Question 1

What is IRC Section 280E and why does it apply to licensed California businesses?

Accepted Answer

Section 280E denies deductions and credits for any trade or business trafficking in Schedule I or II controlled substances. Cannabis remains Schedule I federally, so state licensure does not exempt a California operator. The rule applies regardless of full compliance with California law.

Question 2

If deductions are disallowed, how do cannabis businesses reduce federal tax at all?

Accepted Answer

Through cost of goods sold. COGS is not a deduction — it is subtracted from gross receipts to arrive at gross income. Every lawful cannabis tax strategy is an inventory accounting question about which costs are properly includable in inventory.

Question 3

Why do cultivators get better tax treatment than dispensaries?

Accepted Answer

Cultivators are producers and may capitalize direct materials, direct labor and allocable indirect production costs into inventory. Dispensaries are resellers, limited to the invoice cost of product plus acquisition costs. Same dollars, very different federal outcome.

Question 4

Can a dispensary deduct marketing, delivery or administrative salaries federally?

Accepted Answer

No. Those are selling and administrative expenses, disallowed under 280E and not capitalizable by a reseller. They are paid entirely with after-tax dollars at the federal level, which is why spending discipline matters so much in cannabis retail.

Question 5

Is a management company a legitimate way to reduce 280E exposure?

Accepted Answer

Only where it conducts a genuinely separate non-trafficking business with real substance: independent capitalization, written arm's-length agreements, separate personnel and records, and a business purpose beyond the tax result. Paper-only structures have consistently failed in Tax Court.

Question 6

Should a California cannabis business be taxed as a C corporation?

Accepted Answer

Often, because 280E disallowance in a pass-through creates personal tax on income owners may never receive in cash. A C corporation contains the liability at the entity level but introduces distribution taxation. The decision depends on cash needs, other income and exit plans.

Question 7

Does Section 471(c) allow cannabis businesses to capitalize more costs?

Accepted Answer

Some small-business taxpayers have used 471(c) to align tax inventory with their books. The IRS has publicly disagreed with expansive applications in cannabis. It is a position to take deliberately, with documentation and a clear understanding of adjustment and penalty risk.

Question 8

How is rent treated under 280E?

Accepted Answer

Rent on production or cultivation space is generally an indirect production cost a producer capitalizes into inventory. Rent on retail floor, office or warehouse space used for selling and administration is disallowed. Allocation must be based on measured square footage by function.

Question 9

What happens to 280E if cannabis is rescheduled federally?

Accepted Answer

280E applies only to Schedule I and II substances. A move to a lower schedule would remove cannabis from its reach prospectively, with significant questions about timing, open years and method changes. Operators should follow developments but should not plan as though they have occurred.

Question 10

Does California follow 280E?

Accepted Answer

No. California allows licensed commercial cannabis businesses to deduct ordinary and necessary business expenses for state purposes, which creates permanent differences between the federal and California returns that must be scheduled every year.

Question 11

Who collects and remits cannabis excise tax in California?

Accepted Answer

Licensed cannabis retailers collect excise tax from purchasers and remit it to CDTFA on their excise tax returns, following the transition away from distributor-level collection.

Question 12

Is cannabis excise tax subject to sales tax?

Accepted Answer

Yes. The excise amount is included in the measure subject to state and district sales and use tax on the retail transaction. Incorrect point-of-sale configuration on this point is one of the most common CDTFA audit findings.

Question 13

What is the local cannabis business tax and how much is it?

Accepted Answer

Cities and counties impose their own cannabis taxes, usually as a percentage of gross receipts and often at different rates by license type. Rates, bases and filing calendars vary by jurisdiction and must be tracked individually for each location.

Question 14

Is the state cultivation tax still in effect?

Accepted Answer

The cultivation tax was eliminated for cannabis entering the commercial market from July 2022 forward. Cultivators may still have historical exposure or documentation obligations for earlier periods.

Question 15

Do medicinal patients pay sales tax on cannabis in California?

Accepted Answer

Qualified patients holding a valid state medical marijuana identification card may purchase exempt from sales and use tax. Retailers must verify and retain documentation supporting each exempt transaction.

Question 16

What happens if we are behind on CDTFA filings?

Accepted Answer

Delinquent returns can be prepared and filed, with the actual liability computed rather than accepting an estimated assessment. Installment arrangements are often available, and penalty relief may be pursued where the facts support it. Acting early materially improves the outcome.

Question 17

Can our existing bookkeeper handle a cannabis business?

Accepted Answer

With cannabis-specific structure and CPA supervision, often yes. The transaction mechanics are familiar; the inventory costing, track-and-trace reconciliation and 280E classification are not, and those determine the tax outcome.

Question 18

How often should cannabis books be closed?

Accepted Answer

Monthly, with daily cash and sales reconciliation. Waiting longer makes variances practically impossible to investigate and leaves tax planning without current gross margin data.

Question 19

What makes a cannabis chart of accounts different?

