280E & Tax

What Is Section 280E? The Tax Rule Every Cannabis Business Must Understand

The rule in one sentence

Section 280E of the Internal Revenue Code denies ordinary and necessary business deductions to any business trafficking in Schedule I or II controlled substances. Cannabis remains Schedule I federally — so a fully licensed, state-legal dispensary is, for federal tax purposes, a trafficking operation that cannot deduct its rent, payroll, marketing, or insurance.

The result is a tax bill calculated as if those expenses were never paid. Operators routinely face effective tax rates of 50 to 80 percent of real profit, and in bad years can owe federal tax while losing money.

Where it came from

280E was enacted in 1982 after a convicted cocaine trafficker successfully deducted his business expenses in Tax Court — including scales, packaging, and travel. Congress responded by barring deductions for drug trafficking businesses entirely. Nobody in 1982 imagined a licensed, regulated, tax-paying cannabis industry. But the statute turns on federal scheduling, not state legality, so it applies today to thousands of legitimate businesses.

The one thing that survives: cost of goods sold

280E blocks deductions, but cost of goods sold is not a deduction — it is a reduction in gross income, applied before 280E is ever reached. Section 471 governs what a business may capitalize into inventory, and this is where all serious cannabis tax planning happens.

A cultivator can generally capitalize direct production labor, cultivation supplies, and allocable indirect production costs. A retailer's room is narrower — largely the cost of product and certain acquisition costs. The space between what a business could properly capitalize and what it actually does is where most operators overpay, year after year.

What operators get wrong

The two most common errors run in opposite directions. Some operators claim ordinary deductions a cannabis business cannot take, building an exposure that surfaces under examination with penalties and interest attached. Others — more than you would expect — fail to capitalize costs that legitimately belong in inventory, quietly overpaying by five or six figures a year.

Both errors trace to the same root: books that were never structured around the COGS-versus-expense distinction, kept by professionals for whom that distinction barely matters in any other industry.

What to do about it

Three things, in order. First, get the entity structure right, because it determines how much of the operation falls inside 280E's reach. Second, build the chart of accounts so the cost allocation is visible and consistent from the trial balance. Third, document everything contemporaneously — an allocation reconstructed at tax time is a materially weaker position than one recorded as costs were incurred.

This article is general information, not tax advice. Cannabis tax outcomes depend on facts, documentation, and jurisdiction — talk to a qualified professional about your specific situation.