Cannabis businesses are audited by the IRS at a disproportionately high rate. The combination of federal illegality, high cash volumes, and complex COGS allocation makes cannabis operators an obvious target. Most owners don't discover they have a compliance problem until they receive an audit notice — at which point fixing it is expensive and stressful.
The good news: 280E compliance is not complicated if you build the right systems. The businesses that survive audits are not the ones with the best lawyers — they're the ones that kept good records from the start. This checklist covers everything a cannabis business needs to operate compliantly and defend itself when the IRS comes calling.
Who this is for: Cannabis dispensaries, cultivators, and processors at any stage. Whether you're setting up your first operation or cleaning up a mature business's books, this checklist applies.
Section 1: Accounting System Setup
The foundation of 280E compliance is an accounting system designed for cannabis from day one. Retrofitting a general-purpose chart of accounts after years of operations is expensive and error-prone.
Chart of Accounts
- Separate COGS accounts from operating expense accounts by function, not just by type
- Create sub-accounts for direct production costs (direct materials, direct labor, direct overhead)
- Create sub-accounts for indirect production overhead (allocated rent, utilities, supervision)
- Tag all non-production expenses as Section 162 — non-deductible under 280E
- Document your chart of accounts structure and the reasoning behind each classification
- Apply classifications consistently year over year
Inventory Tracking
- Use seed-to-sale or point-of-sale software that integrates with your accounting system
- Record beginning and ending inventory values at year-end (and quarterly if possible)
- Document your inventory valuation method (FIFO, LIFO, weighted average) and apply it consistently
- Reconcile book inventory to physical inventory count at least annually
- Document and explain any inventory adjustments or write-downs
Section 2: Labor Documentation
Labor classification is the #1 audit trigger for cannabis businesses. The IRS knows that operators try to push non-production labor into COGS, and they look for it. The defense is documentation.
Employee Time Tracking
- All employees with mixed production/non-production duties track time by function
- Time records are kept in a system that can produce reports (not just remembered or estimated)
- Job descriptions clearly specify whether the role is production, non-production, or mixed
- Labor allocation percentages are calculated from actual time records, not estimates
- Payroll records show which wages were capitalized into COGS vs. expensed
- Supervisor and manager time allocation is documented (supervisors of production staff may be COGS-eligible)
Section 3: Facility Documentation
Shared facilities — where production and non-production activities happen in the same building — require careful documentation of cost allocation.
Space Allocation
- Floor plan or sketch showing production vs. non-production square footage
- Photos documenting production space (grow rooms, extraction labs, processing areas)
- Rent allocation calculated based on documented square footage percentages
- Utility allocation method documented (sub-metering production areas is ideal; square footage is acceptable)
- Allocation methodology applied consistently from year to year
- If the facility changes (lease expansion, new space), update documentation and allocation percentages
See your 280E compliance in numbers
The TrimBooks calculator shows you your COGS allocation, non-deductible expenses, and estimated tax liability.
Calculate Your 280E Exposure FreeSection 4: Tax Filings and Calculations
Annual Tax Compliance
- File federal income tax return on time (or on extension) — cannabis businesses face higher scrutiny for late filings
- Estimated quarterly tax payments are current — underpayment penalties apply at the same rates as other businesses
- COGS calculation is documented in a workpaper that ties to your accounting system
- All production overhead allocations are documented with supporting data
- Tax return preparer has cannabis-specific experience and understands 280E
- State tax returns filed (note: some states have decoupled from 280E)
Mid-Year Monitoring
- Run a 280E calculation at Q2 and Q3 — don't wait until year-end to discover problems
- Review COGS as a percentage of revenue each quarter — large swings signal data entry problems
- Confirm estimated tax payments align with projected annual tax liability
- Flag any new expense categories that need COGS/non-COGS classification before year-end
Section 5: Record Retention
The IRS has three years to audit a return under normal circumstances, but can go back six years if it believes income was underreported by 25% or more. Cannabis businesses should retain records for at least seven years.
Records to Keep
- Tax returns and all supporting workpapers (7 years)
- General ledger and chart of accounts (7 years)
- Purchase invoices for all inventory and production inputs (7 years)
- Payroll records and time tracking reports (7 years)
- Lease agreements and facility documentation (duration of lease + 7 years)
- Inventory count records and reconciliations (7 years)
- COGS allocation workpapers with supporting calculations (7 years)
- Bank statements (7 years)
Section 6: If You Get Audited
IRS audits of cannabis businesses are not rare. They're not the end of the world if you're prepared. A few things to know:
- Do not respond to an audit notice without counsel. IRS correspondence about 280E issues should go through a tax attorney or CPA with cannabis audit experience. What you say in initial correspondence matters.
- The audit will focus on COGS. Expect the examiner to scrutinize every expense you classified as COGS-eligible. Your workpapers, time records, and facility documentation are your defense.
- Consistency is credibility. If your allocation methodology changed from year to year without documentation, the IRS will question everything. If it's been consistent and documented, you have a defensible position.
- State audits are separate. A federal audit does not automatically trigger a state audit, but states do share information with the IRS and vice versa. Keep state and federal records aligned.
Quick check: Could you reconstruct your COGS calculation from scratch with documents you have on hand right now? If the answer is no — or even "maybe" — that's where to focus first.
Starting From Zero: Prioritization
If your current compliance state doesn't match this checklist, don't try to fix everything at once. Here's the order of priority:
- Chart of accounts cleanup — You can't produce defensible numbers without the right structure. This comes first.
- Time tracking implementation — Labor is the highest-risk area. Start tracking immediately, even if you're recreating current-year data.
- Facility documentation — Measure, photograph, and document space allocation. This takes an afternoon.
- Run a current-year COGS calculation — Use the TrimBooks calculator to get a baseline for where you stand now.
- Prior-year review — Once current-year systems are in place, consider whether prior-year returns are materially wrong. Amended returns are sometimes the right call.
The free TrimBooks calculator is a good starting point for understanding your current COGS allocation and tax exposure. Enter your revenue and expenses by category and get an instant estimate of your 280E situation — before you spend time with a CPA.
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