Maximizing Cannabis Tax Deductions Under Section 280E

Kenny Hall
February 5, 2024

Running any business is hard work and — thanks to outdated legislation — running a cannabis business is even harder. Despite the fact that 89% of Americans want cannabis legalized to at least some degree, the federal government has spent the last few decades dragging its heels. Section 280E is continuing to be misapplied to legitimate cannabis businesses leading to stifled innovation and limited growth of an already massive market. Luckily, there are some steps that a business owner can take to maximize their deductions.

What is Section 280E?

Section 280E of the United States Internal Revenue Code is a piece of legislation that explicitly forbids any business from deducting any business expenses associated with the “trafficking” of any Schedule I or II substance. These expenses include (but are not limited to): 

  • Payroll
  • Utilities/rent
  • Health insurance
  • Maintenance or repairs
  • Marketing costs
  • Payments to contractors

Under this section, businesses involved in the sale of controlled substances, such as marijuana, are not allowed to deduct ordinary business expenses from their income when calculating federal income tax. While legal in some states, marijuana remains illegal at the federal level, and this part of the tax code prevents businesses engaged in its sale from enjoying the same tax deductions that more “legal” enterprises are entitled to. 

An accountant is reviewing documents related to Section 280E.

Note that everything in this article applies only to federal taxes, each state or municipality has its own laws on the matter. As of the publication of this article, the following states have decoupled Section 280E from their tax codes meaning that all business expenses may be deducted from state taxes: Arkansas, California, Colorado, Hawaii, Louisiana, Maryland, Massachusetts, Maine, Michigan, Minnesota, Mississippi, Missouri, Montana, New Mexico, New York, Oregon, Texas, Vermont, and Virginia.

How Does Section 280E Impact Cannabis Businesses?

The effect that this legislation has had on the cannabis industry is significant. Since marijuana is still a Schedule I substance, any businesses that are involved in its cultivation, processing, or distribution are all subject to the restrictions imposed by Section 280E. This can create several issues for even the savviest entrepreneurs.

  • Limited Deductions: Any business on the cannabis market cannot deduct any of the  “ordinary” business expenses when calculating their taxable income. Typically, businesses can deduct expenses such as rent, payroll, and advertising costs, but marijuana-related businesses are not afforded this same privilege.
  • Higher Tax Liabilities: Because of this lack of deductions, cannabis businesses are likely to face higher effective tax rates when compared to other businesses.
  • Complex Accounting: Any business in the cannabis sector has to navigate through incredibly complex accounting practices to ensure compliance with both state and federal regulations. This may involve practices such as keeping two separate sets of books — one for federal tax purposes (following Section 280E restrictions) and another for state taxes where marijuana is legal.

What Can I Deduct Under Section 280E?

While you may not be able to enjoy the same tax deductions as other businesses, there are several ways that a cannabis business owner can maximize their deductions.

Cost of Goods Sold (CoGS)

This is the big one and the only exception explicitly laid out in the text of the stature itself. Costs of goods sold normally cover things like raw materials, labor, the wholesale price of goods, overhead, storage, and more, and these can add up to a substantial deduction. Sadly, though, for cannabis retailers, the only CoGS that can be deducted are those associated with equipment used in storage and packaging.

While standard overhead expenses may not be deductible, the cost of obtaining inventory is, and this has led to a new wrinkle; what counts as “obtaining”. While this is still something of an open question, costs associated with cultivation, production, and manufacturing (seeds, soil, nutrients, etc) could be eligible as CoGS.

Differentiate Between “Trafficking” And “Non-trafficking” Expenses

If your business does anything other than sell cannabis, keep these recorded as separate expenses. Things like selling merchandise, offering classes or workshops, consultancy, or anything else that either costs or generates money can all be valid deductions for your business. 

A stack of lighters, which can be deducted under Section 280E.

Intellectual Property and Royalty Agreements

This is a fairly novel approach to dealing with financial burdens on cannabis businesses and has some promise. The basic idea is to create a second enterprise that focuses not on cannabis, but on intellectual property (IP) rights and then to pay them a set fee for licensing said rights. Things like logos, slogans, brand names, recipes, formulas, etc. can all be registered and licensed for a fee.

Your cannabis business can then license these rights from your IP business which can then use this revenue to handle sales and marketing functions. In short, this can effectively transfer these expenses to the IP rights holder, potentially contributing to further CoGS deductions.

Do Your Research

Staying abreast of changes in local and federal legislation is the best way to make sure that you’re on the right side of the law. Every year sees changes to the tax code that could save — or cost — you a hefty sum if ignored. By having at least a basic understanding of what you’re getting into, you’ll set yourself up for success.

Hire a Professional

The tax code is incredibly complicated and hiring a specialized cannabis accountant can save you hours of heartache and potentially thousands of dollars. The IRS is well aware of the legal limbo that cannabis businesses are in and — sensing a change in the tide — they have actively been working to close loopholes and catch delinquents. Don’t try to “outsmart” the taxman — hire a cannabis professional.

A cannabis-specialized accountant is reviewing expenses that are deductible under Section 280E.

Will Section 280E Be Removed in 2024?

Section 280E is unlikely to be removed from the US tax code any time soon; however, there is a strong chance that it will simply stop being relevant for cannabis businesses. Section 280E is explicitly concerned with “Schedule I and II” substances and never specifically mentions cannabis. Therefore, a change in the scheduling of marijuana would result in the statute no longer applying.

Over the last few years, there have been major strides in the battle to end cannabis prohibition, and it seems as if the time may be nigh. In a 2023 letter to the US Congress, Michael Miller, acting chief of the Drug Enforcement Administration (DEA), stated that the DEA is now “considering its review” and stated that the agency “has the final authority to schedule, reschedule, or deschedule a drug."

This review came after a mandate from the Biden administration to the Department of Health of Human Services to re-evaluate the scheduling of cannabis. While this is by no means a settled matter at this point, the odds of cannabis being removed from Schedule I are fairly significant.

Stay Ahead Of The Curve

Section 280E is a thorn in the side of every cannabis business operating in the US today. With the cannabis market set to expand in the coming year, competition and scrutiny will only continue to grow. Getting set up accounting solutions tailor-made for the cannabis industry is one of the best ways to separate yourself from the rest.

Schedule a free, no-obligation demo and learn just what KayaPush can do for your cannabis business.

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February 2024


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