Cannabis Accounting Cleanup & 280E: Preparing for the Rescheduling Revolution

As Cannabis businesses rush to prepare for potential rescheduling, a harsh
reality is emerging: most aren't ready for the scrutiny that's coming.
While the industry celebrates this historic shift, many Cannabis operators
are sitting on a powder keg of messy books, questionable 280E positions,
and incomplete documentation that could explode under increased regulatory
attention.

After a decade of helping Cannabis businesses navigate these waters, I can
tell you this with certainty: the difference between thriving and merely
surviving in the post-rescheduling era will come down to two critical
factors - clean books and proper 280E documentation. With the DEA's final
hearing set for December 2024, the window for getting your house in order
is closing fast.

Consider these sobering realities:

- Most Cannabis businesses lack proper audit trails for their 280E
positions
- Few maintain adequate documentation to support COGS calculations
- Many comingle funds across multiple entities, clouding 280E compliance
- The majority aren't prepared for the level of scrutiny rescheduling
will bring
- Almost none are positioned to take advantage of potential retroactive
relief

In this comprehensive guide, we'll break down exactly what you need to do
to get your Cannabis business or clients audit-ready. We'll cover:

- Essential steps for proper accounting cleanup
- Strategic approaches to 280E compliance
- How to build and maintain a bulletproof audit trail
- Critical preparations for the rescheduling transition

Whether you're a Cannabis CFO, accountant, or business owner, the decisions
you make in the coming months could determine whether your business thrives
or struggles once rescheduling happens. Let's dive into the exact systems
and processes you need to implement today to ensure you're ready for
tomorrow's opportunities.


*Understanding 280E in Today's Context *

Let's start with the single sentence that has shaped Cannabis accounting
and tax for decades. Section 280E of the Internal Revenue Code states
simply that businesses trafficking in Schedule I or II substances cannot
deduct business expenses or claim credits on their tax returns. This one
sentence has spawned massive litigation, complex compliance strategies, and
billions in tax implications for the Cannabis industry.

As a reminder, here is what 280E states in full:

*“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.”*

The phrase “any trade or business” is broad. Let’s unpack what it means.


*The Current State of 280E*

280E is so impactful because it doesn't just affect one part of your
business. It touches everything. The IRS has interpreted "trafficking"
broadly, meaning if you're involved in Cannabis commerce in any way, you're
likely subject to these restrictions. This applies whether you're:

- A single-dispensary operation
- A multi-state Cannabis enterprise
- A vertically integrated business
- A cultivation facility
- A manufacturer or processor

The restrictions are comprehensive: no deductions for rent, utilities,
marketing, salaries, or any other normal business expense. The only
allowable reduction from gross income is Cost of Goods Sold (COGS) - and
even that must be calculated following specific rules.


*Key Updates from Recent IRS Guidance*

At the recent 2024 AICPA Cannabis Conference, Luke Ortner, Senior Chief
Counsel of the IRS, made several critical points about 280E compliance:

- 280E remains fully in effect while Cannabis is Schedule I
- The IRS is actively preparing for potential rescheduling impacts
- Current compliance is essential, regardless of pending changes
- Businesses should maintain detailed records of all COGS calculations

Remember - and this is crucial - until rescheduling is official, 280E
remains in full force. Any premature attempts to ignore or circumvent these
restrictions could trigger serious consequences.


*The Risk of Non-Compliance*

The stakes of improper 280E handling are significant. In this section,
we’ll explore each of the following:

- Substantial penalties and interest on underpaid taxes
- Increased likelihood of IRS audit
- Personal liability for responsible parties
- Potential impact on future banking relationships
- Complications for M&A activities or capital raises

*Substantial Penalties and Interest on Underpaid Taxes*

The IRS doesn't just collect the taxes you should have paid - they add
layers of penalties that can cripple a Cannabis business. We're talking
about penalties that can reach 20-25% of the underpayment, plus interest
that compounds daily. A $100,000 tax underpayment can quickly balloon to
$150,000 or more. For Cannabis businesses already operating on thin margins
due to 280E restrictions, these penalties can mean the difference between
survival and closure.


*Increased Likelihood of IRS Audit*

Cannabis businesses already face higher audit rates than other industries,
but improper 280E handling raises even more red flags. The IRS has
specialized teams focused on Cannabis industry compliance, and they know
exactly what to look for. Filing questionable returns or attempting
aggressive 280E positions doesn't just invite scrutiny of the current year
- it often triggers a multi-year examination that can expose your entire
operation to intensive review.


*Complications for Future Banking Relationships*

As the industry moves toward mainstream banking access, your tax compliance
history will matter more than ever. Banks conducting due diligence will
scrutinize your tax records, and a history of 280E issues can derail
banking relationships before they begin. With rescheduling on the horizon
and more traditional financial institutions eyeing the Cannabis space,
clean tax compliance could be your ticket to better banking options.


