What Cannabis Examinations Focus On
Examiners begin with income. In a cash-intensive business they reconcile deposits, POS records and track-and-trace sales data, and they will use indirect methods — bank deposit analysis, markup analysis, cash-flow analysis — if the direct records are weak.
They then move to cost of goods sold. Expect challenges to any cost that resembles 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 track-and-trace 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 communications. The operator should not be answering examiner questions informally, on the phone, or on site. Every information document request is answered in writing, on time, with exactly what was requested and nothing beyond it.
Second, we reconstruct the position. That means rebuilding the inventory rollforward, assembling the allocation studies, tying the return to the general ledger, and identifying weak points before the examiner does so the response strategy accounts for them.
Building the Substantiation File
Cases are won on documentation. The strongest cannabis files contain contemporaneous records: time records that show what cultivation labor actually did, floor plans with measured square footage by function, purchase invoices matched to manifests, physical count sheets signed and dated, 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 evaluates hazards of litigation and often reaches a materially different outcome than a revenue agent, particularly on allocation questions where reasonable methodologies differ.
We also address penalties directly. Accuracy-related penalties can frequently be abated where the taxpayer relied on a documented methodology and professional advice — another reason the methodology memoranda matter long before an audit begins.
State-Level Examinations
CDTFA examinations focus on excise and sales tax: whether tax was calculated on the right base, whether exemption and resale documentation exists, and whether reported sales agree to track-and-trace. Local jurisdictions audit gross-receipts-based cannabis business taxes on similar logic.
These examinations often run in parallel with a federal case and use overlapping records, so we manage them together rather than in isolation.
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 track-and-trace. 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, METRC 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
California State and Local Examinations
Federal exposure is not the only exposure. CDTFA conducts sales and use tax audits that in cannabis frequently focus on exemption documentation, excise reconciliation and the completeness of reported gross receipts against track-and-trace data. Cities with gross-receipts cannabis taxes run their own audits, often with less procedural formality and shorter response windows.
These examinations use the same evidence base as the federal one — POS records, METRC exports, bank deposits and the general ledger — so a single well-maintained reconciliation file serves all of them. We represent operators across all three levels and keep the positions consistent, because an inconsistency between a state 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.
