Section 280E Tax Basics for Cannabis

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:

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.

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.