Why Cannabis Businesses Draw Elevated IRS Scrutiny
The IRS has run dedicated cannabis industry examination initiatives for years, focused almost entirely on 280E compliance — specifically, whether a taxpayer's cost of goods sold calculation is properly supported and whether disallowed expenses were fully added back. A Colorado operator claiming an aggressive COGS position without documentation is a natural audit target.
Documentation an Examiner Will Request
A well-prepared cannabis business keeps this documentation current throughout the year rather than reconstructing it after an audit notice arrives.
- Written cost accounting policy describing the 471/263A methodology used to allocate costs to inventory.
- Supporting schedules tying COGS figures on the return back to the general ledger and METRC production records.
- Time studies or allocation workpapers for employees splitting duties across production and non-production activity.
- Bank statements and cash reconciliation records supporting reported gross receipts.
MED Compliance Reviews and METRC Audits
Separate from federal tax exposure, the Marijuana Enforcement Division conducts compliance inspections that examine METRC data integrity, inventory reconciliation, security plan adherence, and adherence to the Retail Marijuana Code or Medical Marijuana Code as applicable to the license type held. A clean, current METRC-to-GL reconciliation is the single best preparation for this kind of review.
Responding to an Audit Notice
The first 30 days after receiving an IRS or MED audit notice set the tone for the entire process. Assembling the requested documentation promptly, engaging a cannabis-experienced CPA to manage examiner communication, and avoiding informal statements that could be read as admissions all materially affect the outcome.
