The High Cost of Cannabis: How Dispensaries Can Navigate the IRS’s Code 280e

For those of us in the cannabis business, few topics spark more outrage and dread than an innocent-sounding string of letters and numbers: Code 280e. But the code—an ‘80s-era addition to United States tax law—is anything but innocuous. It’s the section of law that prohibits those profiting from federally scheduled substances from deducting nearly all normal business expenses.

In effect, this means that cannabis businesses are prohibited from taking the normal tax deductions any other business would be entitled to.

One of the principal upshots is that with Code 280e in place, it’s vastly more challenging for cannabis businesses to be profitable.

That’s common knowledge, at least among those who follow the cannabis industry. But there’s another, far less reported one.

According to IRS documents obtained by Marijuana Business Daily through a Freedom of Information Act (FOIA) filing, the IRS has devoted a great deal of effort to conducting audits of the legal cannabis industry.


Simple: It makes the tax agency money. A lot of it.

We’ll share the story of Code 280e, along with what’s known about the IRS focus on the cannabis industry. Best of all, we’ll share a few best practices businesses such as dispensaries can employ to lower their tax burden, at least until a more judicious and permanent solution to the issue can be found.

IRS Code 280e: History of a Tax Law Focused on Controlled Substances

Back in the 1970s, a man named Jeffrey Edmonson was engaged in the sale of controlled substances, including amphetamines, cocaine, and cannabis. After he was arrested and imprisoned, the IRS audited his 1974 tax return, knowing that this was a year in which he had profited from his illegal schemes. The agency was simply hoping to deepen the sting by extracting back taxes. But Edmonson turned the tables on the IRS, suing the agency in federal court in 1981 and, remarkably, winning.

How? By reconstructing a paper trail of his transactions, Edmonson claimed the COGS, including the drugs he had bought and sold. He even included the cost of telephone, auto and rental expenses. After this humiliating defeat, Congress quickly revamped the tax code to exclude scheduled substances from COGS calculations. The name of this tax amendment? You guessed it: Code 280e.

Until the start of the legal cannabis industry, Code 280e didn’t attract a great deal of attention. But once states such as Colorado and Washington kick-started the Green Wave, that little-noticed bit of law became a very big deal indeed. Soon, because they couldn’t deduct the COGS from their tax filings, legal cannabis enterprises were being hit with outrageously high taxes. According to some analysts, businesses were being forced to pay as much as 90%—in some cases even more—of their revenue to the IRS. In 2017, for instance, the agency collected $4.7 billion in cannabis-related taxes on slightly less than $13 billion in sales.

What’s more, this imbalance is no accident. According to the IRS documents we referenced above, the agency has been targeting cannabis-related enterprises for special scrutiny. Why? No great surprise there: IRS audits of such businesses can earn the tax agency up to four times what audits of typical mainstream businesses usually net.

Unfortunately, it doesn’t look as though this policy will change any time soon. This February, the then-new Biden administration signaled its intent to continue aggressive enforcement of Code 280e. Despite the conciliatory talk from some members of the administration, in particular Vice President Kamala Harris, this move clearly signals a doubling down on the current regulatory policy, not a reprieve for legal cannabis entrepreneurs. And while encouraging signals about the federal de-scheduling of cannabis continue to bubble up, the fact is that we can expect Code 280e to remain with us for the foreseeable future.

280e tax code

IRS Code 280e: Tactics to Reduce Your Liability

Fortunately, there are a few steps you can take to reduce your tax burden. Many tax law experts recommend these specific actions to take.

Document thoroughly.

We know the cannabis industry already requires a great deal of record-keeping and tracing; we know it adds a real-world burden to the challenges of doing business. But the fact remains: Making sure that all of your expenses are documented clearly and precisely can save you a lot of money down the road.

As an example, in 2018, one Colorado cannabis retailer was found liable for over $75,000 in penalties because she didn’t separate her cannabis-related expenses from her non-cannabis ones.

Keep accurate and specific records, back up your data regularly, and make sure that more than one person in your organization has knowledge of and access to financial information.

Use the best software you can afford.

Using a software platform tailored specifically to the cannabis industry will help you keep accurate records and deliver the IRS the information they need quickly and painlessly. 

Know your deductions.

Because the opportunities for tax deductions are so limited for cannabis businesses, it’s essential that you use each one you can. For cannabis producers, these include:

  • Invoice price of any cannabis purchased and sold
  • Transportation costs, including the cost and shipping cost of cannabis, and any travel costs
  • Electricity purchased (for inventory areas only, not sales areas)
  • Raw materials and cultivation supplies, such as seeds, fertilizer, and other botanical costs
  • Direct pre-sale labor: harvesting, trimming, cleaning, and packaging. for instance
  • Indirect costs such as equipment maintenance, and any tools required

For dispensaries, sadly, the options are even more limited. They include the cost of the product and expenses related to acquiring merchandise, such as transportation costs.

Obviously, we’re hoping this changes soon. But for the moment, the best you can do is keep accurate records and follow the law.