Cannabis Law: Federal Exposure Your State License Won'T Cover

Section 280E of the Internal Revenue Code prohibits businesses trafficking in Schedule I or Schedule II controlled substances from deducting ordinary business expenses from their federal taxable income.

The practical effect is significant. A cannabis retailer with $5 million in gross revenue and $4 million in operating expenses does not pay federal income tax on $1 million in profit. It pays tax on the full $5 million, less only the cost of goods sold. At a federal corporate tax rate of 21 percent, the difference between being able to deduct operating expenses and being unable to do so can represent hundreds of thousands of dollars in additional annual tax liability for a mid-size cannabis business.

The only deduction § 280E does not block is cost of goods sold, which covers the direct cost of producing or acquiring the cannabis products sold. Cannabis businesses structure their operations to maximize the proportion of expenses that qualify as cost of goods sold. That strategy requires precise accounting and a defensible allocation methodology. IRS audits are significantly more frequent in the cannabis industry than in other retail sectors, and an accounting structure that cannot withstand scrutiny produces back-tax assessments that compound with interest and penalties for every year the methodology was applied. An attorney who handles cannabis business compliance can review your current allocation methodology and tell you whether it holds up.

Cannabis license applications are scored competitions in most states, not simple eligibility reviews. The applicant who submits the most complete, compliant, and compelling application wins. The applicant who submits a technically deficient application loses regardless of the quality of their business plan or their personal qualifications.

Common deficiencies that disqualify cannabis license applications include incomplete background check documentation for all owners and investors above specified ownership thresholds, failure to demonstrate proof of site control before the application deadline, insufficient capitalization documentation in the form required by the state, and missing operating plan components such as employee training protocols, security system specifications, or track-and-trace compliance procedures.

Application protests and license denials can be challenged through the state's administrative appeal process. When a competitor is awarded a license based on a scoring methodology applied inconsistently or a factual error in how the applicant's submission was evaluated, a protest filed within the state's review period can result in rescoring or a new licensing round. An attorney who handles administrative law and cannabis licensing matters can review the scoring sheet, identify errors, and file a substantiated protest before the appeal window closes.

Cannabis businesses face IRS audits, license compliance reviews, and banking restrictions that non-cannabis businesses do not. Each operates on its own timeline and its own set of consequences. Contact our cannabis law attorneys today for a confidential review of your federal and state compliance posture before an agency action is initiated.

The 2018 Farm Bill removed hemp from Schedule I and authorized USDA to regulate hemp cultivation, but it did not resolve the regulatory status of CBD products derived from hemp, and the gap between what is legal and what is regulated is a significant source of legal risk for hemp and CBD businesses.

Hemp is defined by federal law as cannabis with a delta-9 THC concentration of no more than 0.3 percent on a dry weight basis. Products made from hemp that stay within this threshold are not controlled substances under the Controlled Substances Act. They are, however, subject to FDA regulatory authority over food, dietary supplements, and drugs. The FDA has not approved CBD as a food additive or dietary supplement ingredient and has issued warning letters to companies making health claims about CBD products that it characterizes as unapproved drug claims.

The regulatory status of delta-8 THC, delta-10 THC, and other hemp-derived cannabinoids is actively contested in both state and federal courts. Some states have banned these compounds outright. Others have no specific regulation addressing them. The federal position remains unsettled, and rules in this space change without notice. An attorney who handles controlled substances act and hemp regulatory matters can review your product line, labeling, and distribution structure against current FDA guidance and state law to identify where exposure exists.

Cannabis legalization has created a category of employment disputes that did not exist ten years ago, and neither employers nor employees have clear federal law to rely on when conflicts arise.

Employees who use cannabis legally under state law and are terminated after a positive drug test have brought wrongful termination claims in a growing number of states. Courts in some jurisdictions have ruled in the employee's favor, finding that termination for off-duty legal cannabis use violates state disability discrimination laws when the use is medically authorized. Courts in other jurisdictions have ruled that employers retain the right to enforce drug-free workplace policies regardless of state cannabis legalization. The outcome depends on the state, the nature of the job, whether federal contracts are involved, and whether the employee holds a safety-sensitive position.

Cannabis industry employers face a distinct set of employment law issues. Employees who handle cannabis are frequently classified in ways that complicate overtime and minimum wage compliance under the Fair Labor Standards Act. Cash compensation practices in response to banking limitations create wage record-keeping risks. The overlap between state cannabis employment protections and federal OSHA workplace safety regulations creates compliance obligations that differ from those in non-cannabis industries. An attorney who handles drug testing protocols and cannabis employment matters can review your drug testing policy, termination procedures, and compensation practices against the specific requirements of your operating state.

Cannabis businesses that generate significant cash revenue, operate across state lines, or have investors with federal government relationships face federal exposure that state licensing does not resolve. Contact our attorneys today before a banking issue, tax audit, or employee dispute becomes a federal matter.

Cannabis law is the body of federal and state statutes, regulations, and court decisions governing the cultivation, manufacture, distribution, retail sale, possession, and taxation of cannabis and cannabis-derived products. It covers state business licensing and compliance, federal tax treatment under Internal Revenue Code § 280E, criminal liability under the federal Controlled Substances Act, employment law issues arising from cannabis use and testing, and the regulatory status of hemp and CBD products under the 2018 Farm Bill.

No. Cannabis remains a Schedule I controlled substance under the Controlled Substances Act, 21 U.S.C. § 812, making cultivation, distribution, and possession federal crimes regardless of what state law provides. The federal government has exercised prosecutorial discretion not to aggressively pursue state-licensed cannabis businesses, but that discretion is not a legal protection and can be reversed at any time. Federal illegality continues to affect cannabis businesses through banking restrictions, tax treatment under § 280E, and the unenforceability of cannabis contracts in federal court.

Internal Revenue Code § 280E prohibits businesses that traffic in Schedule I or Schedule II controlled substances from deducting ordinary and necessary business expenses from federal taxable income. Because cannabis remains Schedule I under federal law, cannabis retailers, cultivators, and manufacturers cannot deduct salaries, rent, utilities, or most other operating costs. Only the cost of goods sold remains deductible. This provision can more than double the effective federal tax rate of a cannabis business compared to a comparable non-cannabis business with the same revenue and expense structure.

License revocation results in immediate cessation of all licensed cannabis activities and may trigger review of related licenses held by the same entity or its principals. The revocation process is an administrative proceeding governed by state law, typically involving a notice of violation, an opportunity to respond, and a hearing before the state cannabis regulatory authority. Revocation decisions can be appealed through the state administrative appeal process and, if necessary, through state court. The specific timeline and grounds for appeal depend on the state's administrative procedure act and cannabis regulations.

In many states, yes. Federal law and the terms of federal contracts create drug-free workplace requirements that many employers must meet regardless of state cannabis law. Even in states with employment protections for off-duty cannabis use, safety-sensitive positions, federally regulated industries, and positions covered by federal contractor requirements typically remain subject to termination for a positive cannabis test. The answer depends on the state, the nature of the position, whether the use was medical or recreational, and the employer's contractual obligations.

Hemp and hemp-derived CBD with less than 0.3 percent delta-9 THC are not Schedule I controlled substances under the 2018 Farm Bill. However, the FDA has not approved CBD as a lawful food additive or dietary supplement, and it has taken enforcement action against companies making unapproved drug claims about CBD products. State law governing hemp-derived cannabinoids varies significantly, and the regulatory status of delta-8 THC and other minor cannabinoids derived from hemp is actively contested in state and federal regulatory proceedings with no settled outcome.