IRC 280E FAQ

Yes — 280E is federal law, not state law. It applies to every cannabis business operating anywhere in the United States, regardless of whether your state has legalized cannabis. Federal law (Controlled Substances Act) classifies cannabis as Schedule I, and 280E applies to any business trafficking in Schedule I substances. State legality does not exempt you from federal tax law. The same rules apply whether you're in San Diego or Denver.

COGS reduces gross income; operating expenses are what 280E blocks. Cost of Goods Sold — the direct cost of acquiring or producing inventory — reduces your gross income under IRC Section 471, which governs inventory accounting. Because 280E only blocks Section 162 (ordinary business expenses) deductions, COGS remains fully deductible. Operating expenses — rent, marketing, non-production salaries, insurance, legal fees — fall under Section 162 and are non-deductible. See our full COGS calculation guide for how to classify specific expenses.

Very limited ones. A dispensary with no production operation can deduct only the acquisition cost of inventory as COGS. If you also cultivate or process, your production staff, direct materials, and production overhead can flow through COGS. Some operators attempt to structure separate non-cannabis business activities in distinct entities to argue those aren't subject to 280E — courts have rejected this when the "separate business" lacked real economic substance. Standard expenses like rent, advertising, admin salaries, and professional fees are non-deductible under 280E.

Each state files separately; 280E applies federally everywhere. State tax treatment varies significantly. California and Oregon have partially decoupled from 280E at the state level — meaning you can deduct normal operating expenses on your state return even though you cannot on your federal return. Colorado has a similar approach. Other states follow federal rules. Multi-state operators need a chart of accounts that tracks expenses by state and by function (production vs. non-production) from the start. Retroactive cleanup is expensive and error-prone.

More than most operators think. The IRS audits cannabis businesses at significantly higher rates than almost any other industry. Required documentation includes:

1. Inventory acquisition records — purchase orders, invoices, and receiving records for every inventory purchase.
2. Production cost records — time cards for production employees, utility invoices allocated by facility area, equipment depreciation tied to production.
3. Written COGS allocation methodology — a documented explanation of how you determined which costs count as COGS.
4. Chart of accounts by function — production vs. non-production, with consistent allocation keys for shared costs.
5. Intercompany transfer pricing documentation if you operate multiple entities.

Inadequate records is the most common reason deductions get disallowed in cannabis tax audits.

280E would stop applying. Section 280E specifically targets businesses trafficking in Schedule I or Schedule II controlled substances. If cannabis moves to Schedule III, it falls off that list — and cannabis businesses could deduct normal operating expenses like any other business. This would be the single largest financial change in the industry's history. However, rescheduling is not yet final. Until it officially takes effect, 280E compliance is mandatory. Read our full breakdown of the rescheduling timeline and what to do now.