What Cannabis Examinations Focus On
Examiners start with income. In a cash-intensive business they reconcile deposits, POS records and seed-to-sale sales data, and they will use indirect methods, bank deposit analysis, markup analysis, cash-flow analysis, if the direct records look thin.
They then turn to cost of goods sold. Expect challenges to any cost that resembles a selling or administrative expense, to labor allocations without time records, to square-footage allocations without measurements, and to inventory balances that do not tie to physical counts or seed-to-sale data.
- Gross receipts and cash reconciliation testing
- Reseller versus producer classification of the taxpayer
- Composition of inventoriable costs and allocation methodology
- Related-party arrangements and separate-trade-or-business claims
- Payroll classification, including contractor versus employee
How We Manage an Examination
First, we take over all communications. The operator should never be answering examiner questions informally, by phone or on-site. Every information document request gets a written response, on time, with exactly what was requested and nothing more.
Second, we reconstruct the position: rebuild the inventory rollforward, assemble the allocation studies, tie the return back to the general ledger, and identify weak points before the examiner does, so the response strategy already accounts for them.
Building the Substantiation File
Cases are won on documentation. The strongest Arizona cannabis files hold contemporaneous records: time records showing exactly what cultivation labor did, floor plans with measured square footage by function, purchase invoices matched to transfer manifests, signed and dated physical count sheets, and written methodology memoranda that predate the examination.
Where records are incomplete, reconstruction is possible but weaker. We are direct about which positions are supportable and which are likely to be conceded, so the operator can make an informed decision about where to spend the fight.
Appeals, Penalties and Resolution
Not every adjustment should be accepted at the examination level. IRS Appeals weighs hazards of litigation and frequently reaches a materially different outcome than a revenue agent, particularly on allocation questions where more than one reasonable methodology exists.
We also address penalties directly. Accuracy-related penalties can often be abated where the taxpayer relied on a documented methodology and professional advice, which is one more reason methodology memoranda matter long before an audit ever opens.
Arizona State-Level Examinations
ADOR examinations focus on TPT and the marijuana excise tax: whether tax was calculated on the correct base for each channel, whether medical exemption documentation exists for AMMA patient sales, and whether reported sales agree to seed-to-sale records. City and county TPT add-ons in places like Phoenix, Tempe and Tucson each get reviewed against the licensed rate.
These examinations often run in parallel with a federal case and pull from overlapping records, so we manage them together rather than treating them as separate problems.
How a Cannabis Examination Typically Unfolds
A cannabis examination usually opens with an information document request focused on inventory: how ending inventory was valued, what costs were capitalized, how labor was allocated, and how the amounts tie to seed-to-sale records. The second wave asks about entity separation, related-party transactions and owner compensation. The third, in cash-intensive cases, addresses bank deposits and cash controls.
Preparation determines the outcome. Operators with a written costing methodology, allocation studies with time records, square-footage measurements, seed-to-sale reconciliations and consistent year-over-year treatment resolve examinations narrowly. Operators without them face reconstruction under time pressure with the burden of proof on their side of the table.
We manage the engagement end to end: we control the flow of information, respond in writing, prepare the client for any interview, and keep the examination inside its stated scope rather than allowing it to expand into an unbounded review.
- Scope control and a single written channel for all responses
- Reconstruction and organization of inventory and allocation workpapers
- Position memoranda supporting each significant treatment
- Appeals, penalty abatement and collection alternatives where needed
Arizona State-Level Examinations
Federal exposure is not the only exposure. ADOR conducts TPT and excise tax audits that frequently focus on medical exemption documentation, excise reconciliation for adult-use sales, and the completeness of reported gross receipts against seed-to-sale data. These reviews can move quickly and carry shorter response windows than a federal examination.
These examinations use the same evidence base as the federal one, POS records, seed-to-sale exports, bank deposits and the general ledger, so a single well-maintained reconciliation file serves all of them. We represent operators across both levels and keep the positions consistent, because an inconsistency between an ADOR filing and a federal one is exactly what an examiner looks for.
Where liabilities are established, the work turns to resolution: installment agreements, penalty abatement on reasonable-cause grounds, and structuring payment against seasonal cash flow so that resolving one year does not create failure in the next.
