In an industry defined by barriers to entry, constant legal challenges, and burdensome regulations and restrictions, an outdated tax code is the last thing legal cannabis businesses need.

Behold: Internal Revenue Code (IRC) Section 280E.

Deep in the Internal Revenue Service’s mountain of tax provisions (known as the Internal Revenue Code) lies a little-known provision that has consequential implications for legal cannabis businesses. Section 280E is simple—those “trafficking” Schedule I and II substances are prohibited from claiming tax deductions and credits when paying federal income tax. Since cannabis is still categorized by the federal government as a Schedule I substance under the Controlled Substances Act, even businesses that operate legally under state authority and regulation are subject to prohibitionist federal policies like Section 280E. Further, most states (even those with legal cannabis) conform their tax laws to Section 280E, extending restrictions into state tax deductions.

For the typical non-cannabis business calculating their federal tax liabilities,the cost of goods sold (COGS) and “ordinary and necessary” business expenses (such as employee salaries, rent, insurance, etc.) are deducted from their taxable income. Under Section 280E, cannabis businesses are only permitted to deduct COGS, while those ordinary and necessary expenses are deemed non-deductible. Examples of ordinary and necessary expenses that all other businesses typically deduct from their tax liability include employee salaries, utilities, license fees, and professional services. As a result, cannabis businesses pay a substantially higher amount of federal income taxes compared to non-cannabis businesses—total rates as high as 75-80% according to some reports. 

Combine this reality with other tax burdens, like state corporate income taxes, state sales taxes, state excise taxes, and local sales taxes, it’s abundantly clear that cannabis businesses face a taxation nightmare. The current tax environment recognizes the cannabis industry as a cash cow—but by no means is this cow free to graze. By maintaining prohibition, the federal government is athanksble to generate more tax revenue on the backs of cannabis businesses,  to Section 280E.

A few states have brought some tax relief to cannabis operators by decoupling their state tax code from Section 280E. In 2019, California eliminated the state’s conformity with Section 280E, allowing cannabis businesses to deduct their ordinary and necessary expenses when paying state income taxes. Oregon’s adult-use legalization ballot measure included a provision that exempts cannabis businesses from Section 280E restrictions within the state tax code—and even allows them to deduct expenses for any federal deduction that would otherwise be disallowed under Section 280E.

States that have legalized cannabis should waste no time in addressing this prohibitionist and predatory tax provision. Decoupling from Section 280E is a straightforward, albeit incomplete, path toward putting cannabis businesses on a level playing field with the rest of the economy. It’s a relatively easy legislative fix that can bring significant relief to struggling entrepreneurs and gain favor with cannabis-conscious voters. At the federal level, relieving legal cannabis businesses of Section 280E restrictions would be a significant and underrated achievement. 

With federal legalization unlikely to occur anytime soon, the cannabis industry is in dire need of some wins—even if that only involves an exemption from a small federal tax provision. The cannabis industry and voters nationwide won’t let it go unnoticed.