Your tax bill came back and your stomach dropped.
On paper, your dispensary or grow is finally making real money. Then your CPA plugs in 280E, and suddenly:
- 30–40% margins shrink to something that feels like 5–10%
- Your effective tax rate looks closer to 60–80% than the 25–30% your non‑cannabis friends pay
- Cash that should be going into expansion, upgrades, or debt pay‑down is evaporating into tax checks
If you’re plant‑touching in 2026, 280E isn’t a line in a textbook—it’s one of the main forces shaping whether your business survives.
This guide explains, in plain language:
- What 280E is and who it really hits
- What you can still deduct (COGS, some depreciation, etc.)
- How cannabis vs CBD/hemp are treated
- How state‑level “decoupling” can help (even when federal law hasn’t moved)
- Practical ways to design your accounting and structure so 280E hurts less—and doesn’t blow up in an audit
This is not legal or tax advice for your specific situation. It’s the framework you need so conversations with your cannabis tax advisor actually move the needle.
What 280E Actually Is (And Why It Exists)
Internal Revenue Code Section 280E says:
No deduction or credit shall be allowed for any amount paid or incurred in carrying on any trade or business if such trade or business consists of trafficking in controlled substances (Schedule I or II) which is prohibited by Federal law.
Translation:
- If, under federal law, you’re “trafficking” in a Schedule I or II substance (and cannabis still qualifies at the federal level), you may not deduct normal business expenses.
- You can only reduce income by cost of goods sold (COGS)—the cost of acquiring or producing the product you sell.
State legalization doesn’t override this. You can be 100% compliant in your state and still be treated as trafficking under federal tax law.
That’s why a “profitable” cannabis business can feel like it’s constantly under cash pressure: 280E is effectively taxing you on something closer to gross profit than real net income.
Who 280E Hits (Cannabis vs CBD vs Hemp)
Plant‑touching cannabis businesses
If you are:
- A dispensary / retailer selling THC‑containing cannabis products
- A cultivator or manufacturer producing THC‑containing products
- A vertically integrated operator doing any of the above
You should assume 280E applies at the federal level, unless and until the law actually changes.
CBD and hemp businesses
Here it depends.
- If you’re strictly dealing in hemp (≤0.3% delta‑9 THC on a dry‑weight basis) in compliance with the Farm Bill, you’re generally not trafficking in a controlled substance for federal tax purposes. 280E typically does not apply.
- If you’re selling THC products alongside hemp/CBD, or selling “gray‑area” products (synthetic cannabinoids, high‑THC variants marketed as hemp, etc.), you’re in a more complex and riskier zone.
Mixed operations need careful structuring and accounting to:
- Separate non‑280E‑impacted activities from plant‑touching ones, and
- Be ready to defend that separation under scrutiny.
If someone tells you “CBD means no 280E” without asking detailed questions about your products, sourcing, and structure, that’s a red flag.
What You Can Still Deduct Under 280E: COGS
280E does not disallow COGS. It disallows most other ordinary and necessary business expenses.
COGS is different depending on whether you’re a reseller (dispensary) or a producer (cultivator/manufacturer).
For dispensaries (resellers)
COGS is generally limited to:
- The purchase cost of cannabis products you buy for resale
- Certain costs necessary to bring inventory to a “saleable” condition (freight‑in, some handling), depending on method and facts
COGS typically does not include:
- Rent and utilities for the retail floor
- Budtender wages and benefits
- Marketing, loyalty programs, or discounts
- General admin overhead
For cultivators and manufacturers (producers)
Producers have more room in COGS under long‑standing inventory rules.
COGS can often include:
- Direct materials (seeds, clones, nutrients, grow media, packaging for production)
- Direct labor (grow staff, trimmers, production workers directly tied to making product)
- Certain indirect production overhead:
- A portion of facility rent and utilities tied to production areas
- Depreciation on grow and manufacturing equipment
- Some supervisory labor and production‑related indirect costs
Still excluded from COGS:
- Non‑production G&A (executive salaries, general office expenses)
- Sales and marketing
- Most admin staff
- Retail‑level costs if you’re vertically integrated
The line between production and non‑production costs is where a lot of 280E planning—and a lot of audit risk—lives.
You want to:
- Use the most favorable allowable cost‑accounting methods, without inventing positions the IRS can knock down.
- Document your logic in memos, cost schedules, and clear policies.
What You Cannot Deduct: The Painful Part of 280E
For plant‑touching businesses, 280E makes most ordinary business expenses non‑deductible at the federal level.
Typically non‑deductible:
- Rent and utilities for retail space
- Most payroll and benefits for sales, admin, and management staff
- Marketing, promotions, loyalty programs
- Insurance (general, product, D&O, etc.)
- Professional fees (legal, accounting not tied to inventory)
- Office expenses, software, travel, meals & entertainment
You still have to pay these costs to run the business.
You just don’t get to deduct them when you compute taxable income for federal purposes.
