You’re running (or planning) a cannabis business with partners. You’re juggling licensing, compliance, cash management, staff, and product. Then tax season hits and you realize: this industry plays by a completely different set of rules.
Cannabis partnership taxes are not just “normal partnership taxes plus a few quirks.” IRC 280E, state rules, and partnership agreements all collide in ways that can make or break your cash flow – and your relationships with co‑owners.
This guide walks through:
- How cannabis business taxes work under 280E
- How partnership taxes operate for cannabis LLCs and partnerships
- Why operating agreements are a key tool for surviving 280E
- Planning ideas and common structures used in cannabis partnerships
- FAQs about cannabis partnership taxes, distributions, and deductions
Use this as a roadmap for conversations with your CPA and attorney, especially if you’re revisiting your operating agreement or thinking about bringing in (or buying out) a partner.
Cannabis Business Taxes and IRC 280E
Most of the pain in cannabis partnership taxes starts with one short section of the Internal Revenue Code: IRC 280E.
What is IRC 280E?
IRC 280E says that a business trafficking in Schedule I or II controlled substances cannot deduct ordinary and necessary business expenses for federal income tax purposes.
For a licensed cannabis business, that means:
- No deduction for rent
- No deduction for wages and payroll tax
- No deduction for marketing, professional fees, insurance, utilities, etc.
The one big exception: cost of goods sold (COGS).
What can a cannabis partnership usually include in COGS?
The exact calculation can be nuanced, but generally COGS can include:
- Direct product costs (raw materials, wholesale purchase price)
- Certain direct labor tied to production
- Some indirect production costs, depending on how your operation is structured and how inventory accounting rules apply
Operating and overhead costs that are common in other industries often get stuck on the wrong side of 280E and are not deductible.
For a cannabis partnership, this means your taxable income can be much higher than your cash profit feels. And that inflated taxable income flows straight through to the partners.
How Partnership Taxes Work for Cannabis Businesses
Most multi‑owner cannabis businesses are structured as LLCs taxed as partnerships. That choice has big tax and legal implications.
Pass‑through taxation
In a partnership:
- The entity itself normally does not pay federal income tax
- Instead, the partnership files Form 1065 and issues a Schedule K‑1 to each partner
- Each partner reports their share of income, deductions, credits, etc. on their personal or corporate return
With 280E in the picture, the partnership’s taxable income can be much higher than expected, and that higher number is what gets reported on each partner’s K‑1.
Allocations and Ownership: Who Gets Taxed on What?
Partnerships have flexibility to allocate income, loss, and deductions among partners, as long as allocations have substantial economic effect under the tax rules.
Your operating agreement should spell out:
- Ownership percentages
- How profits and losses are allocated
- Treatment of guaranteed payments (for partners who work in the business)
- Special allocations, if any (for example, to an investor who put in more capital)
In a cannabis partnership, these decisions are magnified by 280E. If taxable income is high because of disallowed deductions, that income still gets allocated somewhere – and partners still face tax on it.
Tax distributions
Here’s where a lot of cannabis partnership disputes start:
- The partnership shows taxable income (because 280E disallows deductions)
- Cash in the bank is much lower (because rent, payroll, and overhead still had to be paid)
- Partners get K‑1s with large taxable income and no cash to pay the tax
This is why many operating agreements include “tax distribution” provisions – requiring the partnership to distribute enough cash to help partners cover the tax hit, at least to a certain percentage.
In cannabis, those tax distributions can be substantial and need to be planned for.
How 280E Interacts With Cannabis Partnership Taxes
Let’s put these pieces together: partnership rules + 280E + a cannabis business.
280E Disallows Deductions at the Entity Level
For a partnership:
- The partnership calculates its income
- 280E disallows a big chunk of deductions (especially overhead)
- The resulting higher taxable income flows through to the partners via K‑1s
Partners are taxed even if:
- The business is still “scaling”
- Cash has been reinvested
- There were large non‑deductible expenses (rent, wages, etc.)