*Impact on M&A Activities or Capital Raises*

The Cannabis industry is heading into a period of consolidation and
significant capital investment. Buyers and investors are becoming
increasingly sophisticated in their due diligence, and 280E compliance is
always high on their checklist. A history of aggressive or questionable
280E positions can:

- Reduce your company's valuation
- Complicate deal structures
- Increase escrow requirements
- Lead to personal indemnification requirements
- Kill deals entirely

We've seen these implications play out repeatedly across the industry.
That's why proper 280E compliance isn't just about following rules - it's
about protecting your business's future opportunities in a rapidly evolving
market.

As we move closer to rescheduling, proper 280E compliance becomes even more
critical. Why? Because the transition period will likely bring increased
scrutiny, and your historical compliance will be under the microscope.

In the next section, we'll dive into exactly how to clean up your books and
build the robust financial systems needed to withstand this scrutiny. But
first, remember this: while 280E poses significant challenges today, proper
preparation now positions you to capitalize on the opportunities that
rescheduling will bring.


Interested in Offering World-Class Accounting Services to the Cannabis
Industry?

The Cannabis industry needs trained accountants now more than ever, to help
them with compliance and maintaining a profitable, healthy business. We’ll
teach you how to provide CFO-level support to growing companies in one of
the fastest growing industries in our generation.

Learn More


*The Art of Cannabis Accounting Cleanup*

Getting your Cannabis books in order isn't just about reconciling accounts
- it's about building a financial foundation that can withstand both
regulatory scrutiny and support strategic growth. In our decade of Cannabis
accounting experience, we've found that true clean-up requires both
systematic processes and industry-specific expertise.


*Building Rock-Solid Foundations*

The complexity of Cannabis operations demands more than standard accounting
practices. Here's what makes Cannabis accounting uniquely challenging:

- *Multiple Verticals Under One Roof:* Most Cannabis businesses aren't
just single-operation entities. They often combine cultivation,
manufacturing, retail, and distribution - each with its own accounting
complexities. Your systems need to track and segregate these operations
while maintaining cohesive financial reporting.

- *State-Specific Compliance Requirements:*: Every state has unique
Cannabis regulations, and some directly impact accounting practices.
Missing these requirements can jeopardize your license - a risk no Cannabis
business can afford. In some jurisdictions, penalties for non-compliance
can reach 50% of revenue.

- *Complex Entity Structures:* We often see Cannabis businesses
operating through multiple entities - sometimes unnecessarily complex
structures created by well-meaning attorneys. This complexity increases
your accounting costs and complication exponentially.


*Example of a Dispensary Sample Transaction & Complexity Issues:*

That is why we recommend beginning your cleanup whenever you onboard a new
client. There are two key things we want to set up whenever we onboard a
new client: their perpetual data room and a permanent audit trail,

Let’s explore what each of those is in more detail.


*The Perpetual Data Room: Your Financial Command Center*

One of the most powerful tools in Cannabis accounting is what we call the
"perpetual data room." Think of it as your business's financial fortress.
Here's how to build one:

*1. Cloud-Based Organization*

- Set up a dedicated server space (Dropbox, Box, or Google Drive)
- Create a logical folder structure for all financial, operational, and
organizational documents
- Establish clear naming conventions and access protocols


*2. Essential Documentation*

- Organizational documents
- Investor agreements
- Insurance policies
- Legal and lease agreements
- Debt and equity documentation
- Monthly financial records
- Tax returns and supporting documents


*3. Monthly Maintenance*

- Bank statements and reconciliations
- Invoice documentation
- Journal entry support
- Internal control documentation
- Maintain “Permanent Audit Trail” report (so company is always audit
ready)
- Compliance certificates
- Tax payments and filings

The perpetual data room isn't just about organization - it's about creating
value. When investors, regulators, or potential buyers come calling, having
this system in place can mean the difference between closing a deal and
missing an opportunity.



*Building Your Permanent Audit Trail*

Every transaction in your Cannabis business needs to be traceable from
source to financial statements. Here's how to create an ironclad audit
trail:

*1. Transaction Documentation*

- Link each entry to source documents
- Maintain clear supporting evidence
- Document business purpose
- Track compliance requirements


*2. System Integration*

- POS system records
- Seed-to-sale tracking
- Accounting software entries
- Bank transactions
- Tax reporting


*3. Monthly Verification*

- Balance sheet account reconciliations
- Significant P&L account analysis
- Inventory counts and valuations
- Intercompany transaction review and reconciliations

Remember: In Cannabis accounting, your work isn't just about accuracy -
it's about proving that accuracy to others. Every financial assertion you
make needs to be backed by clear, organized documentation. Also,
financials must be complete, and timely.

