We didn’t know this would affect our license—until the renewal got flagged.

We hear it all the time: well-intentioned operators doing their best with limited resources and unclear rules, only to find out that payroll missteps can jeopardize more than employee morale—they can put your entire cannabis license at risk.

This guide breaks down the five most common payroll-related mistakes we see—and how to avoid them before your next renewal, audit, or inspection.

What You’ll Learn

• How minor payroll issues escalate into compliance violations

• Why payroll documentation is central to license renewals

• The top 5 traps cannabis operators fall into (and how to avoid them)

• What regulators are really looking for in audits

• How to proactively clean up risk before it catches up to you

Trap #1: Paying Staff Off the Books

Paying employees in cash without proper documentation may feel like a short-term fix—but it creates long-term compliance and legal exposure.We’ve covered this in detail before, but it bears repeating: paying budtenders, trimmers, or delivery staff in cash—without proper records—may feel like a short-term fix, but it’s a long-term liability. State labor departments, tax authorities, and cannabis licensing boards are increasingly working together. If your payroll doesn’t match your reported headcount or tax filings, red flags go up.

In states like Massachusetts, Oregon, and New York, we’ve seen operators denied renewals or hit with penalties because former employees filed unemployment or wage complaints—and the business had no records to validate or respond.

Imagine if you’re…

• An HR manager at a vertically integrated operator in Michigan: You’re onboarding seasonal trimmers quickly and relying on verbal agreements and Venmo. A surprise DOL visit means you're scrambling for documents you never collected.

• A Tribal Sovereign license holder trying to protect your economic development project: If just one team member reports off-books pay, it could jeopardize access to state partnerships or delay interjurisdictional approvals.

• A first-time owner in New Mexico: You thought paying two budtenders in cash was fine until one applied for unemployment—and now you’re under audit.

Trap #2: Misclassifying Workers (W-2 vs. 1099)

Many cannabis businesses try to save time and costs by treating everyone as a 1099 contractor. But that’s not how employment law works. Most roles in cannabis—especially customer-facing, hourly, or supervised positions—fail the IRS and DOL’s independent contractor tests.

If you misclassify someone, you could be liable for back wages, payroll taxes, and even employment insurance fraud. Regulators don’t just care about intent—they care about structure. Proper classification is foundational. And if you’ve got both W-2 and 1099 workers, your payroll system should handle the nuance.

Trap #3: Missing or Incomplete Onboarding Docs

Licensing bodies often require that operators maintain full onboarding records: I-9s, W-4s, offer letters, and signed policy acknowledgments. These aren’t just HR formalities—they’re part of your audit trail.

If a regulator or labor board asks for employee documentation and you can’t produce it, that becomes a mark against your license. We’ve seen it happen in California and Michigan, where missing I-9s or outdated job descriptions became license renewal blockers.

Trap #4: Using a Non-Compliant Payroll Provider

Just because your payroll software lets you run payroll doesn’t mean it’s built for cannabis. Many platforms don’t ask what you do—and that’s a problem. If your provider isn’t cannabis-compliant, they may not file your taxes correctly, classify your NAICS code accurately, or help you defend your records in an audit.

Worse, we’ve seen clients dropped mid-payroll cycle once their provider “realized” they were in cannabis. That kind of disruption is more than frustrating—it’s reputationally risky and potentially license-threatening if you miss filings or pay dates.

Trap #5: Ignoring Local or State-Specific Payroll Rules

Cannabis is governed locally, and payroll rules vary wildly by state. Some states require special taxes, local sick leave accrual, or industry-specific wage minimums. Others have detailed reporting requirements that tie into licensing boards. Your payroll system needs to know these differences—and apply them in real time.

In Colorado, cannabis employees are subject to a specific occupational tax. In Illinois, licensed operators must report certain labor data to the state as part of annual renewals. And in California, you’re expected to maintain pay stub transparency down to the deduction level. These aren’t optional—they’re regulated.

What Auditors and Regulators Actually Look For

Most operators assume audits are about taxes or operations—but increasingly, they’re about your people. Regulators want to see that you’re treating your workforce fairly, documenting everything correctly, and not hiding risk behind weak systems. Here's what they focus on—and why it matters:

Consistency in reported headcount vs. tax filings
If your tax filings show three employees but your dispensary has five people on the floor, something doesn’t add up. Regulators compare wage reports, unemployment insurance filings, and payroll tax data to licensing applications. Inconsistencies suggest off-books payments or misclassification.

Payroll records and payment schedules
Regularity matters. Skipped pay periods, unusual payment intervals, or inconsistent reporting can suggest financial instability or non-compliance. In 2026, states like Massachusetts and New York are tracking payroll cadence as part of workforce protection rules for cannabis licensees.

Worker classification and documentation
Misclassified workers are a red flag for fraud. Regulators will check if your 1099 contractors are actually acting like W-2 employees—especially in roles like sales, delivery, or retail. Proper documentation (contracts, job descriptions, time logs) helps prove intent and legality.

Wage compliance (especially in hourly roles)
Budtenders and hourly cultivators must be paid according to local wage laws, including overtime, sick time, and hazard pay where applicable. States like California and Illinois have added cannabis-specific wage audits to their labor enforcement priorities in 2026.

I-9 and onboarding completeness
Failure to complete and store I-9s accurately is one of the fastest paths to fines. Regulators also view incomplete onboarding as a sign that you may not be vetting hires properly—which raises concerns about safety, liability, and transparency.

Audits aren’t just about penalties—they’re about proving you’ve built a business that can be trusted. This is your chance to show regulators you’re not cutting corners.

If any of these fall short, they can be flagged. And while one flag may not sink your license, it starts a pattern. That pattern is what gets licenses denied, paused, or revoked.

How to Clean It Up Before It Costs You

If you’re unsure where you stand, start with a simple audit of your own:

• Can you generate W-2s and 1099s on demand?
  If not, you may not be compliant with year-end tax reporting—especially important in states like Colorado and California, which require timely documentation for license renewal and labor audits.

• Do your records match your most recent tax filings?
  Mismatches between reported wages and payroll tax submissions are a common trigger for query audits. In 2026, several states have ramped up cross-agency data matching (e.g., New York, Oregon).

• Are your I-9s stored securely and completed correctly?
  Incomplete or missing I-9s can lead to fines from USCIS and problems with state labor departments. In Illinois and Maryland, missing onboarding records are increasingly cited in cannabis license reviews.

• Can you confirm everyone is classified properly?
  Misclassified workers (especially 1099s treated as W-2s) are top enforcement priorities. The IRS has announced stepped-up review of cannabis employers in 2026.

• Does your payroll provider stand behind cannabis clients in audits?
  If your provider won’t supply documentation or won’t go on record supporting your business, you’re effectively alone in the event of an audit. With increased scrutiny in 2026 post-rescheduling momentum, this support is now non-negotiable.

If the answer to any of these is “no”—or even “I’m not sure”—that’s your signal. If the answer is “yes,” your next move is to document that system clearly, create a compliance calendar, and sanity-check your provider’s cannabis alignment.

You Built Too Much to Risk It Now

You’ve put time, capital, and courage into your cannabis business. Don’t let a payroll oversight be the thing that unravels it. These traps are avoidable—but only if you see them in time.

If any of this raised concerns—or if you want help getting ahead of renewal season—let’s talk.