Marijuana tax law in the United States is defined by one federal rule and many state ones. At the federal level, Section 280E of the Internal Revenue Code denies most business deductions to any company trafficking in a Schedule I or Schedule II controlled substance, which has historically meant every state-licensed cannabis business. That changed for part of the industry in April 2026, when the DEA moved state-licensed medical marijuana and FDA-approved marijuana products to Schedule III. Recreational cannabis stayed on Schedule I and still lives under 280E. On top of federal treatment, states layer their own excise taxes, cultivation taxes, general sales taxes, and local add-ons, and the combined burden at the register can exceed 30%.
Section 280E and Why It Dominates the Industry
Section 280E is a single sentence: no deduction or credit is allowed for any amount paid in carrying on a business that consists of trafficking in Schedule I or Schedule II controlled substances.1Office of the Law Revision Counsel. 26 USC 280E – Expenditures in Connection With the Illegal Sale of Drugs For a cannabis business still covered by that rule, rent, payroll for salespeople, advertising, utilities, and other ordinary operating expenses are not deductible.
The math is punishing. A dispensary that grosses $1 million and has $700,000 in expenses does not pay tax on $300,000 the way a restaurant would. It pays tax on something close to the full $1 million, because only cost of goods sold reduces gross income under 280E. Effective tax rates commonly land at 70% or more of gross profit. That pressure has pushed licensed operators out of business and left them competing against an illicit market that pays no tax at all.
One Tax Court decision, Californians Helping to Alleviate Medical Problems, Inc. v. Commissioner, held that when a cannabis business also runs a genuinely separate, non-trafficking activity, expenses tied to that second activity remain deductible.2vLex United States. Californians Helping to Alleviate Medical Problems Inc v Commissioner of Internal Revenue Operators have structured around this holding by running distinct activities under one roof, though the IRS scrutinizes these arrangements closely.
What the 2026 Rescheduling Changed
On April 28, 2026, a final rule from the DEA and the acting U.S. Attorney General moved two categories of marijuana into Schedule III: FDA-approved drug products containing marijuana, and marijuana handled under a state-issued medical marijuana license. Because 280E targets only Schedule I and Schedule II substances, businesses operating under state medical marijuana licenses are no longer subject to its deduction disallowance. The acting Attorney General said as much in the final rule.3Federal Register. Schedules of Controlled Substances: Rescheduling of FDA-Approved Products and State-Licensed Marijuana
Treasury and the IRS have announced plans to issue guidance on the transition, including a rule that would treat the rescheduling as applying for the full taxable year that includes the effective date.4U.S. Department of the Treasury. Treasury, IRS Announce Process for Tax Guidance Following DOJ Final Order
What did not change: any marijuana that is not an FDA-approved product and is not covered by a state medical license remains Schedule I.3Federal Register. Schedules of Controlled Substances: Rescheduling of FDA-Approved Products and State-Licensed Marijuana Recreational cannabis, unlicensed marijuana, and synthetically derived THC all stay on Schedule I and remain fully subject to 280E.
For businesses that hold both medical and recreational licenses, the forthcoming Treasury guidance is expected to address how to apportion expenses between the two activities. Until it is published, operators should keep meticulous records separating medical and recreational operations. Getting the allocation wrong can mean losing deductions on one side or triggering penalties on the other.
Cost of Goods Sold: The One Break 280E Cannot Block
Cost of goods sold is technically an adjustment to gross income, not a deduction, so Section 280E does not reach it. This distinction is the single most valuable piece of tax knowledge for a recreational cannabis business, because it decides whether the company pays tax on its actual margin or on something close to gross revenue.
What qualifies depends on the operator’s role in the supply chain. Growers and manufacturers can capture direct production costs and a share of indirect production costs under what accountants call the full absorption method:
- Direct materials: seeds, clones, soil, nutrients, and other supplies that go into the finished product.
- Direct labor: wages, overtime, payroll taxes, and benefits for workers directly involved in cultivation or manufacturing.
- Indirect production costs: a proportionate share of facility rent allocable to the grow or production area, depreciation on production equipment, and utilities for the production space.
Retailers who buy finished products from a wholesaler have a narrower category: the purchase price of inventory, freight, and costs to prepare products for sale. Retail-side payroll, marketing, and storefront rent do not count.
Detailed inventory records, time-allocation logs for workers who split duties between production and sales, and clear cost-segregation studies are not optional in this industry. They are the difference between surviving 280E and going under. Federal income is reported on IRS Form 1120 for corporations or Schedule C for sole proprietorships.5Internal Revenue Service. About Form 1120, U.S. Corporation Income Tax Return
State Excise Taxes
Every state with a legal cannabis market imposes its own excise taxes, and the structures vary enough that generalizing is risky. Most states use one of three approaches: a percentage of the retail or wholesale price, a flat dollar amount per weight, or a rate tied to THC content. Some combine methods.
Percentage-based excise taxes in states with legal adult-use sales run from roughly 6% to 37% of the retail price. Weight-based systems work differently. Alaska charges $50 per ounce of mature flower, $25 per ounce of immature flower, and $15 per ounce of trim. Connecticut and Illinois tie their rates to THC potency, taxing concentrates and edibles at higher rates than flower.
