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.
State legalization does not override this. You can be 100% compliant in your state and still be treated as trafficking under federal tax law.
That is why a profitable cannabis business can feel like it is 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 grow, manufacture, distribute, or sell cannabis containing THC, you should assume 280E applies at the federal level unless and until the law actually changes.
CBD and hemp businesses
If your products are derived exclusively from compliant hemp (under 0.3% THC) and you do not handle any cannabis products, 280E generally does not apply. However, mixed operations that handle both THC and CBD products need careful structuring and accounting to separate the activities properly. If someone tells you CBD means no 280E without asking detailed questions about your products, sourcing, and structure, that is 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 are a reseller (dispensary) or a producer (cultivator or manufacturer).
For dispensaries (resellers)
COGS is generally limited to the purchase price of inventory, inbound freight and shipping costs, and any direct costs of receiving and inspecting product. COGS typically does not include budtender wages, store rent, marketing, or point-of-sale technology, as these are selling expenses rather than inventory costs.
For cultivators and manufacturers (producers)
Producers have more room in COGS under long-standing inventory rules (IRC Sections 471 and 263A). They can include direct materials, direct labor, facility costs allocable to production, production equipment depreciation, and qualifying indirect costs. The line between production and non-production costs is where a lot of 280E planning and audit risk lives.
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. This includes rent for non-production space, marketing and advertising, management salaries not tied to production, professional fees, office expenses, and most general overhead.
You still have to pay these costs to run the business. You just do not get to deduct them when you compute taxable income for federal purposes.
That is why 280E often leaves operators feeling like they are paying tax on money they never really kept.
A Simple 280E Example: How Taxable Income Grows
Consider a single cannabis retailer with $1,800,000 in revenue, $1,200,000 in COGS, and $300,000 in operating expenses (rent, payroll, marketing, etc.). Book net income before tax is $300,000.
If this were a non-cannabis business, you might expect to pay roughly 25-30% on that $300K, leaving around $210K-$225K in after-tax profit.
Under 280E, you cannot subtract all those operating expenses for federal tax purposes. Federal taxable income might be closer to $600,000 (revenue minus COGS only). At a combined 40% effective rate, that produces a tax bill of roughly $240,000 against only $300,000 in book profit.
That is how you get into situations where effective tax rates feel like 60-80% or more of book profit. You are paying tax on something closer to gross profit while still paying all your normal operating expenses in cash.
Vertical-Specific 280E Impact: Retail vs Cultivation vs Vertically Integrated
Retail and dispensaries
Retailers have the most limited COGS and therefore the least ability to offset revenue under 280E. 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 and manufacturing
Producers can include more costs in COGS under Section 263A, giving them a more favorable 280E profile. However, they also carry higher operational and capital risk. Done well, producers can sometimes achieve better after-tax results than pure retailers.
Vertically integrated operations
Vertical integration can improve overall economics by allowing more costs to flow through COGS on the production side. But this only works with coherent structure, cost accounting, and documentation. Poor implementation can actually increase audit risk.
CBD, Hemp, and Mixed Operations: Where 280E Gets Messy
Pure hemp and CBD businesses
If your products are derived from compliant hemp with under 0.3% THC and you do not handle any Schedule I substances, 280E generally does not apply. You can deduct ordinary business expenses like any other non-cannabis business.
Mixed THC and CBD operations
Well-designed structures might allow the CBD portion of the business to operate outside of 280E while the THC portion remains subject to it. This requires genuine separation of activities, books, and operations. Poorly designed or sloppily executed structures invite the IRS to treat everything as trafficking or to collapse entities together.
State-Level Decoupling: 280E Is Not Always the Whole Story
Even while federal 280E remains in place, some states have decoupled from 280E for state income tax purposes. These states allow cannabis businesses to deduct ordinary expenses on their state returns even though they cannot do so federally. The list of decoupled states continues to evolve. Because this is changing and state-specific, the safe approach is to work with an advisor who tracks these developments and can quantify the state-level impact for your operation.
Common 280E Audit Triggers and Pitfalls
A few patterns tend to draw IRS attention. Aggressive COGS classifications that include costs more properly categorized as selling or administrative expenses are a major trigger. Inconsistent methods year over year, especially when changes always increase COGS, also raise flags. Lack of documentation or formal cost studies supporting your COGS position is another common issue.
When the IRS looks at a cannabis business, they typically focus on whether COGS classifications are supported by contemporaneous records, whether allocation methods are consistent and reasonable, and whether the entity structure has genuine business substance.
If your 280E position relies on a prior accountant saying it was fine without supporting documentation, you are exposed.
Practical 280E Tax Planning: What Actually Helps
Within the constraints of the law, there are levers you can pull.
Get serious about cost accounting and inventory
A formal Section 263A cost study can identify indirect costs that legitimately belong in COGS. For producers, this often adds six figures to defensible COGS. For retailers, proper inventory costing methods ensure you are capturing every dollar of product cost and freight.
Design coherent, substance-based structures
Entity separation can create legitimate deduction opportunities for non-cannabis activities, but only if the structure has real business purpose, separate operations, and proper documentation. The IRS has successfully collapsed structures that were created purely for tax avoidance.
Tighten operations to reduce non-deductible overhead
280E makes inefficiency twice as expensive, because you pay the cost and you get no tax benefit from it. Every dollar of unnecessary overhead is a dollar lost with no offset.
Plan with realistic models, not best-case scenarios
If your business only works in the everything-goes-right column, it is not 280E-ready. Build financial models that account for the actual tax burden you will face.
The Future of 280E: Rescheduling, Reform, and Reality
There have been ongoing efforts toward rescheduling cannabis, passing the SAFE Banking Act, and introducing other legislative reforms. Those efforts matter and may reshape how cannabis is taxed in the long term.
But as of this writing, cannabis remains Schedule I, 280E remains in effect, and no legislative fix has been enacted. The only safe way to plan is to assume 280E will apply for the foreseeable future and build your business to thrive under current law. If reform happens, treat it as upside rather than a baseline assumption.