No topic causes more anxiety for cannabis operators than taxes. Not compliance. Not competition. Taxes. Specifically, IRS Code 280E, which prevents businesses trafficking in Schedule I or II controlled substances from deducting ordinary business expenses. For a dispensary with $5 million in revenue and 25 percent gross margins, 280E can turn a modest profit into a six-figure tax loss. This guide explains how 280E works, what you can still deduct, and how to structure your business to minimize the impact.
What 280E actually says
IRC 280E states that no deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business consists of trafficking in controlled substances. The key word is "trafficking." If your business touches the plant — cultivation, manufacturing, distribution, or retail — 280E applies to you.
What you can still deduct: COGS
280E does not eliminate Cost of Goods Sold (COGS). For retailers, COGS includes the purchase price of inventory, freight-in, and certain indirect costs like storage and handling. For cultivators, COGS includes seeds, nutrients, labor directly involved in cultivation, and utilities for the grow space. The strategy is to allocate as many legitimate costs as possible into COGS rather than operating expenses.
The separate business entity strategy
Some operators create separate legal entities for activities that do not touch the plant: management companies, real estate holding companies, and consulting firms. These entities can deduct ordinary business expenses because they are not "trafficking" in cannabis. The strategy is complex and must be structured carefully to avoid IRS challenge under substance-over-form doctrine.
Record-keeping for audit defense
The IRS audits cannabis businesses at higher rates than average. When they audit, they will want to see: detailed COGS calculations with supporting invoices, time allocations showing which employees work on COGS-qualifying activities versus general operations, and clear separation of expenses between cannabis-touching and non-cannabis entities.
Working with a cannabis-savvy CPA
Not all accountants understand 280E. A generalist CPA who has never worked with a cannabis client may miss COGS allocations that save you tens of thousands. Find a CPA who has defended cannabis audits, knows the current case law (including the Harborside and Alpenglow cases), and can structure your chart of accounts for maximum defensibility.
The bottom line
280E is unfair, but it is the law. The operators who survive are the ones who plan for it from day one. Structure your entities correctly. Allocate costs aggressively but defensibly into COGS. Keep immaculate records. And never, ever try to hide revenue from the IRS. The penalties for tax fraud make 280E look like a parking ticket.