Let’s explore a successful cleanup strategy in more detail, beginning with
client onboarding.


*Implementing Your Clean-Up Strategy*

A successful Cannabis accounting clean-up isn't a one-time event - it's a
systematic process that builds the foundation for ongoing compliance and
growth.

Here's your roadmap for implementation.


*Phase 1: Initial Assessment and Planning*

Before diving into the details of your clean-up strategy, you need to
establish a solid foundation through careful planning and assessment. This
initial phase sets the tone for your entire engagement and creates the
framework for success. Think of it as building the blueprint for your
Cannabis accounting house - get this right, and everything else will fall
into place more smoothly. Let's break down the essential components of this
crucial first phase.


*Engagement Setup*

The foundation of any successful Cannabis accounting engagement lies in a
properly structured engagement letter. This isn't your standard accounting
engagement - Cannabis work requires specific considerations:

*Engagement Letter Requirements:* The foundation of any successful Cannabis
accounting engagement lies in a properly structured engagement letter. This
isn't your standard accounting engagement - Cannabis work requires specific
considerations:

- *Cannabis-Specific Language:* Include explicit language about the
unique challenges and requirements of Cannabis accounting. Reference 280E
compliance, state-specific regulations, and the current federal legal
status of Cannabis. This protects both you and your client by setting clear
expectations about the industry's complexities.
- *Scope of Services and Limitations:* Clearly outline what you will and
won't do. For example: "We will perform monthly reconciliations and provide
GAAP-compliant financial statements, but we do not provide legal advice
regarding Cannabis regulations." Be explicit about services that require
additional fees.
- *280E Considerations:* Include specific language about 280E compliance
requirements and limitations. State clearly that you'll follow IRS guidance
regarding non-deductible expenses and COGS calculations. Explain that your
work will be based on current regulations, which may change with
rescheduling.
- *Communication Protocols:* Define how and when you'll communicate with
the client. For example: "We will provide weekly status updates during the
initial cleanup phase and monthly reports thereafter. Emergency issues will
be communicated within 24 hours."
- *Deliverables and Timelines:* List specific deliverables with
deadlines. Instead of vague promises, use concrete language: "Monthly
financial statements will be delivered by the 15th of the following month,
provided all required documentation is received by the 5th."

With your engagement letter signed and scope clearly defined, the next
crucial step is establishing a sustainable and clear fee structure. The
complexity of Cannabis accounting demands careful consideration of both
initial cleanup costs and ongoing maintenance fees.



*Retainer Structure:* Your pricing model needs to account for both the
intensive initial cleanup work and ongoing maintenance while protecting
your firm from scope creep and payment issues.

- *Fixed Monthly Fees:* Set clear monthly fees for ongoing work based on
the company's size, complexity, and number of entities. For example:
"$10,000 per month covers standard monthly closing procedures,
reconciliations, and financial reporting."
- *Historical Cleanup Rates:* Establish separate hourly rates for
historical cleanup work. Be clear that messy books will cost more to clean
up: "Historical cleanup work will be billed at $100 per hour due to the
intensive nature of the work."
- *Payment Terms:* Define when payments are due and consequences for
late payment. For example: "Monthly retainer due by the 1st of each month.
Work will pause if payment is more than 15 days late."
- *Scope Changes:* Outline the process for handling additional work:
"Changes to scope will be documented in writing and billed at our standard
hourly rate after client approval."

With your foundation established through careful planning and comprehensive
documentation, it's time to build the systems and controls that will
support your ongoing operations. This second phase is where theory meets
practice - where we translate our planning into actionable processes that
will keep your Cannabis business running smoothly and compliantly. Think of
it as building the engine that will power your financial operations for
years to come.

*NOTE: Engagement letters are legal documents so make sure to consult your
attorney before implementing above. This is not legal advice.*


*Phase 2: Systems and Controls Implementation*

Establishing robust systems and controls is crucial for maintaining clean
books and ensuring compliance. This phase focuses on setting up the
infrastructure that will support ongoing operations.

*Control Documentation:* Creating clear, comprehensive documentation of all
control processes and procedures.

- Process flowcharts: Visual guides showing workflow from start to finish
- Control points: Key checkpoints where verification occurs
- Review procedures: Steps for checking work accuracy
- Exception handling: How to deal with unusual situation)

*Segregation of Duties:* Establishing clear separation of responsibilities
to prevent fraud and errors.

- Cash handling controls: Different people count, deposit, and record
- System access limits: Restricted access based on role
- Review requirements: Independent verification of work
- Backup procedures: Cross-training to cover absences


*Phase 3: Historical Clean-Up*

This phase involves methodically reviewing and correcting historical
records to ensure accuracy and completeness.


*Starting Point Verification*

We’ll begin by establishing a reliable foundation for your cleanup efforts
by confirming beginning balances.