The Effective Tax Rate can be Brutal
Because 280E inflates taxable income, the effective tax rate on the true economic profit can be very high. For example:
- The partnership earns $500,000 in gross profit
- It spends $400,000 on rent, salaries, marketing, and other overhead
- Economic profit: $100,000
- But if much of that $400,000 is disallowed under 280E, taxable income could be closer to $500,000 than $100,000
That $500,000 is then allocated among the partners. They pay tax as if they earned much more than their share of the actual cash profit.
Partnership Vs Corporation Under 280E
Here’s a simplified comparison of how 280E hits different federal entity types.
| Entity type | Who pays tax? | How 280E shows up |
| C‑corporation (C‑corp) | Corporation pays corporate income tax | 280E disallows deductions at corp level |
| S‑corporation (S‑corp) | Income passes through to shareholders | 280E inflates pass‑through taxable income |
| Partnership / LLC (taxed as partnership) | Income passes through to partners on K‑1s | 280E inflates pass‑through taxable income |
| Single‑member LLC (disregarded) | Owner reports on own return | 280E disallows deductions at owner level |
Partnerships don’t escape 280E. They just pass the impact directly to owners.
Why Operating Agreements Matter So Much For Cannabis Partnerships
Operating agreements often get treated as a formality at startup. In a 280E world, they’re a key part of tax and risk management. Here are core operating agreement topics that matter for cannabis partnership taxes:
Profit and loss allocations under 280E
Your operating agreement should clearly answer:
- Are profits allocated strictly based on ownership percentages?
- Are there any special allocations (for example, to a partner who provided a license, IP, or large capital infusion)?
- How are losses handled, given that 280E often limits deductions and can distort economic results?
Because taxable income can be much higher than cash profit, partners need to understand how that pain is shared.
Tax distributions for cannabis partners
Many cannabis partnerships include a provision that says something like: “To the extent cash is available, the partnership will make distributions sufficient to cover estimated tax liabilities, using a specified tax rate (for example, the highest combined federal and state rate reasonably expected).”
Key decisions for your operating agreement:
- Is there a tax distribution requirement at all?
- How is the rate determined? (e.g., highest marginal rate vs. each partner’s actual rate)
- Are tax distributions treated as advances against future profits?
- What happens if the partnership doesn’t have enough cash to fund tax distributions?
This is one of the main areas that prevents resentment between a working partner and an investor partner in a cannabis business.
Capital contributions and capital calls
Cannabis is capital‑intensive. With 280E added, cash flow can be tight.
Your agreement should address:
- Initial capital contributions for each partner
- Whether additional capital contributions can be required (capital calls)
- What happens if a partner can’t or won’t contribute when needed
Sometimes, capital calls arise specifically because 280E taxes are eating into cash. Your agreement should anticipate that scenario, not ignore it.
Guaranteed payments to partners
Working partners often receive guaranteed payments (similar to a salary for tax purposes). These:
- Are taxed to the recipient as ordinary income
- Reduce the partnership’s income for non‑cannabis businesses
- In cannabis, can be caught by 280E, meaning they don’t reduce taxable income the way you might expect
Your operating agreement should:
- Spell out who receives guaranteed payments
- Clarify whether they continue during low‑cash periods
- Coordinate with 280E planning so guaranteed payments don’t create unexpected tax spikes
Exit, buyouts, and changes in tax law
With federal law possibly shifting in the future, your agreement should at least touch on:
- What happens if federal law changes and 280E is repealed or modified
- How buyouts or partner exits are valued, especially if the business suddenly becomes more profitable after a law change
- How partners handle past tax exposures if the IRS audits prior years
This isn’t about predicting the future – it’s about acknowledging that tax rules for cannabis are unusually sensitive to legal changes and planning for that in your partnership structure.
Common Cannabis Partnership Structures And Tax Angles
Every cannabis operation is unique, but a few patterns show up repeatedly.
