The do’s and don’ts of cannabis 280E tax avoidance - how not to trip landmines
Introduction: The Challenge of Cannabis Income Tax
Cannabis income tax is one of the most complex and burdensome issues facing today’s cannabis operators. While the industry presents exciting opportunities and attracts bold entrepreneurs, it also comes with unique obstacles. These include market oversaturation, high barriers to entry, and—perhaps most challenging of all—unfavorable financial regulations.
Among these, the biggest roadblock is the infamous IRC Section 280E, which can turn a profitable cannabis company into one that operates at a loss. For many cannabis business owners, navigating these tax burdens is the difference between survival and failure.
Section 1: Understanding IRC 280E and Its Impact
IRC Section 280E states that any business trafficking in a controlled substance is not allowed to claim tax deductions or credits against gross income. Because cannabis is still federally classified as a Schedule I substance, even state legal cannabis companies fall under this rule.
The IRS purposely wrote this section vaguely, leaving most interpretations to court rulings and surrounding tax law which results in confusion, legal battles, and additioanl uncertainty in the cannabis industry.
The key to success is learning how to maximize what you can do under the law while avoiding what you cannot. For cannabis CEOs, who are often risk-takers by nature, it’s tempting to push the limits. But when it comes to the IRS, aggressive tax positions often backfire.
Section 2: Failed Strategies and Court Cases Every Cannabis Operator Should Know
Over the years, many cannabis businesses have tried—and failed—to find loopholes around 280E taxation.
Harborside Case: Probably largest cannabis tax court case to date, Harborside tried deducting expenses, reclassifying costs into cost of goods sold (COGS), and even claiming producer status rather than reseller. The IRS rejected virtually all arguments, resulting in back taxes, penalties, interest. All for the small price of very high legal fees to defend these unsustained positions.
Alternative vs. Commissioner: This case involved using a management company to handle payroll and administration. The IRS ruled the entity was still “plant touching,” disallowing deductions and causing double taxation.
IRC 471C Strategy: Some companies attempt to use 471C (a provision for businesses under $25 million in gross receipts, adjusted for inflation annually) to shift costs into inventory. However, IRS guidance explicitly states that expenses disallowed under 280E cannot simply be moved into COGS. Ongoing cases, like Alternative Therapies Group, show that the IRS continues to fight these strategies aggressively.
IRS comment on 471(c): “…some taxpayers may interpret section 471(c)… as permitting a taxpayer to capitalize a cost to inventory for Federal income tax purposes… irrespective of: (1) whether the amount is deductible or otherwise recoverable for Federal income tax purposes; or (2) when the amount is capitalizable under the taxpayer’s overall method of accounting used for Federal income tax purposes. The Treasury Department and the IRS do not agree with this interpretation.” - Internal Revenue Bulletin: 2020-34
Other common ideas, like filing protective claims for refunds in case 280E is ever deemed unconstitutional, are not without risk either. These approaches almost always invite audits, which are costly, time-consuming, and expose investors to an audit as well. No bueno.
If the strategy sounds like a loophole, it probably has other holes in it too.
Section 3: Avoiding Tax Landmines in Cannabis Accounting
As a CPA, I tell clients that smart cannabis accounting isn’t about risk aversion—but it’s about avoiding landmines. The first rule of money is simple: don’t lose money. Playing games with the IRS is a fast way to do just that.
Contrary to popular belief, tax is not a gray area. There are clear rules, established precedents, and court cases that guide us. The best cannabis tax strategies involve respecting these rules, not trying to outsmart them.
By focusing on what’s proven to work, you can protect your business from audits, penalties, and financial collapse.
Section 4: Playing the Long Game in Cannabis Business Taxation
Cannabis companies that generate steady revenue and avoid risky tax positions are far more likely to attract investors and survive long term. While the present tax burden is heavy, the enterprise value of cannabis businesses remains strong.
Yes, there’s a holding cost—operating under 280E until federal rescheduling happens is difficult. But those who stay compliant and financially disciplined will be well-positioned when regulations eventually change.
In other words: the winners in this industry are those who can stay alive long enough to reap the rewards.
Section 5: Smart, Legal Strategies to Reduce Cannabis Taxes
So how can cannabis businesses legally minimize their tax burden under 280E? The answer lies in maximizing cost of goods sold (COGS) within the boundaries of the law.
GAAP Cost Absorption Accounting: Costs directly tied to inventory can be capitalized and deducted once the product is sold. For producers, this can include materials, labor, and overhead tied to production.
Producer vs. Reseller Advantage: Producers generally have more expenses they can legally include in COGS compared to resellers. Identifying correctly is critical.
Cash Basis Accounting: When possible, using the cash method can help delay taxes, pushing liabilities into the future—likely when cannabis tax policy will be more favorable.
In many cases, clients are able to allocate a healthy amount of expenses into inventory through proper accounting, dramatically reducing taxable income. This isn’t shady—it’s simply applying the rules correctly in an inventory-based business.
Conclusion: Building Sustainable Cannabis Companies
The path forward isn’t about fighting the IRS—it’s about playing the game right. By avoiding risky tax strategies and focusing on sound cannabis accounting practices, businesses can remain profitable, attract investors, and increase enterprise value.
If you want help structuring your cannabis business accounting correctly, avoiding tax landmines, and maximizing your cost of goods sold legally, I’d love to connect. Book a call now and let’s get you taken care of.
Stay smart,
Jonathan Sussman CPA
