IRS 280E Tax Code Guide for Cannabis Businesses

Cannabis businesses face unique tax challenges due to IRS Section 280E. Here’s what you need to know:

280E blocks deductions for most business expenses
Only Cost of Goods Sold (COGS) can be deducted
Tax rates often top 70%, vs 21% for other businesses

Key strategies:

Maximize COGS deductions
Keep detailed records
Work with cannabis tax experts
Stay informed on potential changes

Aspect	Cannabis Business	Other Business
Deductions	COGS only	All expenses
Tax rate	Can exceed 70%	~21%
Profits	Squeezed	Normal

While rescheduling could change 280E’s impact, compliance is crucial for now. Understanding 280E is key for cannabis business survival and growth.

Background of Section 280E

History and purpose

280E came about in 1982 after a cocaine dealer won tax deductions in court. Congress quickly closed this loophole to stop drug dealers from getting tax breaks.

Impact on legal cannabis

280E now affects state-legal cannabis businesses because:

Cannabis is still federally illegal (Schedule I)
280E applies to Schedule I/II substances
State legality doesn’t matter for federal taxes

This creates major issues:

Impact	Details
High taxes	Often 70%+ vs 21% for others
Limited deductions	No rent, salaries, marketing
Cash flow problems	Less money for growth

Example: Harborside Health Center owed millions in back taxes due to 280E. This shows how it can cripple even large cannabis companies.

Main parts of 280E

Non-deductible expenses

280E blocks most common deductions:

Rent and utilities
Employee wages/benefits
Marketing costs
Legal/professional fees
Travel expenses
Equipment repairs
Insurance premiums

This covers nearly all typical business costs.

Deductible expenses (COGS)

Cannabis businesses can deduct Cost of Goods Sold:

COGS	Examples
Direct materials	Cannabis, seeds, fertilizer
Direct labor	Trimming, packaging
Some indirect costs	Equipment upkeep, grow room utilities

The IRS strictly limits COGS for cannabis companies.

Impact vs other businesses

280E hits cannabis much harder than other industries:

Aspect	Cannabis	Non-Cannabis
Deductions	COGS only	All expenses
Tax rate	Can top 70%	~21%
Profits	Squeezed	Normal

Example: A cannabis business with $2M revenue and $600K COGS would owe $294K in taxes on $300K profit – a 98% rate. A non-cannabis business would pay just $63K – 21%.

This massive gap shows why 280E is so problematic for the cannabis industry.

How 280E changes business operations

Higher tax rates

280E leads to tax rates up to 4x higher for cannabis vs other businesses:

Business	Revenue	COGS	Other Expenses	Taxable Income	Tax (21%)	Effective Rate
Non-Cannabis	$2M	$600K	$1.1M	$300K	$63K	21%
Cannabis	$2M	$600K	$1.1M	$1.4M	$294K	98%

This shows how 280E can wipe out cannabis profits.

Budgeting challenges

280E makes planning tough. Cannabis businesses must:

Save more for taxes
Limit growth/improvements
Struggle with competitive wages

Profit and growth limits

280E creates "phantom income" – taxable money that never reaches the bank. This makes it hard to:

Reinvest in the business
Attract investors
Compete with illegal sellers
Expand operations

Some split operations to deduct non-cannabis expenses. But 280E remains a major hurdle for industry growth.

Ways to follow 280E rules

Good accounting practices

To comply with 280E:

Use cannabis-specific software
Create detailed accounts with a CPA
Track all cash transactions
Keep electronic records

Pro tip: Back up data and ensure multiple people can access it.

Maximizing COGS

COGS is the main 280E deduction. To maximize it:

Include direct/indirect production costs
Deduct cultivation labor costs
Track employee time on production vs sales

Deductible COGS	Non-Deductible
Production labor	Sales labor
Materials	Rent
Packaging	Marketing
Storage equipment	Admin costs

Splitting business activities

Creating separate entities can help manage 280E:

Cannabis production/sales: Subject to 280E
Non-cannabis activities: Normal deductions allowed

This "vertical integration" can optimize taxes.

Given high audit rates, working with a cannabis CPA is crucial for 280E compliance.