Single Entity: Operating Llc Taxed As A Partnership
This is the most straightforward:
- One cannabis license
- One LLC taxed as a partnership
- Owners are members of the LLC
Pros:
- Simpler to administer
- Only one set of financials and tax returns
- Easy to explain to investors and lenders
Cons:
- 280E applies to the entity’s operations, inflating taxable income
- Harder to separate different risk pools (e.g., real estate vs operations)
Multi‑entity Structures
Some groups use more than one entity to separate activities, such as:
- A licensed operating entity that handles plant‑touching activity
- A separate real estate entity that owns the property
- A management company that provides certain services
The goals can include:
- Separating legal risk
- Managing ownership restrictions under state law
- Isolating certain income streams
Tax authorities pay close attention to these setups. If they’re mostly designed to avoid 280E without any real economic substance, they can be challenged.
If you use a multi‑entity model:
- Each entity’s role should be clear and commercially reasonable
- Intercompany agreements should be documented
- Your CPA should model how 280E applies (and doesn’t apply) to each entity
Investors Vs Working Partners
It’s common in cannabis partnerships to have:
- Investor partners who contribute capital and expect a preferred return or priority on distributions
- Operating partners who contribute time and expertise and may take guaranteed payments
Your operating agreement should:
- Coordinate profit allocation, preferred returns, and tax distributions
- Clarify what happens if 280E makes the tax bill high while cash is tight
- Protect both sides from surprises during audits or law changes
Planning Strategies For Cannabis Partnership Taxes
None of the following is a silver bullet. But they are recurring themes in well‑run cannabis partnerships that take taxes seriously.
COGS optimization and documentation
Because 280E allows COGS, many cannabis businesses work closely with their CPAs to:
- Correctly classify expenses between COGS and non‑deductible operating costs
- Choose and apply consistent inventory accounting methods
- Maintain documentation that supports their COGS methodology in case of audit
Overly aggressive COGS positions can backfire, so this is an area for careful, documented judgment – not guesswork.
Operating agreement tax provisions
Consider including, and actually using, the tax‑related tools in your operating agreement:
- Clear profit and loss allocation language
- Tax distribution provisions with realistic assumptions
- Rules for handling IRS or state audits and partnership‑level adjustments under the centralized audit regime
- Limits on unilateral decisions that affect taxable income (for example, large discretionary spending)
Cash flow and estimated taxes for partners
Because taxable income can exceed cash profit, partners need a plan for:
- Estimated tax payments throughout the year
- How tax distributions fit into the partnership’s cash budget
- What happens in a year with high taxable income but tight cash (for example, after expansion or a big capital project)
Ignoring estimated taxes until April often leads to panic for both the business and the partners.
State tax and 280E decoupling
Some states have passed laws that decouple from 280E, allowing cannabis businesses to deduct more expenses at the state level, even though they’re disallowed federally.
The specifics change frequently, but states that have adopted some form of relief include, for example:
- California
- Colorado
- New York
- Massachusetts
- New Jersey
- Michigan
- Oregon
- New Mexico
- Connecticut
This list is not complete and the rules in each state differ (some allow full relief, others partial or only for certain license types).
| Level | Treatment of 280E for licensed cannabis business |
| Federal | 280E fully applies; only COGS allowed |
| Some states | Provide partial or full 280E relief for state income tax |
| Other states | Follow 280E similar to federal rules |
For a multi‑state cannabis partnership, your agreement and tax planning should acknowledge:
- Different state tax burdens by location
- Possible special allocations or adjustments if one location faces a higher net tax load
- The impact on cash distributions to partners
Next steps for your cannabis partnership
If you’re already operating or planning a multi‑owner cannabis business, here are practical steps to move forward:
- Pull out your operating agreement
- Confirm how profits, losses, and tax distributions actually work
- Make sure 280E realities are reflected, not ignored
- Meet with a cannabis‑savvy CPA
- Review your COGS methodology and documentation
- Model your tax exposure under 280E for the next 1–3 years
- Coordinate your legal and tax strategy
- If anything in your structure or agreement doesn’t match economic reality or tax planning, bring your attorney and CPA into the same conversation
- Talk openly with your partners
- Align expectations on tax distributions, reinvestment of cash, and how 280E affects everyone’s personal tax situation
Cannabis partnership taxes can be harsh, but with the right structure and a thoughtful operating agreement, you can reduce surprises, protect relationships, and keep your focus on growing the business – not just reacting to the tax bill.
