In the US, cannabis is a recent multibillion-dollar industry regulated for its use and sale. Many states are legalizing cannabis to bring in revenue. Despite this progress, cannabis businesses continue to operate under a cloud of federal restrictions that create serious financial and operational challenges.
One of the most important hurdles is IRS Code 280E, a federal tax that treats state-legal cannabis firms as if they were illegal drug dealers. The rejection of ordinary business deductions under 280E leads to larger tax bills and cash flow issues. This makes it much harder for even fully compliant operators to achieve profitability and long-term viability.
Understanding IRS Rule 280E
IRS Code 280E is a federal tax rule that prohibits businesses involved in the trafficking of Schedule I or Schedule II controlled substances from deducting ordinary and necessary business expenses.
The tax law that was enacted in the early 1980s prevents drug dealers from deducting their expenses. Because cannabis is still classified as a Schedule I substance at the federal level, the rule now applies to state legal cannabis businesses as well.
Under 280E:
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Cannabis businesses cannot deduct ordinary expenses like rent, utilities, employee compensation, advertising, or consultancy fees.
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Businesses are allowed to deduct only the cost of goods sold.
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Often, taxable income is far greater than actual profit.
This structure places cannabis companies at a major disadvantage compared to other legal industries.
How 280E Impacts Cannabis Businesses?
The IRS Code 280E does not just result in higher taxes; it actually impacts how cannabis companies operate, plan, and pay. Cannabis businesses cannot deduct ordinary expenses, unlike most legal businesses, because expenses such as rent, employee salaries, marketing, and professional services are standard tax deductions. This makes an environment that is expensive and limiting
Here are some key consequences:
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Cannabis businesses face federal tax rates of 60-70% that are much higher than normal corporate tax rates. Taxable income is calculated without accounting for most operating expenses, even if the business is profitable on paper.
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High taxes often prevent companies from having sufficient cash flow to cover daily operations, payroll, rent, utilities, and inventory. The inability to extend credit makes it hard for the business to respond to unanticipated expenses or growth initiatives.
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Big firms don’t reinvest their earning as much as they should in innovations or other important aspects. What happens instead is these revenues get taxed by the federal government. When pricing is identical across brands, this slows growth, reduces competitive advantage, and can stifle innovation.
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Small and medium operators are especially vulnerable to a greater failure risk. Many businesses can go bankrupt or shut down with an established pattern of successful sales and efficient operations if they do not have large cash reserves or access to capital.
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The prices of most cannabis companies go up to cover tax liabilities, which makes the legal products less competitive against black-market offerings. Ironically, the prohibition of business deductions under section 280E contributes to more illegal sales.
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The law complicates financial planning and investor relations. Businesses spend a significant amount of effort and money for tax planning and accounting compliance. Investors may be hesitant to fund companies exposed to unpredictable tax burdens, further limiting growth opportunities.
In essence, 280E is not just a tax issue. It affects everything from structure to competition and sustainability, affecting decisions about prices, staffing, expansion, and investment strategy in the legal cannabis industry.
The Conflict Between State and Federal Law
One of the most frustrating aspects of 280E is that it punishes compliance. States heavily regulate legal cannabis businesses through licensing fees, inspections, security requirements, and reporting requirements. Various businesses are therefore denied even the most basic tax treatment because federal law has lagged behind the state reforms.
This conflict creates obstacles to legalization efforts. Legal cannabis markets were meant to reduce illegal markets, create jobs, and add tax revenues. Instead, the 280E tax makes it harder for licensed operators to compete against unregulated sellers who don’t pay any tax. In this way, the tax code unintentionally supports the very black-market activity that legalization was meant to eliminate.
Common Strategies Used to Reduce 280E Exposure
Many cannabis companies try to mitigate the impact of 280E in several ways. Even if none of these methods gets rid of the problem, they may bring some relief.
Methods that are often used include;
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Increasing Cost Of Goods Sold (COGS)
Allocating eligible production and inventory costs to minimize taxable income.
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Non-productive Cannabis Activities
When that is legally and operationally permitted, create separate entities for non-cannabis sales services.
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Reorganizing Operations
Changing business models, such as vertical integration, to improve cost allocation.
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Collaboration with Tax Experts
Making sure to follow the rules while spotting legitimate planning opportunities.
Cannabis tax return strategies require precision and documentation because the IRS scrutinizes cannabis tax filings. To know more about best operational practices, read this article: THCA in Trouble: Why Hemp Retailers and States Are Pushing Back
Difficulties with Laws and Reform Efforts
Over the years, cannabis companies have challenged the application of 280E in court. Though some cases have refined specific accounting rules, the courts have maintained the same law as long as cannabis remains illegal under federal law.
At the same time, interest has shifted to policy reform. Supporters say that the only way to achieve meaningful relief is through:
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Federal rescheduling or descheduling of cannabis.
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Amendments to the tax code by Congress.
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Clear exclusions for state-operated cannabis businesses.
Despite the rise in reform discussions, nothing permanent is in practice yet. To know more about cannabis businesses facing broader operational pressures, read this article: Challenges Facing the Cannabis Industry: Supply Chain, Banking & Regulation.
Preparation of Cannabis Businesses Until Reforms Happen
Cannabis operators should take action on 280E before substantive reform happens.
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Ensure COGS costs are auditable, precise, and separated from expenses.
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Employ accountants knowledgeable about cannabis taxation.
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Be conservative in planning for taxes and holding cash.
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Staying up to date on federal policy changes and potential tax relief opportunities.
While these measures can’t eliminate the burden of 280E, they can still help businesses manage risk and survive.
Conclusion
IRS Code 280E keeps cannabis companies on the fence as it restricts their normal business operations, but why, though? They do not operate illegally, but if federal law permitted state legalization, this wouldn’t be an issue. Section 280E inflates tax liabilities, reduces profitability, and discourages business growth for businesses, especially for small and mid-sized businesses.
Unless cannabis is reclassified or Congress amends the tax code, this clause will remain a continuous challenge.
Preparation of Cannabis Businesses Until Reforms Happen
Cannabis operators should take action on 280E before substantive reform happens. They should:
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Ensure COGS costs are auditable, precise, and separated from expenses.
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Employ accountants knowledgeable about cannabis taxation.
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Be conservative in planning for taxes and holding cash.
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Keep themselves up to date on federal policy changes and potential tax relief opportunities.
While these measures can’t eliminate the burden of 280E, they can help businesses manage risk and survive.
Conclusion
IRS Code 280E keeps cannabis companies on the fence as it restricts their normal business operations, but why, though? They do not operate illegally, but if federal law permitted state legalization, this wouldn’t be an issue. Section 280E inflates tax liabilities, reduces profitability, and discourages business growth for businesses, especially for small and mid-sized businesses.
Unless cannabis is reclassified or Congress amends the tax code, this clause will remain a continuous challenge. Cannabis operators must navigate a complex landscape, balancing compliance, financial planning, and advocacy while operating in a system that treats them as criminals for tax purposes—even as they follow the law at the state level.
For further reading on the cannabis business landscape, visit CBHD News.