Common mistakes and how to avoid them

Expense misclassification

Avoid these costly errors:

Wrongly claiming non-COGS as deductible
Deducting prohibited expenses like rent

To prevent this:

Use a cannabis CPA for detailed accounting
Review expense categories regularly
Use cannabis-specific software

Poor record-keeping

With high audit rates, good records are key. Common issues:

Incomplete cash transaction logs
Missing inventory/expense docs
Inconsistent accounting methods

To improve:

Use robust cannabis management software
Keep detailed records, especially for cash
Organize and back up all financial docs

Ignoring state rules

Overlooking state regulations can cause:

Federal/state tax filing conflicts
Missed state-level deductions
Compliance penalties

To stay compliant:

Consult state-specific cannabis tax experts
Update your tax strategy as laws change
Keep separate state/federal tax records

Mistake	Consequence	Prevention
Misclassifying expenses	Higher taxes	Use a cannabis CPA
Poor records	Audit troubles	Use specialized software
Ignoring state rules	Fines/penalties	Stay informed on local laws

Recent changes and possible updates

Court cases

Recent rulings back the IRS on 280E:

Alpenglow Botanicals: Supreme Court upheld 280E enforcement
Harborside: Tax Court confirmed 280E applies to all business activities

These show ongoing 280E challenges for cannabis companies.

Proposed laws

Some efforts aim to change 280E:

Small Business Tax Equity Act: 280E exception for state-legal cannabis
Nancy Mace’s bill: Allow deductions for state-compliant sales
STATES/MORE Acts: Amend controlled substance laws, affecting 280E

Industry efforts

The cannabis industry is pushing for 280E reform:

Advocacy groups lobby for changes
DEA suggested moving cannabis to Schedule III, potentially ending 280E issues

Current 280E	Potential Post-Rescheduling
70%+ tax rate	21% rate
No expense deductions	Full deductions
COGS deductions only	Normal tax treatment

While progress is happening, businesses should operate as if 280E will stay for now.

Tips for cannabis businesses

Use good accounting systems

Cannabis needs advanced tools. Use software that:

Connects different accounting areas
Has built-in compliance checks
Allows three-way matching

Review inventory and finances regularly for accuracy.

Get expert tax advice

Hire a cannabis-specialized CPA to:

Find deductions beyond COGS
Allocate expenses correctly
Prepare for audits

Keep up with changes

Stay informed on cannabis tax laws:

Watch proposed bills like the Small Business Tax Equity Act
Follow court cases reinforcing 280E
Be cautious with tax positions to avoid audits

Use the right tools and experts to navigate cannabis taxation.

Real examples of 280E effects

Business strategies

Companies tackle 280E differently:

Trulieve got $100M+ in refunds, arguing 280E shouldn’t apply
Richmond Patients Group owed $2M for wrongly classifying expenses
Alternative Health Care Advocates faced double taxation for a management company setup

Lessons learned

Separate non-cannabis activities carefully
Be cautious with management companies
Keep meticulous records
Prepare for severe impacts

Example: A $2M revenue cannabis business could face a 98% effective tax rate due to 280E.

What might happen next

Federal changes and 280E

Rescheduling marijuana could reshape cannabis taxes:

Businesses might write off expenses, saving billions
Tax rates could drop from 70%+ to normal levels
Savings could fuel growth or lower prices

But 280E applies until changes are final.

Preparing for changes

To get ready:

Review finances
Plan for different scenarios
Stay informed
Consider broader impacts like banking access

While change could bring prosperity, businesses should remain cautious.

Conclusion

280E creates major challenges for cannabis businesses:

Blocks most deductions
Leads to 40-80% tax rates vs 21% for others
Only allows COGS deductions

To handle 280E:

Keep detailed records
Properly allocate expenses
Work with cannabis tax experts

Proper 280E management is crucial for survival and growth in the cannabis industry.

FAQs

280E strategy for cannabis?

Key points:

Maximize COGS deductions
Keep detailed records
Use cannabis tax experts

COGS includes direct product costs, some labor, and cultivation expenses.

Can cannabis companies deduct expenses?

Only COGS-related expenses. They can’t deduct:

Marketing
Retail rent
Most salaries

But they can deduct:

COGS (Deductible)	Non-Deductible
Inventory costs	Advertising
Cultivation labor	Rent
Packaging	Most salaries

Work with experts to categorize expenses correctly. Cannabis faces high audit rates, so compliance is crucial.