How Northstar Financial Advisory Helps Cannabis Partnerships Tackle Taxes and 280E
Running a cannabis business with partners is demanding enough without wondering whether 280E and partnership tax rules are quietly draining your cash. The stresses around taxable income, K‑1s, and operating agreement gaps are real — especially if you’re trying to grow while staying compliant.
This is exactly where Northstar Financial Advisory comes in.
Our dedicated cannabis accounting and 280E planning services are built for multi‑owner cannabis operators. Through our 280E Accounting and Cannabis Accounting solutions, we help you:
- Build books that clearly separate COGS and non‑deductible expenses
- Model how 280E and partnership allocations affect each partner’s tax bill
- Design tax‑aware policies for profit allocations and tax distributions
- Coordinate with your attorney so your operating agreement actually matches how the numbers work
We also support cannabis partnerships with Cannabis Bookkeeping and Tax Compliance and Strategy, so monthly records, state filings, and federal returns are consistent and audit‑ready.
When you work with Northstar, you’re not just getting someone to close the books. You’re getting a partner who understands both the rules of 280E and the practical realities of running a cannabis business with multiple owners — from cash flow pressure to partner expectations.
If you’re unsure whether your current structure, operating agreement, or tax approach is helping you or holding you back, it’s a good time to get a second look.
Talk to Northstar Financial Advisory about your cannabis partnership taxes and explore how to align your entity, operating agreement, and tax strategy before the next return is due.
FAQs
Are cannabis partnerships taxed differently from other partnerships?
The partnership rules themselves are similar: pass‑through taxation, K‑1s, allocations based on the operating agreement.
The difference is 280E:
- Many expenses that would be deductible for a non‑cannabis partnership are disallowed
- That pushes taxable income higher
- Partners pay tax on that higher income, even if cash profits are modest
So the structure is the same; the outcomes are often much more painful.
Does 280E apply to an LLC taxed as a partnership?
Yes, if the LLC is engaged in federally illegal cannabis activity, 280E applies regardless of entity form.
- Single‑member LLC? The owner feels the impact on their return.
- Multi‑member LLC taxed as a partnership? The partnership’s deductions are limited by 280E, and the inflated taxable income flows through to partners.
Can a cannabis partnership deduct salaries and rent?
For federal income tax:
- Salaries, payroll tax, rent, and most operating expenses are not deductible due to 280E
- The main federal deduction available is COGS, subject to inventory rules
For state income tax:
- Some states allow cannabis businesses to deduct these expenses at the state level because they decouple from 280E
- Others follow the federal rule and disallow those expenses
So the answer is different at the federal and state levels.
How are distributions from a cannabis partnership taxed to partners?
Distributions themselves are not usually taxable if:
- The partner has sufficient basis in the partnership
- The distribution doesn’t exceed that basis or trigger specific gain rules
However:
- Partners are taxed on their share of partnership income, whether cash was distributed or not
- Distributions help cover the tax but do not by themselves reduce taxable income
In cannabis, the real issue is that 280E inflates income, and distributions may not keep up with the resulting tax bill unless the operating agreement requires tax distributions.
How should a cannabis operating agreement address 280E?
There’s no one‑size‑fits‑all template, but strong cannabis operating agreements often include:
- Explicit recognition that the business is subject to 280E
- Clear rules for profit and loss allocations under those conditions
- Tax distribution provisions that aim to cover partners’ tax liabilities
- Guidance on how to approach COGS and taxable income calculations, at least at a policy level
- Procedures for handling audits and law changes
Your attorney and CPA should work together so that the operating agreement matches the tax reality of your business.
Is a partnership or corporation better for a cannabis business under 280E?
Each has trade‑offs:
- Partnership / LLC taxed as a partnership
- Pros: Flexibility, pass‑through losses in early years (subject to limitations), customizable ownership
- Cons: 280E‑inflated income flows straight to partners, who may face high individual rates
- C‑corporation
- Pros: Corporate tax rate may be lower than top individual rates; simpler profit allocation
- Cons: Potential double taxation (corporate level plus dividends); 280E still applies at the corporate level
The “better” choice depends on your investors, growth plans, state rules, and exit strategy. It’s a business and tax decision, not just a legal formality.