Accepted Answer

Every cost account is designated inventoriable or non-inventoriable at setup, production costs are segmented by function, and activity is tracked by license, location and business line so the trial balance itself supports the COGS computation.

Question 20

How long does a books cleanup engagement take?

Accepted Answer

Typically four to ten weeks for one to two years of activity, depending on record quality, entity count and whether physical inventory support exists. We scope the sequence and endpoint before starting.

Question 21

Which accounting software works best for California cannabis operators?

Accepted Answer

The structure imposed on the platform matters more than the platform. We work with mainstream accounting systems paired with cannabis POS, seed-to-sale and inventory tools, selected by transaction volume, entity count and integration reliability.

Question 22

Do you work with vertically integrated operators?

Accepted Answer

Yes, and functional separation is essential for them. Cultivation, manufacturing, distribution and retail each have different cost profiles and different capitalization rules, so the accounting must keep them distinct even inside one entity.

Question 23

Why do METRC and accounting inventory never agree?

Accepted Answer

They are maintained by different people for different purposes. Untracked samples, unrecorded waste, repackaging, manifest quantity differences and manual compliance adjustments without journal entries all create drift that compounds until reconciled.

Question 24

How often should track-and-trace be reconciled to the books?

Accepted Answer

Monthly, as part of the close, with cycle counts running continuously and full physical counts at period end. Quarterly is workable only for very small licensees.

Question 25

What inventory variance level is acceptable?

Accepted Answer

There is no published tolerance. Operators should set an internal threshold, investigate anything beyond it, and document the investigation. A consistent pattern of small unexplained losses is viewed far more seriously than one documented event.

Question 26

How do you cost product through extraction and manufacturing?

Accepted Answer

By defining conversion rules in advance: yield assumptions, joint and by-product allocation, and processing labor and overhead absorption. Cost follows material through each identifier change so finished goods carry an explainable unit cost.

Question 27

How likely is an IRS audit for a California cannabis business?

Accepted Answer

Materially higher than for general businesses. The size of the potential 280E adjustment and the cash-intensive nature of the industry both raise examination priority, which is why audit readiness should be continuous.

Question 28

What do IRS examiners look at first in a cannabis audit?

Accepted Answer

Gross receipts. In a cash business they reconcile deposits, POS data and track-and-trace sales, using indirect methods if direct records are weak. They then attack cost of goods sold composition and allocation methodology.

Question 29

What should we do the day an examination notice arrives?

Accepted Answer

Note the deadline, do not respond substantively, do not begin sending records, do not alter or recreate anything, and route all contact through your representative under a power of attorney.

Question 30

Can we defend an audit if prior-year records are incomplete?

Accepted Answer

Often, through reconstruction from track-and-trace data, bank records, utility bills, payroll registers and vendor invoices. It is more expensive and less certain than contemporaneous documentation but far better than conceding a full disallowance.

Question 31

How far back can the IRS examine our returns?

Accepted Answer

Generally three years from filing, six years for a substantial omission of income, and without limit for a fraudulent or unfiled return. Inventory issues frequently pull earlier years into scope because opening balances originate there.

Question 32

Are accuracy-related penalties avoidable in a 280E adjustment?

Accepted Answer

Frequently, where the taxpayer relied on a documented methodology and professional advice created before the return was filed. That is one of the strongest practical arguments for contemporaneous methodology memoranda.

Question 33

Do you work only with cannabis businesses?

Accepted Answer

Our practice is built around licensed California cannabis operators and the ancillary businesses that serve them. That focus is what makes the 280E, inventory and track-and-trace work efficient rather than exploratory.

Question 34

Do you serve operators outside major California metros?

Accepted Answer

Yes. We work with licensees throughout the state, including Humboldt, Mendocino, the Central Valley and the desert regions, and engagements are handled remotely with scheduled on-site work where inventory or cash procedures require it.

Question 35

How are engagements priced?

Accepted Answer

Recurring accounting, tax and CFO work is quoted as a fixed monthly fee based on entity count, transaction volume and license types. Projects such as cleanup, audit representation or transaction support are scoped separately with a defined deliverable.

Question 36

Can you take over mid-year from another accountant?

Accepted Answer

Yes. We start with a diagnostic of the current books, establish the inventory baseline, identify open exposure, and set the sequence for bringing the year current before the filing deadline.

Question 37

Do you work alongside our attorney and compliance team?

Accepted Answer

Regularly. Entity restructuring, licensing changes, examinations and transactions all require coordination between accounting, cannabis regulatory counsel and compliance staff, and outcomes are better when that coordination is planned rather than improvised.

Question 38

What does the first consultation cover?

Accepted Answer

Your license types and structure, current accounting and record state, tax filing status and open exposure, the immediate deadlines, and a candid assessment of what needs to happen first and in what order.

California Cannabis Accounting Questions, Answered

280E & Federal Tax

California Taxes

Accounting & Bookkeeping

METRC & Inventory

Audits & Compliance

Working With Us

Speak with a California cannabis CPA