- Last filed return review: Confirm accuracy of starting point
- Opening balance verification: Prove beginning numbers are correct
- Documentation gaps: Identify missing support
- Adjustment documentation: Record needed changes

*Account-by-Account Review*

Then we’ll do a systematic examination of each material account to ensure
accuracy and proper documentation.

- Materiality assessment: Focus on significant items first
- Support verification (Confirm backup exists for entries
- Reconciliation completion (Match all accounts to support
- Adjustment recording (Document necessary changes

*Inventory Clean-Up*

Next we’ll do a detailed review and correction of all inventory-related
records and processes.

- Physical count verification: Confirm actual quantities on hand
- Cost documentation: Support for inventory values as well as GAAP cost
accounting
- System reconciliation: Match physical to recorded amounts
- Adjustment recording: Fix identified discrepancies

*Fixed Asset Verification*

Finally, we’ll do a comprehensive review of all fixed assets to ensure
proper recording and valuation.

- Asset existence: Confirm assets are still in use
- Cost documentation: Support for recorded values
- Depreciation review: Verify correct depreciation applied
- Disposal recording: Document removed assets

With your foundation established and historical records cleaned up, it's
time to focus on maintaining this high standard going forward. Remember:
Clean books aren't a destination - they're an ongoing journey that requires
consistent attention and proactive management. The next phase will ensure
your systems and processes continue to serve you well in the evolving
Cannabis industry.


*Phase 4: Maintaining Clean Books Going Forward*

Clean books in the Cannabis industry aren't a "set it and forget it"
proposition - they require constant attention and proactive management.
This phase establishes the routines and procedures that will keep your
financial records accurate, compliant, and audit-ready. By implementing
these systematic approaches to ongoing maintenance, you'll not only protect
your business from compliance issues but also position it to capitalize on
opportunities as the industry evolves through rescheduling and beyond.
Let's explore each component of a robust maintenance strategy.


*Monthly Close Process*

Establishing a systematic approach to closing your books ensures accuracy
and timeliness.

- Closing calendar: Detailed schedule with clear deadlines
- Task assignments: Specific responsibilities for each team member
- Review procedures: Multi-level verification process
- Documentation requirements: Standards for supporting materials

*Regular Reconciliations*

Consistent account reconciliation prevents small issues from becoming major
problems.

- Bank reconciliations: Daily cash position monitoring
- Inventory counts: Weekly cycle counts for retailers and monthly full
counts for farms and manufacturers
- Account analysis: Review of all balance sheet accounts
- Variance investigation: Prompt research of unexpected differences

*Compliance Monitoring*

Staying ahead of regulatory requirements prevents costly violations and
penalties.

- License tracking: Monitor renewal dates and requirements
- Tax filings: Schedule of all required filings and deadlines
- Regulatory updates: System for tracking changing requirements
- Audit preparation: Maintaining audit-ready records

*Quality Control Procedures*

Regular quality checks maintain the integrity of your financial records.

- Data entry review: Verification of transaction accuracy
- System checks: Regular testing of software integrations
- Error correction: Standard procedures for fixing issues
- Documentation updates: Regular review of procedures

*Financial Reporting*

Timely, accurate reporting provides crucial insights for decision-making.

- Standard reports: Core financial statements and metrics
- Management dashboards: Key performance indicators
- Budget Vs Actuals
- Forward Cash Rolling Forecast
- Investor reporting: Required disclosures and updates
- Regulatory reporting: State-specific requirements

*Team Training and Development*

Keeping your team sharp ensures consistent execution of procedures.

- Onboarding procedures: Training for new team members
- Ongoing education: Regular updates on industry changes
- Cross-training: Backup coverage for key functions
- Process improvement: Regular review and refinement of procedures

With your systems running smoothly and your team well-trained, you've built
a financial infrastructure that can withstand scrutiny and support growth.
But in the rapidly evolving Cannabis industry, the work is never truly
finished. Let's wrap up with key takeaways and action steps to ensure your
business stays ahead of the curve.


*Conclusion: Positioning for Success in the Rescheduling Era*

The journey to clean books and proper financial controls isn't easy, but
it's essential for survival and success in the Cannabis industry. As we
approach the historic rescheduling of Cannabis to Schedule III, businesses
that have done this foundational work will be positioned to thrive, while
others may struggle to catch up.

Don't wait for rescheduling to force your hand. The time to prepare is now.

Our DOPE CFO Certified Advisors help Cannabis clients successfully navigate
the complexities of 280E and avoid penalties that can ruin Cannabis
businesses. We know what the IRS is looking for, and have exclusive access
to several sources that provide that info.

Give your clients the full suite of CFO services that they deserve, and
become a DOPE CFO Certified Advisor today.

Learn More