Two Distinct Audit Risks: CRC and IRS
New Jersey cannabis operators face two separate but related audit risks: CRC compliance reviews focused on regulatory adherence, including Metrc accuracy and licensing conditions, and IRS examinations focused on 280E compliance and cost of goods sold support. Preparation for one strengthens preparation for the other, since both hinge on accurate inventory and financial recordkeeping.
Operators should not assume that passing a CRC review eliminates IRS audit risk, or vice versa, since the two agencies evaluate different aspects of the same underlying records.
What the IRS Scrutinizes in a Cannabis Audit
IRS examiners reviewing a cannabis business typically focus on whether cost of goods sold has been inflated by improperly capitalizing disallowed operating expenses, whether intercompany allocations between plant-touching and non-plant-touching entities are supported by real services and arm's-length pricing, and whether the taxpayer can substantiate its inventory costing methodology under IRC 471 and 263A.
Cases like Olive v. Commissioner illustrate how the IRS challenges cost allocations lacking clear documentation, while Champ Inc. shows that properly separated and documented activities can survive scrutiny. New Jersey operators should model their documentation practices on the standards these cases established.
Documentation That Supports an Audit Defense
A strong audit defense file includes a written cost accounting policy explaining how labor, materials, and overhead are allocated to inventory, monthly Metrc-to-general-ledger reconciliations, intercompany agreements with supporting invoices for any management or service fees, and contemporaneous time records for employees performing mixed cultivation and administrative duties.
Maintaining this documentation continuously, rather than assembling it only after an audit notice arrives, dramatically improves both the speed and outcome of an examination.
- Written cost accounting and allocation policy
- Monthly Metrc-to-GL reconciliation records
- Intercompany agreements and supporting invoices
- Contemporaneous employee time records for mixed roles
CRC Compliance Review Readiness
A CRC compliance review may examine financial records to verify source of funds disclosures remain accurate, confirm ownership has not changed without proper notification, and assess whether Metrc records match physical inventory. Operators in Camden and Newark undergoing license renewal should proactively review these areas rather than waiting for a scheduled review.
Municipal host community agreements may also include reporting obligations that intersect with a CRC review, so operators should keep municipal correspondence and reporting organized alongside state-level compliance files.
Responding to an Audit or Review Notice
Upon receiving an audit or review notice, operators should assemble their documentation promptly, avoid providing information beyond what is specifically requested, and engage a cannabis-experienced advisor before responding substantively. Early missteps in an audit response can be difficult to unwind later in the process.
Cannabis CPA NJ provides audit representation and compliance review preparation for New Jersey cannabis operators facing IRS or CRC scrutiny. Contact (609) 806-5154 or advisory@cannabiscpanj.com if you have received an audit or review notice.
