Why IRS 280E Drains Your Cannabis Bank Account

What Is IRS 280E

IRS Code Section 280E prohibits businesses trafficking in Schedule I or II controlled substances from deducting ordinary and necessary business expenses.

Because cannabis remains Schedule I federally, 280E applies to state-licensed dispensaries.

280E does not apply because of New York law.
It applies because of federal tax law.

What You Cannot Deduct

Under 280E, cannabis businesses cannot deduct typical operating expenses such as:

• Payroll
• Rent
• Marketing
• Insurance
• Utilities
• Professional fees
• Security services
• Software subscriptions

These are considered ordinary business deductions for most industries. Cannabis retailers cannot deduct them.

What You Can Deduct

Cannabis retailers may deduct Cost of Goods Sold (COGS).

COGS typically includes:

• Inventory purchase costs
• Direct production costs (if applicable)
• Certain inventory-related expenses

COGS reduces gross revenue before taxable income is calculated.

Operating expenses do not.

How 280E Inflates Taxable Income (Real Example)

Example:

A dispensary generates:
$3,000,000 in gross revenue

COGS:
$1,800,000

Operating expenses (rent, payroll, insurance, etc.):
$900,000

Actual net profit before tax:
$300,000

Under normal tax rules:
Taxable income would be $300,000.

Under 280E:
Taxable income is calculated as:

$3,000,000 – $1,800,000 = $1,200,000

The IRS taxes you as if you made $1.2 million, even though your real profit was $300,000.

That difference is why 280E strains bank accounts.

High Effective Tax Burden

Because expenses are nondeductible:

• Effective tax rates can exceed 60%–80% of true profit
• Cash tax payments are significantly higher
• Quarterly estimated payments are larger
• Refund risk is limited

This creates heavy cash flow pressure.

Why 280E Impacts Your Bank Account

280E affects banking because:

• Tax payments must be made in cash or liquid reserves
• Operators must hold larger cash balances
• Profit margins appear higher on paper than in reality
• Lenders see distorted income statements
• Payment processors evaluate higher perceived risk

Your financial statements look profitable.
Your actual cash position may be tight.

Why Larger Cash Reserves Are Required

Due to 280E:

• Quarterly tax payments must be reserved early
• Year-end liabilities can be substantial
• Unexpected audits create additional exposure
• Underpayment penalties increase risk

Operators who fail to reserve aggressively often experience:

• Account overdrafts
• Emergency capital raises
• Forced inventory reduction
• Delayed vendor payments

What Inspectors and Auditors Focus On

Tax authorities may review:

• COGS allocation methodology
• Inventory accounting
• Expense categorization
• Documentation supporting deductions
• Cash handling controls

Improper allocation can trigger audits and penalties.

Why This Matters

280E is the primary reason:

• Cannabis businesses pay unusually high federal taxes
• Cash flow planning is more complex
• Banking relationships are cautious
• Financial reserves must be larger

Until federal Schedule I status changes or 280E is amended, this remains the financial reality for dispensaries.

Go Here Next

• Cannabis Banking Rules (Federal Law)
• Why Cannabis Businesses Can't Use Credit Card
• Why Cannabis Legalized in NYS

Source Material

• Internal Revenue Code §280E
• Controlled Substances Act, 21 U.S.C. §812 (Schedule I Classification)
• IRS Chief Counsel Memoranda on Cannabis Businesses
• U.S. Tax Court Cases: CHAMP v. Commissioner; Olive v. Commissioner

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