Medical marijuana patients pay lower rates or no excise tax at all in most legal states. Retailers verify a patient’s state-issued registry card at the time of purchase to apply the medical rate.
Cultivation and Production Taxes
Several states impose a separate tax at cultivation or first wholesale transfer, before any product reaches a dispensary shelf. These taxes fall on growers and processors and are usually calculated by the dry weight of harvested plant material, with flower taxed at the highest per-ounce rate and trim, leaves, and immature buds at lower amounts. Some systems tax per plant instead, guaranteeing revenue regardless of yield.
The obligation typically triggers at harvest or when the cultivator transfers product to a processor or distributor. Producers must track every plant from seed through sale using state-mandated software, and discrepancies between reported harvests and actual transfers draw audits quickly. Production-level taxes stack on top of retail excise taxes, so processors converting raw flower into oils, edibles, or concentrates have to price both layers into their wholesale.
Sales Tax and Local Add-Ons
Most states apply their standard general sales tax to marijuana purchases on top of any cannabis-specific excise tax. The sales tax is calculated on the excise-tax-inclusive price, so consumers pay tax on a price that already includes another tax.
Local governments add another layer. Cities and counties in many states can impose their own cannabis-specific taxes, usually capped by state law at somewhere between 2% and 5%. Add up state excise, state sales tax, and local add-ons, and a consumer in a high-tax jurisdiction can easily pay a combined rate above 30% on a single purchase. Retailers must break out each component on customer receipts.
Dispensaries collect all consumer-facing taxes at the register and hold the funds in trust for the relevant government. Point-of-sale systems calculate the correct rates based on the store’s location. Failing to collect or remit is one of the fastest ways to lose a cannabis license. Most states require monthly or quarterly filings through dedicated electronic portals.
Cash Payments, Banking, and Form 8300
Despite the partial rescheduling, most cannabis businesses still operate in a banking gray area. Major financial institutions remain cautious because recreational cannabis is still federally illegal, and no federal safe-harbor banking legislation has been enacted as of mid-2026. Many operators handle large volumes of cash for everything from vendor payments to tax remittances.
Federal taxes are paid through the Electronic Federal Tax Payment System, which is free and handles quarterly estimated payments and annual returns.6Internal Revenue Service. EFTPS: The Electronic Federal Tax Payment System Businesses that have banking access can use EFTPS like any other taxpayer. Those that cannot may need to schedule appointments with IRS offices to deliver cash payments, a process that involves advance notice, security protocols, and precise denomination counts matching the filed return.
Any business that receives more than $10,000 in cash in a single transaction or a series of related transactions must file IRS Form 8300 identifying the source of funds and the parties involved.7Internal Revenue Service. Form 8300 and Reporting Cash Payments of Over $10,000 In a cash-intensive industry these filings are routine, and the IRS watches for cannabis businesses that handle heavy cash volumes without corresponding reports.
Penalties for Noncompliance
The penalty structure mirrors the general tax code but hits harder in an industry where margins are already thin. Accuracy-related penalties under 26 U.S.C. ยง 6662 add 20% to any underpayment caused by negligence or a substantial understatement of income.8Office of the Law Revision Counsel. 26 USC 6662 – Imposition of Accuracy-Related Penalty on Underpayments If the IRS proves fraud by clear and convincing evidence, the penalty jumps to 75% of the underpayment attributable to the fraud.9Office of the Law Revision Counsel. 26 US Code 6663 – Imposition of Fraud Penalty
Cannabis businesses face elevated fraud risk in the eyes of the IRS because the industry involves large cash flows, and courts have identified involvement in illegal activity and attempts to conceal it as primary indicators of fraudulent intent. Underreporting cash sales or inflating cost of goods sold matches the pattern auditors are trained to detect.
Form 8300 violations carry their own penalties. Failing to file correctly brings a civil penalty of $270 or more per return, with an annual cap of $3 million. Intentional disregard of the filing requirement jumps to the greater of $25,000 per return or the amount of cash involved, up to $100,000. Willful violations are a felony carrying fines up to $25,000 for individuals and up to five years in prison.10Internal Revenue Service. 4.26.10 Form 8300 History and Law
At the state level, failing to collect or remit excise and sales taxes typically results in license suspension or revocation, which for a cannabis business means shutting down entirely. State revenue departments audit dispensaries and cultivators regularly, comparing reported sales against seed-to-sale tracking data. Discrepancies between the two are the most common audit trigger.
Hemp-Derived THC Products Sit Outside This Framework
The 2018 Farm Bill legalized hemp by defining it as cannabis with 0.3% or less delta-9 THC by dry weight. That definition inadvertently created a category of intoxicating hemp-derived products, such as those made from delta-8 THC, that fall outside the Controlled Substances Act and carry no federal excise tax. There is no specific federal tax classification for these products, and federal guidance has not caught up with the market.
States have responded unevenly. Some have banned intoxicating hemp-derived products outright, others have folded them into their existing cannabis tax and licensing frameworks, and some have done nothing. Congress has considered redefining hemp to exclude intoxicating derivatives, but no federal legislation has been enacted as of mid-2026. For businesses in this space, tax obligations are almost entirely a matter of state law, and the landscape changes frequently.