Section 280E Tax Code: What It Is, How It Works & The 280E Loophole

What is Section 280E?

Section 280E of the Internal Revenue Code states that businesses trafficking in controlled substances (Schedule I or II) cannot deduct ordinary business expenses. Since cannabis remains federally classified as a controlled substance, this means cannabis businesses cannot deduct rent, payroll, marketing, utilities, or most other normal business expenses from their federal taxes.

The one exception: Cost of Goods Sold (COGS). Cannabis businesses can still deduct the direct costs of producing or acquiring their inventory. This makes COGS calculation the most important accounting exercise for any cannabis business.

How 280E Impacts Your Tax Bill

Consider a dispensary with $1M in revenue, $400K in COGS, and $500K in operating expenses:

Item	Normal Business	Under 280E
Revenue	$1,000,000	$1,000,000
Cost of Goods Sold	-$400,000	-$400,000
Operating Expenses	-$500,000	$0 (not deductible)
Taxable Income	$100,000	$600,000
Federal Tax (21%)	$21,000	$126,000
Effective Tax Rate	21%	126% of profit

In this example, the business only made $100K in actual profit but owes $126K in federal taxes. This is the devastating reality of 280E - you can owe more in taxes than you earned in profit.

Strategies to Minimize 280E Impact

While you cannot avoid 280E, a skilled cannabis CPA can help minimize its impact:

Maximize COGS allocation - Properly allocating costs to COGS under IRC Section 471 is the primary strategy. This includes direct labor, materials, and certain overhead costs that can be attributed to production or acquisition of inventory.
Entity structuring - Some operators separate plant-touching and non-plant-touching activities into different entities. The non-plant-touching entity can deduct normal business expenses.
Inventory accounting method - The method used to value inventory (FIFO, weighted average, etc.) affects COGS calculations. Your CPA should select the method that maximizes legitimate deductions.
State decoupling - Some states (California, Colorado, Oregon) have decoupled from 280E, meaning you CAN deduct operating expenses on your state return even if you cannot federally.

Key Court Cases

Three Tax Court decisions define how 280E is applied to cannabis businesses:

CHAMP (Californians Helping to Alleviate Medical Problems) v. Commissioner, 128 T.C. 173 (2007) - The Tax Court allowed a dispensary with dual activities (cannabis sales and caregiving services) to deduct expenses attributable to the non-cannabis caregiving portion. This opened the door to the "dual entity" structuring strategy.
Olive v. Commissioner, 139 T.C. 19 (2012) - Rejected the argument that dispensary services constituted a separate trade or business and reinforced that 280E applies to the full business when its primary activity is trafficking in a controlled substance.
Patients Mutual Assistance Collective Corp. (Harborside) v. Commissioner, 151 T.C. 176 (2018) - Confirmed that 280E applies even to state-legal cannabis businesses and limited the scope of deductible COGS to direct production costs under IRC Section 471(a).

Federal Rescheduling and 280E

In late 2025, cannabis was rescheduled from Schedule I to Schedule III under federal law. This is the most significant cannabis policy change in 50 years. Section 280E only applies to Schedule I and II substances, so rescheduling to Schedule III should eliminate the 280E burden.

However, the implementation details are still being worked out. Cannabis businesses should consult with their CPA about the timeline and how to handle tax filings during the transition period. Some operators may be eligible to amend prior year returns.

Section 280E FAQ

What is IRC Section 280E?+

Section 280E of the Internal Revenue Code prohibits businesses that traffic in Schedule I or II controlled substances from deducting ordinary business expenses on their federal tax return. Since cannabis remains federally classified as Schedule I, state-legal cannabis businesses cannot deduct rent, payroll, marketing, utilities, or most other operating expenses. Only Cost of Goods Sold (COGS) under IRC Section 471 is deductible.

How much more tax do cannabis businesses pay because of 280E?+

Effective federal tax rates for cannabis operators routinely exceed 70% of actual profit. In extreme cases where operating expenses are high relative to COGS, the tax bill can exceed 100% of net income. For a dispensary with $1M revenue, $400K COGS, and $500K operating expenses, a normal business would owe $21K; under 280E, the same business owes $126K.

Does rescheduling cannabis to Schedule III eliminate 280E?+

Yes - 280E only applies to Schedule I and II substances. Rescheduling to Schedule III would remove cannabis from 280E's scope, allowing operators to deduct ordinary business expenses again. However, the transition has complex implications for prior-year returns, state tax treatment, and inventory accounting. Cannabis operators should consult a specialized CPA before making any assumptions about back-taxes or amended returns.

Can I structure around 280E with a dual-entity setup?+

Partially. The CHAMP case established that a cannabis business with meaningful non-trafficking activities (e.g. caregiving services) can deduct expenses attributable to the non-trafficking entity. In practice, operators often split plant-touching and non-plant-touching functions into separate legal entities. The non-plant-touching entity can deduct normal expenses. This requires careful structuring and specialized counsel - the IRS has successfully challenged sham structures.

Do state taxes also apply 280E?+

Some states - notably California, Colorado, and Oregon - have decoupled from 280E at the state level, meaning you CAN deduct operating expenses on your state return even though you cannot federally. Other states conform to the federal treatment. This creates opportunities for legitimate state-level tax savings that a non-specialist CPA may miss.

What court cases shape how 280E is enforced?+

Three Tax Court decisions are foundational: CHAMP v. Commissioner (128 T.C. 173, 2007) which allowed dual-entity expense allocation; Olive v. Commissioner (139 T.C. 19, 2012) which rejected arguments that dispensary services constitute a separate trade; and Patients Mutual (Harborside) v. Commissioner (151 T.C. 176, 2018) which confirmed 280E applies to state-legal cannabis and limited deductible COGS to IRC Section 471(a) direct costs.

Sources & References

IRC Section 280E, full statute text: Cornell Legal Information Institute

IRC Section 471 (inventory accounting): Cornell LII

IRS Marijuana Industry FAQs: irs.gov

CHAMP v. Commissioner, 128 T.C. 173 (2007)

Olive v. Commissioner, 139 T.C. 19 (2012)

Patients Mutual Assistance Collective Corp. (Harborside) v. Commissioner, 151 T.C. 176 (2018)

DEA notice of proposed rulemaking on cannabis rescheduling: Federal Register

Last reviewed: April 2026. This guide provides general educational information and is not tax or legal advice.

Section 280E Tax Basics for Cannabis