California Cannabis Dispensary Accounting and Compliance Explained

Overview on California Cannabis Dispensaries

As of October 3, 2024, there are a total of 1204 active cannabis retail licensees in the state of California, according to the Department of Cannabis Control (DCC). Many dispensary owners have gone into this industry with hopes of cashing in on the growth of the cannabis industry.  However, the reality of the situation is much different.

According to the California Division of Tax and Fee Administration (CDTFA), sales as of 2024’s Q2 are $2,440,475,235.  Last year at this point in the year, sales were $2,617,360,670.  This is a decrease of 6.76%.

Seeing how the numbers pan out on the financial statements, this is not surprising.

Gross Profit margins are usually about 60% in a California based dispensary - (Plus 60%)

Operating expenses before taxes generally equal 40-70% of revenue.  - (Minus 40-70%)

280E taxes are about 12.6% of revenue (60% * 21% corporate tax rate).  - (Minus 12.6%)

If you do the math on this, you can see, it’s difficult for a dispensary to be profitable.

We are in a cleansing period.  Many owners are eagerly selling their dispensaries, realizing it’s not an easy business to run. But the owners and operators who can plan, manage cash flow, and survive, will be around for when things turn around again.  To achieve this, an operator must understand how to navigate the financial issues that a California Cannabis dispensary faces.

Dealing with the IRS and IRC Code 280E

Despite the fact that cannabis is legal, either medically or recreationally, in most states now, it is still illegal on the federal level.  The IRS collects very high tax revenues from cannabis dispensaries, and they love to audit them. 

Generally, they are 5 times more likely to audit a cannabis companies than any other type of business.  The reason for this is that they average very high tax recoveries from audits – about $4 for every $1 spent on a cannabis company audit. 

Since dispensaries tend to have the highest tax rate of any cannabis vertical, dispensaries can be vulnerable if they are not tax and audit ready at all times.  Why is this?

Well, under IRC Code 280E, cannabis dispensaries can’t deduct operating expenses from gross income.  That means that the only legal way to reduce taxable income is by recording cost of goods sold. 

This generally means that there will be losses recorded, and cash flow will be dependent on financing through capital or debt.

Navigating California Regulations and Ordinances

The state of California collects high sales and excise taxes from cannabis companies, but they confer income tax benefits when possible.  This is because they do not conform to 280E – i.e. dispensaries can deduct ordinary expenses from their state income tax. 

The state of California has an excise tax on all cannabis products, but this does not mean there is an excise tax on all sales.  Products that are excluded from excise tax are those that can be purchased without a cannabis related product.  For example, a lighter, or a T-shirt would not incur excise tax.  However, a cart would incur excise tax in its entirety, even though a part the material is not technically cannabis.

The state also offers tax credits to cannabis companies, including the High Road Tax Credit, and the Cannabis Equity Tax Credit.  These credits are nonrefundable, but they can offset state income taxes, or be carried forward.

CA Sales Tax: State + Local taxes generally equals 7.25%

CA Excise Tax: Collected from consumers, equals 15% of cannabis product sales price

Banking Issues that Cannabis Dispensaries Face

Most banks won’t do business with cannabis dispensaries since it’s federally illegal, and those that do tend to be expensive and difficult to work with.

These forces operators to find workarounds and the need for alternative payment methods.

This leads to accounting and tax challenges.

Accounting Challenges and How to Manage Them

A cannabis dispensary that neglects taxes, or does 280E, incorrectly, will often find themselves needing tax relief.  This can be a costly process and has no guarantee of working.  It’s important to stay on top of tax obligations in order to avoid this outcome.

Cannabis dispensaries must abide by Generally Accepted Accounting Principles (GAAP) cost accounting principles.  This means that accrual accounting.  This necessitates some different procedures

This includes tracking:

• Accounts Payable

• Inventory

• Cost of Goods Sold

• Cash Counts

• Receipts

• Bank Accounts

• Credit Card Accounts

• Matching all of this, and other accounts, to tax returns

Things to Avoid – Why to Have a Cannabis Specialized CPA

The IRS and tax courts tend to be aggressive towards cannabis companies, 

Here are some IRS penalties to consider:

• Failure to file form 8300 on time within 15 days of the transaction - $310 per return in 2024

• Failure to file Partnership or S-Corp tax return on time - $220 for each partner for each month the return is filed late, including extensions.  Limited to $10,000

• Failure to pay income tax on time for C-Corps and Individuals – .5% per month for amounts due, limited to 25%

The state of California also imposes penalties for noncompliance, including:

• Failure to file a sales tax return on time will result in a 10% penalty + 50% for the cannabis tax program, resulting in a 60% penalty

• Failure to file an income tax return on time results in two penalties

  • 5% +.5% per month past due, limited to a total of 25%

  • $135 or 100% of the tax due, whichever is less

Some common mistakes with financial planning that California dispensaries make:

• Weak or no tax strategy – results in paying more in tax, either through overpayments or penalties, and increases audit risk

• Poor financial statements and accounting info -  leaves dispensaries unprepared for investor due diligence, which can result in missed opportunities for capital, financing, or exiting

• Dispensaries without a solid financial plan will likely run into cash flow issues that can lead to insolvency or other issues

Achievable Financial Goals for a Cannabis Dispensary and How to Reach Them

Given the current nature of the business landscape and taxation, it is unlikely that any given dispensary will be very profitable.  The goal should not be profitability, as almost no dispensary turns a profit, even amongst the larger MSOs.  A better goal is increasing business valuation, as this will drive capital, and can result in a successful merger, exit, or IPO.

To do this, very accounting is a must.  This should be done by a cannabis specialized CPA, as a generalist is not a good idea for a dispensary.

Need to a solid tax strategy that accounts for 280E to ensure that cash flows remain steady, and that the business doesn’t suffer from tax related penalties that can harm them.

Owners should stay updated on the constantly changing tax laws to ensure that they are compliant and using the best strategies.

All of this necessitates compliance with federal and CA law. Furthermore, the books and records should be up to date and accurate.  This helps ensure a good tax strategy. 

And if you’re unsure about the accounting of your cannabis dispensary, consult with a cannabis specialized CPA to optimize your business and avoid costly mistakes.