The federal Internal Revenue Code Section 280E, originally enacted in 1982 to prevent drug traffickers from deducting business expenses for Schedule I or II substances, continues to impose severe constraints on state-licensed cannabis businesses. While operators may deduct cost of goods sold (COGS), they are barred from deducting ordinary and necessary business expenses such as rent, wages, utilities, marketing, and depreciation. That leaves cannabis companies taxed on gross profit, not net—an anomaly in modern business taxation.
Disproportionate Burden on Margins and Cash Flow
Industry data shows that due to the 280E restriction, cannabis businesses often face effective federal tax rates exceeding 70%, far above the standard 21% corporate tax rate. For dispensaries in particular, margins are crushed. Analysts estimate that in 2022, cannabis operators paid at least $1.8 billion in excess federal taxes, with that total projected to increase to $2.1 billion by 2023.
In one illustrative example cited by the IRS, a marijuana retailer with $1 million in revenue, $750,000 COGS, and $200,000 of non-deductible expenses would carry a federal tax liability of $75,000. If ordinary deductions were permitted, the federal tax would be $15,000—a five-fold increase in tax expense due solely to 280E.
Financial Innovation Meets Legislative Inertia
Some cannabis operators have explored accounting strategies under IRC § 471(c), which allows small taxpayers (under $27 million in revenue) to report inventory based on their underlying books, potentially reclassifying some previously non-deductible costs into COGS. However, the IRS has not provided clear guidance and the method remains complex and uncertain.
Larger multistate operators are seeking “non-280E” positions—filing amended returns or taking tax positions on current filings with legal opinions arguing Section 280E should not apply to their state-legal business models. To date, the IRS has declared that taxpayers are not entitled to refunds for prior payments under 280E and has warned about lack of reasonable basis in unsupported legal arguments.
Rescheduling Offers Hope—but Reform Remains Distant
Federal policy changes could dramatically alter the landscape. The Department of Justice and DEA have initiated a proposed rule to reschedule cannabis from Schedule I to Schedule III, and agency feedback began in mid-2024. That change could effectively remove the 280E restriction and permit standard business deductions for cannabis businesses.
Analysts and industry leaders estimate that rescheduling would yield tens of millions in annual savings for major operators. For example, MariMed’s CEO projected that repeal of 280E could free “millions of extra cash flow every year” to reinvest in growth and employees. Similarly, Verano expects to pay $80–100 million in combined state and federal 280E taxes in one year.
Yet even as companies await rescheduling, the IRS insists that previous overpayments will not be refunded and that 280E remains in effect until formal rulemaking is complete.
Operational Implications and Strategic Constraints
Because cannabis operators must pay taxes on gross income rather than net, many otherwise profitable companies see negative cash flow. That restricts available capital for expansion, inhibits hiring or research and development investments, and forces higher retail prices. Some firms report that 280E has directly caused closures or hindered scale.
Federal tax penalty also disincentivizes compliance innovation. Dealers forced into cash-heavy operations due to banking restrictions compound complexity, as they must coordinate tax payments in physical cash.
Meanwhile, state governments that conform to federal rules also deny state-level deductions, although a few states—including New York, California, Oregon, and Massachusetts—have decoupled their tax codes to allow full deductions at the state level. While that helps, state exemption cannot offset the crushing burden of federal policy.
Looking Ahead: Rescheduling and Beyond
Cannabis businesses continue to press for policy reforms. A move to Schedule III could legally eliminate the application of 280E and allow cannabis firms to deduct ordinary business expenses. That shift is seen by industry insiders and the U.S. Cannabis Council as the only permanent remedy to the tax penalty.
But until rescheduling is finalized and IRS guidance issued, cannabis operators remain trapped in a high-tax framework that treats regulated businesses more like illicit dealers. The tax law today undermines state-led legalization goals by discouraging legitimate markets, raising prices, prompting closures, and depressing long-term investment.
In review, Section 280E continues to exact a heavy toll on cannabis industry profitability. It dramatically raises tax burdens, distorts business decision-making, and undermines growth—even in fully compliant, state-sanctioned companies. While potential rescheduling offers a ray of hope, its timing and effect remain uncertain. Until federal law catches up, cannabis operators must navigate deeply unequal taxation—in effect, financing federal policy resistance with sky-high taxes on their own growth.