IRS 280E (Cannabis Federal Tax Rule)
Last reviewed · By Chad Griffith
Section 280E of the Internal Revenue Code disallows ordinary business deductions for any trade or business that consists of trafficking in Schedule I or II controlled substances. Because cannabis remains Schedule I under the Controlled Substances Act, state-legal cannabis businesses cannot deduct ordinary business expenses (rent, utilities, marketing, salaries beyond direct production labor) on their federal tax return. Cannabis operators may only deduct Cost of Goods Sold (COGS) under IRC 471. The result is dramatically higher effective federal tax rates — often 60-80% of net income — versus non-cannabis businesses paying 21% federal corporate tax. 280E compliance is one of the largest financial burdens facing cannabis operators.
Frequently Asked Questions
Why does 280E apply to state-legal cannabis?
280E was enacted in 1982 in response to a Tax Court decision that allowed a convicted drug dealer to deduct business expenses. The statute bars deductions for any business 'consisting of' trafficking in controlled substances 'prohibited by Federal law or the law of any State.' The Tax Court has consistently held that 280E applies to state-legal cannabis businesses because cannabis remains federally illegal. The 2024 DEA proposed rule to reschedule cannabis to Schedule III would, if finalized, remove 280E's application.
What can cannabis businesses deduct under 280E?
Cannabis businesses may deduct Cost of Goods Sold (COGS) under IRC 471. For cultivators, COGS includes direct production costs (seeds, soil, nutrients, water, electricity for growing operations, direct labor harvesting). For dispensaries, COGS is generally limited to the wholesale cost of inventory. Indirect costs (administrative salaries, marketing, rent on retail space, banking fees, professional services) are NOT deductible under 280E.
How do cannabis businesses document 280E compliance?
Documentation requires careful cost accounting separating COGS from non-deductible operating expenses. Cultivators typically use IRC 471-2 inventory accounting. Multi-state operators commonly maintain separate accounting books by license type and state to support COGS allocations. IRS examinations of cannabis returns are increasingly common — typical document requests include detailed COGS schedules, time studies allocating labor, and expense allocation methodologies.
Will the proposed federal cannabis rescheduling end 280E?
Yes — if cannabis is rescheduled to Schedule III as proposed by the DEA in May 2024, 280E would no longer apply because Schedule III substances are not covered by the statute. The rescheduling rule is in administrative review as of 2026. If finalized, the change applies prospectively from the effective date. Cannabis operators should not assume any change has occurred until the final rule is published in the Federal Register.
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