculation, collection, and remittance of excise taxes. Failure to comply with state-specific excise tax requirements can result in significant penalties and financial setbacks.
• Local Taxes: In addition to state taxes, some local jurisdictions impose additional taxes on cannabis businesses. These local taxes can vary significantly in rates and requirements, impacting overall financial planning and compliance. Businesses must carefully track and comply with these local tax obligations to avoid penalties and ensure accurate financial reporting. Staying informed about the specific local tax rates and regulations applicable to each area of operation is essential for maintaining compliance and optimizing tax strategies.

Challenges of Dealing with Cash Transactions: Due to federal banking restrictions, many cannabis businesses operate primarily on a cash basis, presenting unique challenges in tax filing:

• Meticulous Record-Keeping: Maintaining detailed logs of all cash transactions is essential. This includes issuing receipts for every transaction, keeping daily cash reports, and maintaining accurate financial records.
• IRS Form 8300: Any cash transaction over $10,000 must be reported using IRS Form 8300. Timely filing of this form is crucial to avoid penalties and ensure compliance with federal regulations. This form is essential for preventing money laundering and maintaining transparency in cash-heavy businesses. Cannabis businesses must be diligent in accurately completing and submitting Form 8300 to avoid significant fines and legal issues.
• Cash Handling Procedures: Implementing robust internal controls to manage cash flow, secure storage, and reconcile cash transactions regularly is crucial to prevent theft and ensure accurate reporting.

Dual Compliance with Federal and State Laws: Cannabis businesses must navigate the complexities of dual compliance with both federal and state laws, which can often be conflicting:

• Federal Filing Requirements: Despite state legalization, cannabis remains illegal at the federal level. Businesses must file federal income tax returns and comply with Section 280E, calculating taxes based on limited allowable deductions.
• State Filing Requirements: Each state has its own tax regulations and filing requirements. Businesses must ensure compliance with state-specific tax forms, rates, and deadlines. This often involves different calculations and documentation compared to federal filings.
• Maintaining Separate Records: To effectively manage dual compliance, cannabis businesses need to maintain separate financial records and documentation for federal and state compliance. This practice helps avoid legal issues and financial penalties by ensuring that all regulatory requirements are met accurately.

In summary, tax filing for cannabis and CBD/Hemp businesses involves navigating significant restrictions under Section 280E, adhering to additional state and local tax requirements, managing the complexities of cash transactions, and ensuring dual compliance with federal and state laws. These challenges necessitate meticulous record-keeping, robust internal controls, and specialized knowledge to successfully manage tax obligations in this unique industry.

6. Calculating and Reporting COGS in Tax Filing

For cannabis and CBD/Hemp businesses, accurately calculating and reporting the cost of goods sold (COGS) is critical due to the restrictions imposed by Section 280E. Properly documenting COGS allows these businesses to maximize their allowable deductions and minimize taxable income.

Breakdown of What Can Be Included in COGS:

• Inventory Costs:
• Raw Materials: Costs for seeds, soil, nutrients, and other supplies used in cultivation.
• Purchased Inventory: The cost of acquiring cannabis products or materials for resale.
• Packaging: Costs associated with packaging materials directly tied to product sales.
• Direct Labor:
• Cultivation Labor: Wages and salaries for employees directly involved in growing cannabis plants.
• Processing Labor: Compensation for workers engaged in harvesting, drying, trimming, and curing cannabis.
• Manufacturing Labor: Wages for those involved in the manufacturing and extraction processes, such as producing concentrates and edibles.
• Manufacturing Overhead:
• Utilities: Costs for electricity, water, and gas used in the production facility.
• Rent: Rent for the portion of the facility used for production purposes.
• Depreciation: Depreciation on equipment and buildings used in the manufacturing process.
• Repairs and Maintenance: Costs associated with maintaining production equipment and facilities.
• Processing Costs:
• Extraction Costs: Expenses related to extracting cannabinoids from cannabis plants.
• Laboratory Testing: Costs for testing products to ensure quality and compliance with state regulations.
• Production Supplies: Materials used in the production and processing stages, such as solvents and filtration systems.

Importance of Maintaining Detailed Records and Supporting Documentation:

• Invoice and Receipts: Keep detailed records of all purchases, including invoices and receipts for raw materials, equipment, and other COGS-related expenses.
• Payroll Records: Maintain comprehensive payroll records for all employees whose wages are included in COGS.
• Utility Bills: Document utility expenses specific to the production areas.
• Depreciation Schedules: Track depreciation on production equipment and facilities accurately.
• Inventory Logs: Maintain precise inventory logs to support the inclusion of inventory costs in COGS.