That’s why 280E often leaves operators feeling like they’re paying tax on money they never really “kept.”
A Simple 280E Example: How a Dispensary’s Taxable Income Blows Up
Let’s walk through a simplified example for a single cannabis retailer.
Scenario:
- Revenue: $4,000,000
Book P&L:
- COGS (product purchased for resale): $2,200,000 (55%)
- Gross profit: $1,800,000 (45%)
Operating expenses:
- Payroll & benefits (retail + admin): $900,000
- Rent & occupancy (retail, admin): $300,000
- Marketing & promotions: $80,000
- Insurance, licenses, software, other G&A: $220,000
Total operating expenses: $1,500,000
Book net income (pre‑tax):
- $1,800,000 – $1,500,000 = $300,000
If this were a non‑cannabis business, you might expect to pay, say, ~25–30% total on that $300k, leaving ~$210k–$225k in after‑tax profit.
Under 280E, you don’t get to that $300k by subtracting all those expenses.
For federal tax, taxable income might look more like:
- Revenue: $4,000,000
- Minus COGS only: $2,200,000
- Taxable income: $1,800,000
If your combined effective tax rate (federal + state) is, say, 40% in this simplified example:
- Tax: 40% × $1,800,000 = $720,000
But your book pre‑tax profit was only $300,000.
That’s how you get into situations where effective tax rates feel like 60–80% or more of book profit: you’re paying tax on something closer to gross profit, while still paying all your normal operating expenses in cash.
The planning game is:
- Maximize what can be legitimately included in COGS, and
- Keep overall operating expenses as lean and targeted as possible,
without crossing into positions that fall apart the moment an IRS agent asks, “Show me how you calculated this.”
Vertical‑Specific 280E Reality: Retail vs Cultivation vs Vertically Integrated
Retail / dispensaries
Biggest pressure points:
- Limited COGS (mostly product purchased for resale)
- High labor and security costs at the store level
- Expensive real estate and build‑outs in many markets
- Aggressive discounting and loyalty programs in competitive markets
Result: book EBITDA might look decent, but after 280E and taxes, cash yield is thin unless you are very disciplined on pricing, labor, and overhead.
Cultivation / manufacturing
Pros:
- Broader COGS categories under producer inventory rules
- More legitimate room to capitalize costs into inventory and COGS
Cons:
- Capex‑heavy, with long lead times for facilities and equipment
- More complex cost accounting and inventory management
- Yield risk, crop loss, and price volatility still apply
Done well, producers can sometimes achieve a more favorable 280E profile than pure retailers—but with higher operational and capital risk.
Vertically integrated operations
Potential:
- Capture margin at multiple points (cultivation → manufacturing → retail)
- Structure entities to separate COGS‑heavy activities from retail and services
Risk:
- More entities and intercompany transactions = more audit complexity
- Poorly designed structures that try to stuff everything into COGS are prime 280E targets
- If one part of the stack underperforms (e.g., cultivation), it drags everything else down
Vertical integration can improve overall economics—but only with coherent structure, cost accounting, and documentation.
CBD, Hemp, and Mixed Operations: Where 280E Gets Messy
Pure hemp/CBD businesses
If you:
- Work only with compliant hemp under the Farm Bill (≤0.3% delta‑9 THC), and
- Do not traffic in federally illegal THC products,
then, in general, 280E does not apply, and you can deduct ordinary business expenses like any other non‑cannabis business.
You still have:
- Inventory and COGS rules
- State and local tax complexity
- Potential scrutiny around how “hemp” your products really are
…but you’re not in the 280E penalty box strictly because of your product.
Mixed THC/CBD operations
If you:
- Sell both state‑legal THC products and CBD/hemp, or
- Manufacture blended products, or
- Run THC and CBD brands from shared entities and infrastructure,
you’re in a hybrid world.
Key questions:
- How is the business structured legally—separate entities, shared services, leases?
- How are books and records organized—can you cleanly separate 280E‑impacted activity from non‑impacted?
- Are you taking 280E positions based on reality, or on wishful allocations that won’t stand up to scrutiny?
Well‑designed structures might allow:
- One entity to operate non‑280E‑impacted business (pure hemp/CBD), with ordinary deductions
- Another to operate the THC business, with 280E limitations clearly applied
Poorly designed or sloppily executed structures invite the IRS to treat everything as trafficking, or to collapse entities together.
State‑Level Decoupling: 280E Isn’t Always the Whole Story
Even while federal 280E remains in place, some states have “decoupled” from 280E for state income tax purposes.
That means:
- For federal returns, you still apply 280E as usual.
- For state returns, your cannabis business may be allowed to deduct some or all ordinary business expenses, reducing state taxable income.
Practical implications:
- Your total effective tax burden can be lower than a straight “federal 280E + state 280E” stack.
- You may see a meaningful difference between your state tax and federal tax positions.
