DENVER – Denver is not effectively making sure marijuana businesses pay the taxes they owe to Denver and that the city is collecting those taxes, according to a new audit report out today from Denver Auditor Timothy M. O’Brien, CPA.
“When voters approved marijuana legalization, many supported the law because of the tax revenue it would generate for things like education, enforcement and regulation,” Auditor O’Brien said. “It is the city’s responsibility to ensure it is collecting the full amount of taxes owed to support resident services.”
But we found the city is relying on faulty assumptions and inaccurate data when selecting which marijuana businesses to audit. The city is also not keeping necessary documentation to support audit work, it is not working with the state to get information for audits, and it is not doing enough to identify unlicensed marijuana delivery businesses not paying taxes.
By not using a thorough, data-driven approach to choosing which businesses to audit, the city cannot be as effective as possible in identifying the businesses with the highest risk of underreporting or underpaying taxes to the city. These taxes are needed to support services for the public, as designated by law.
The city collects a 4.31% tax on all taxable sales of goods. In addition to that, for recreational marijuana products, the city collects both a 3.5% special sales tax that goes into the general fund and a 2% special sales tax that goes into the Affordable Housing Property Tax Revenue Fund for affordable housing projects.
The state also provides a “shareback” of state sales tax revenue to local jurisdictions.
The city’s Treasury Division, within the Department of Finance, oversees collection, recording, and depositing of all city taxes and other city revenues. The audit unit is the largest unit in Treasury. The division assigns one dedicated tax technician specialist to help identify marijuana businesses to audit.
Our testing showed Treasury’s audit unit uses several false assumptions regarding the risks associated with marijuana businesses. First, the audit unit assumes marijuana businesses are more compliant than nonmarijuana businesses.
We did further testing beyond what Treasury does and found there is no statistically significant difference between marijuana and nonmarijuana businesses, when it comes to the likelihood that the business will report and pay taxes according to the law.
Second, the audit unit also assumes total taxes paid and prior audit history are effective risk indicators when deciding which businesses to audit. Our testing showed these are ineffective in determining risk factors. We recommend a data-driven approach, so Treasury can effectively identify which risk indicators help predict underreporting.
We also recommend the dedicated marijuana tax specialist regularly report clearly defined “abnormal” or “erratic” payments from marijuana businesses to Treasury’s audit unit. This should happen every six months. However, our audit team was able to identify instances when there were large fluctuations in monthly sales reported by marijuana businesses that should have raised red flags.
“We did a thorough data analysis of aspects of the tax assessments Treasury has done, and we found examples of missed risks and a need for more attentiveness to warning signs,” Auditor O’Brien said.
Another key finding in our report was a lack of document retention to support marijuana audits. We recommend keeping documentation used to support tax assessments and sales tax reconciliations, in accordance with leading auditing practices. The IRS and the state of Colorado both retain these types of documents for a minimum of 10 years, and the city’s own records retention policy specifically requires the audit unit to maintain tax audit information for six years after an audit’s completion.
Treasury disagrees with our recommendation, saying the files may be too voluminous or contain personally identifiable information. We believe the documents we recommend keeping are neither too cumbersome to keep nor do they typically include personally identifiable information.
“Good auditing principles should be a basic expectation for any audit unit,” Auditor O’Brien said. “I am disappointed to see Treasury’s resistance to ensure the standard of work Denver needs and deserves.”
Treasury is also not adequately identifying marijuana delivery businesses operating illegally and without a license. Marijuana delivery businesses will be able to apply for state licenses this year or next year, depending on whether they will deliver medical or recreational marijuana. We recommend Treasury identify these businesses to ensure they are paying required taxes.
Finally, the city is not adequately reviewing the state’s “shareback” payment, which could lead to a loss of revenue for the city or a liability owed to the state.
“All of these factors are important to ensure the city is collecting all marijuana taxes owed,” Auditor O’Brien said. “Taxes like these support services for the public — such as preschool programs and affordable housing — and we need these resources now more than ever.”
Treasury agreed to all but one of our 11 recommendations.