Accurate and detailed documentation is essential to justify COGS calculations, especially in the event of an IRS audit. This meticulous record-keeping ensures that all allowable deductions are captured and can be substantiated.

Instructions for Reporting COGS on the Appropriate IRS Forms:

• Form 1125-A for Corporations:
• Step-by-Step: Corporations report COGS on Form 1125-A, which is attached to the main corporate tax return (Form 1120).
• Completion: Provide detailed breakdowns of beginning inventory, purchases, labor, materials, and ending inventory.
• Attachment: Ensure Form 1125-A is accurately completed and attached to Form 1120.
• Form 1065 for Partnerships:
• COGS Reporting: Partnerships report COGS on Form 1065, specifically on the Schedule B of the form.
• Details: Include all relevant costs, from inventory to labor and overhead, ensuring accurate reflection of COGS.
• Compliance: Ensure all supporting documentation is available for each item reported as part of COGS.
• Schedule C for Sole Proprietors:
• Simplified Reporting: Sole proprietors use Schedule C to report business income and expenses, including COGS.
• Sections: Complete the COGS section of Schedule C, detailing beginning inventory, purchases, cost of labor, materials and supplies, and ending inventory.
• Documentation: Maintain thorough records to support all entries on Schedule C.

By accurately calculating and reporting COGS, cannabis and CBD/Hemp businesses can effectively manage their taxable income and comply with IRS regulations, even under the stringent requirements of Section 280E. This meticulous approach to COGS reporting not only ensures compliance but also supports the financial health of the business.

7. Conclusion

Navigating the complex world of bookkeeping, tax filing, and compliance is a unique challenge for cannabis and CBD/Hemp businesses. The intricate and often conflicting regulatory landscape requires these businesses to maintain meticulous records, implement robust internal controls, and adopt specialized accounting practices. The impact of Section 280E of the Internal Revenue Code, which limits allowable deductions to the cost of goods sold (COGS), underscores the need for detailed and accurate financial documentation.

Ensuring compliance involves not only adhering to federal and state regulations but also managing extensive cash transactions with rigorous security measures and thorough reconciliation processes. Employing cannabis-specific POS systems, implementing video surveillance, and conducting regular external audits are essential practices to validate transaction authenticity and prevent fraud.

The additional tax filing requirements, including state-specific regulations and local excise taxes, further complicate the financial landscape. Businesses must be diligent in maintaining dual compliance with federal and state laws, meticulously reporting cash transactions, and accurately calculating and documenting COGS.



By focusing on these critical elements and leveraging specialized knowledge and tools, cannabis and CBD/Hemp businesses can achieve financial integrity and compliance. This not only ensures their sustainability and growth in a highly regulated industry but also positions them to capitalize on the expanding opportunities within the cannabis market. Working with experienced professionals who understand the nuances of cannabis accounting is invaluable in navigating these complexities and securing the financial health of the business.

How Otterz Can Help

Otterz offers specialized accounting packages tailored specifically for Cannabis and CBD/Hemp businesses. Our comprehensive packages include bookkeeping, tax accounting, and access to our Financial Management Platform powered by Nyra - the first AI Accountant. Nyra is trained on your accounting and financial data, providing instant insights and automating several basic bookkeeping tasks. This powerful AI assists with tax filing and delivers a level of business understanding and financial clarity that has never been experienced before in the industry. By leveraging Otterz's industry-specific expertise and innovative technology, Cannabis and CBD/Hemp businesses can navigate the complexities of their financial management with ease and confidence.

Reach out to us today to explore how our expert services can streamline your most vital financial processes.

About the Authors:

Ektaa Shah

CPA & Taxation Expert

Ektaa is a Certified Public Accountant with a Master’s in Taxation, driven by a wealth of expertise and a commitment to excellence. Demonstrating dedication to academic and professional achievement, Ektaa has gained valuable experience across diverse industries, including professional service firms, life sciences and consumer goods. Serving as a tax specialist on audits and serving as a tax advisor for small to medium sized-businesses, she developed a deep understanding of complex tax issues. Beyond her professional endeavors, Ektaa is actively involved in community service and leadership. She proudly serves as the Treasurer on the Board of Directors for the non-profit organization Womanspace, demonstrating her commitment to giving back and empowering others.

Daniel Ionescu

Marketing Expert

Daniel is an Experienced Marketing Expert deeply passionate about financial technologies, startups, and small business growth. He is dedicated to empowering startups and small businesses through insightful content and innovative tools designed to enhance financial management and operational efficiency. Daniel is committed to delivering valuable, tech-driven solutions to entrepreneurs and business owners.