- Planning needs to consider both layers: federal and each state you operate in.
The list of decoupled states is evolving. Some have:
- Fully decoupled for licensed cannabis businesses,
- Partially decoupled, or
- Left things unchanged.
Because this is changing and state‑specific, the safe approach is:
- Assume federal 280E still applies until law or guidance says otherwise.
- Have your advisor confirm, for each state:
- Whether they follow or decouple from 280E
- Whether special rules apply only to licensed cannabis businesses
- How to reflect those differences in your returns and projections
Common 280E Audit Triggers and Pitfalls
A few patterns tend to draw attention:
- Huge swings in COGS year‑over‑year without clear explanation
- Unusually high COGS percentages compared to peers in the same market
- Complex entity structures with heavy intercompany charges but weak documentation
- Using “management companies” or “IP entities” primarily as 280E end‑runs, with no real substance
- Sloppy or nonexistent inventory records and cost‑allocation workpapers
When the IRS looks at a cannabis business, they typically focus on:
- Whether you applied the correct inventory rules for your type of business (reseller vs producer)
- How you determined which costs went into COGS vs were expensed
- Whether your books and returns tell a consistent, supportable story
If your 280E position boils down to “our previous CPA said it was fine,” you’re exposed.
Practical 280E Tax Planning: What Actually Helps
Within the constraints of the law, there are levers you can pull. High‑level examples:
Get serious about cost accounting and inventory
- Implement systems that track direct and indirect production costs at the level needed to support COGS allocations.
- Use acceptable inventory methods for your business type (e.g., 471‑based rules for resellers and producers), documented in writing.
- Align operational data (batches, yields, room usage) with financial data (cost allocations, absorption).
Design coherent, substance‑based structures
- Consider separating real estate, services, and plant‑touching operations where it makes sense economically and legally.
- Ensure each entity has real employees, contracts, and function—not just an invoice with “management fee” on it.
- Avoid structures created purely to “hide” costs in COGS with no operational justification.
Tighten operations to reduce non‑deductible bloat
280E makes inefficiency twice as expensive, because you:
- Pay the cost in cash, and
- Don’t get a tax benefit for most of it.
That puts a premium on:
- Labor discipline (scheduling, productivity, turnover)
- Smart rent and location decisions
- Efficient marketing and promotions, not endless discounting
- Lean, clean G&A—especially if you’re in a low‑margin market
Plan with realistic models, not best‑case scenarios
Work from models that:
- Start with realistic revenue, pricing, and margin assumptions for your state
- Build 280E and state decoupling into the tax line explicitly
- Show owner/investor cash flow after debt service and tax
- Include downside cases (price compression, wholesale disruption, regulatory cost spikes)
If your business only works in the “everything goes right” column, it’s not 280E‑ready.
The Future of 280E: Rescheduling, Reform, and Reality
You’ve seen the headlines:
- Rescheduling to Schedule III
- Reform proposals in Congress
- Industry groups lobbying to eliminate 280E for cannabis
Those efforts matter. Long term, they may reshape how cannabis is taxed.
But as of the last update to this guide:
- 280E is still in effect for plant‑touching cannabis businesses at the federal level.
- Rescheduling and reform are processes, not outcomes you can bank on.
- Banking your entire strategy on “280E going away soon” is how otherwise good operators end up in crisis.
The only safe way to plan is:
- Build a business that works with 280E baked in, and
- Be ready to benefit if/when the rules improve, rather than needing them to improve to survive.
280E‑Ready Cannabis Tax and Accounting With Northstar
If you’re still reading, you’re probably not looking for a generic explainer.
You’re asking:
- “What does 280E really do to my P&L and cash flow?”
- “How much can I legitimately move into COGS without blowing up in an audit?”
- “What’s the smartest way to structure our entities given our state, verticals, and investors?”
- “What do my investors or buyers see when they look at my numbers under 280E?”
That’s the level Northstar operates at.
We work with cannabis and CBD operators who need their finance and tax posture to be as dialed‑in as their operations—especially with 280E in the mix.
We help you:
- Turn messy, tax‑only books into 280E‑aware financials that lenders, investors, and regulators can follow
- Design and document COGS and inventory methodologies that optimize your position without crossing the line
- Build federal + state tax models that show the real after‑tax economics of your business, including decoupled states
- Structure and refine entities and intercompany agreements to add substance—not just more paper
- Prepare for audits and exams with a coherent story, workpapers, and documentation, not scramble‑mode spreadsheets
280E isn’t going away just because it’s painful. The businesses that survive and attract capital in this environment are the ones that confront it head‑on.
If you want to know what 280E really means for your operation—not in theory, but in dollars, margins, and owner cash flow—we’d be happy to walk through it with you
👉 Talk to Northstar Finance about a 280E Impact & Tax Strategy Review so that your next tax season—and your next raise or exit—is driven by a 280E plan you understand and believe in, not just a surprise at the bottom of your return.
