What are the unique tax challenges and opportunities within the cannabis industry?

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Under Internal Revenue Code § 280E, any trade or business that consists of “trafficking in controlled substances” (Schedules I or II under the Drug Enforcement Administration’s Controlled Substances Act) cannot claim deductions or credits for amounts paid or incurred in the taxable year, aside from cost of goods sold (COGS). In practical terms, this means that state-licensed cannabis enterprises, even fully compliant under state law, are still treated as trafficking businesses at the federal level and therefore cannot deduct general operating expenses such as SG&A (selling, general and administrative expenses). As a result, such companies often show significant book (GAAP) losses but large taxable income for federal purposes, a stark disadvantage compared with most other industries.

Why Planning Now is Critical

With the industry closely watching a possible move by the DEA to reclassify cannabis to Schedule III in 2025, its tax posture could change materially. While nothing is certain, since the hearing has been delayed multiple times, this possible rescheduling opens a window for strategic planning. If cannabis is rescheduled and 280E no longer applies, or applies in a different way, you would likely see two major shifts:

1. Expanded access to deductions and credits previously off-limits
2. New compliance burdens and accounting-method shifts to navigate

As you plan, keep in mind that tax compliance and planning in this environment will no longer be just about mitigating 280E impact. It will become about managing transition, method changes, asset placements, and ongoing new rules.

Areas to Focus On

1. Interest Expense
Today under 280E, interest expense is nondeductible since it’s an SG&A cost and not part of COGS. If 280E stops applying, the interest-expense limitation under IRC §163(j) comes into play, allowing deduction only up to 30 percent of adjusted taxable income, with carry-forwards of disallowed amounts.

2. R&D and Amortization / Credits
 In a typical business, internal research and development costs can qualify for the R&D Tax Credit and are handled under IRC §174. Under current 280E treatment, many R&D costs were simply disallowed. If 280E falls away, companies are required to capitalize and amortize domestic R&D over five years (international over fifteen) and may then qualify for the R&D credit, which can be 5 to 10 percent of qualifying expenses.

3. Inventory / UNICAP (IRC §263A)
 Many growers or processors may have average gross receipts above the threshold, for example $29 million, which triggers UNICAP rules requiring capitalization of indirect costs into inventory. Under 280E, these rules were less relevant because indirect SG&A costs were disallowed anyway. Post-reschedule, you would likely face these inventory valuation burdens.

4. Bonus Depreciation / Energy Credits
 Currently, bonus depreciation and many tax-accelerated methods are difficult to optimize under 280E. A future change would open the door for cost segregation studies, placed-in-service timing strategies, and renewable energy credits, particularly relevant for cannabis operations, which tend to be energy intensive

5. Labor, Credits & Net Operating Losses
 Labor-intensive industries like cannabis may qualify for workforce tax credits, such as the WOTC, post-reschedule. Also, net operating losses (NOLs) and change-of-ownership limitations under IRC §382 and §383 will demand attention if historic losses exist.

Strategic Actions to take

• Review and document current SG&A, R&D, and capital expenditures so that you are ready to shift treatment if or when rescheduling happens.
• Evaluate whether a 280E management company structure could safely segregate non-trafficking activities, if appropriate, to limit 280E exposure, especially for growers or ancillary businesses.
• Begin putting systems in place for accurate inventory costing and UNICAP compliance now, as that burden may increase rapidly.
• Align your payroll and labor cost tracking to support future credits and audit documentation.
• Model potential scenarios: what happens if 280E is allowed to lapse on a prospective date, or retroactive to the tax year? When is it beneficial to defer asset placements, recognize expenses, or change accounting methods?
• Consider use of technology and platforms, such as Avalara, to streamline tax-compliance workflows, especially for multistate operations and changing tax-credit regimes.
• Monitor regulatory and IRS guidance carefully, because the IRS has already issued reminders that the schedule hasn’t changed yet and refunds for previous years under 280E are not currently available.

Conclusion

While 280E has long meant the cannabis industry faces a harsher tax environment relative to other businesses, the potential shift to Schedule III or some form of federal reform offers a window for meaningful planning. However, this is not a simple pivot. With change comes complexity, new rules, new compliance obligations, method changes, and strategic decisions about asset placements, capital structure, and workforce costs. For companies, focusing now on cannabis tax planning and accounting, starting from a solid foundation of documentation and forward-looking modeling, is the best way to turn uncertainty into opportunity.

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