So you own a cannabis dispensary under state law, have all of the correct licenses and follow all of the rules. It’s been a struggle but you’re starting to make a profit. You have enough business experience to know that your ordinary and customary business expenses are deductible from your federal income taxes – right, but, when it comes to a cannabis business, even for those that are operating completely within the rules of state law – maybe not.

Under the U. S. Controlled Substances Act, possession, use, sale or cultivation of cannabis in any form is not permitted.  Cannabis is listed as a Schedule 1 narcotic, having no lawful use under federal law.  Those who engage in state legal cannabis activities must then confront the impact of federal tax laws in their business activities.

Enter Section 280e of the Internal Revenue Code, which says:

No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances (within the meaning of Schedule I and II of the Controlled Substances Act) which is prohibited by Federal law or the law of any State in which such trade or business is conducted. 

Since cannabis is a Schedule 1 narcotic, any cannabis business must pay attention when it comes to their federal taxes.

It’s rare when the law is an unambiguous straight line from word to application and that is the case here.   One way to avoid some of the impact of Section 280e is to engage in a lawful non-cannabis business that is related in some way to your cannabis business.  An example is a yoga studio in the space rented for your dispensary. All ordinary and customary business expenses associated with the yoga business are deductible.  But some states don’t allow shared services. In this case, and also in the case of shared services, even under Section 280e, a cannabis business may deduct the costs of goods sold. What’s this?

That is a question that is easier asked than answered. Generally, the costs associated with trafficking in cannabis are not deductible but the costs associated with producing it may be deductible. It’s unclear how this applies and you should consult a tax professional before you attempt a cost of goods sold deduction.

As you might expect, there is a debate well under way on whether and how to reform Section 280e.