Running a cannabis business in Washington State is not easy. You are operating in a regulated, competitive market while facing a federal tax code that treats you fundamentally differently than almost every other business in America. IRS Section 280E is at the center of that challenge — and misunderstanding it, or failing to plan around it, can cost cannabis operators tens or even hundreds of thousands of dollars every year.
This guide explains what Section 280E actually says, what it means for your tax bill, where the real planning opportunities live, and how Washington State adds its own layer of tax exposure on top. If you are a cannabis operator in the South Puget Sound region or anywhere in the state, this is required reading.
What Section 280E Actually Says
IRS Section 280E is a provision of the Internal Revenue Code that reads, in plain terms, like this: no deduction or credit shall be allowed for any amount paid or incurred in carrying on any trade or business that consists of trafficking in a controlled substance.
Congress enacted this provision in 1982, largely in response to a court case in which a drug dealer successfully deducted his business expenses. Lawmakers closed that door quickly — but the language they used was broad, and it has remained on the books unchanged.
The critical connection for cannabis businesses: under federal law, cannabis is still classified as a Schedule I controlled substance under the Controlled Substances Act. That classification has not changed. That means, regardless of what Washington State law says about licensed cannabis operations, the IRS views your business as trafficking in a controlled substance — and Section 280E applies in full.
What You Cannot Deduct (and Why It Hurts)
Under Section 280E, cannabis businesses are denied the ordinary and necessary business deductions that every other industry takes for granted. That means you cannot deduct:
- Rent or lease payments on your facility
- Wages and salaries for non-production employees (management, sales, marketing, administrative staff)
- Utilities — electric, gas, water
- Marketing and advertising costs
- Professional fees (legal, accounting, consulting)
- Security systems and services
- Insurance premiums
- Office supplies and equipment
What this means in practice: A traditional business earning $1 million in gross revenue with $700,000 in operating expenses would report $300,000 in taxable income. A cannabis business in the same position reports taxable income closer to $1 million — because most of those $700,000 in expenses cannot be deducted. The effective federal tax rate for cannabis businesses often lands between 55% and 70% of net income. That is not a typo.
This is why cannabis accounting is a specialty, and why general-purpose tax preparers who are unfamiliar with 280E consistently leave money on the table — or worse, expose their clients to audits and penalties.
The One Major Exception: Cost of Goods Sold
Section 280E disallows deductions, but it does not change the rules around Cost of Goods Sold (COGS). COGS is not a deduction — it is an offset to gross income used to calculate gross profit. That distinction matters enormously.
Cannabis businesses can and must deduct COGS when calculating their taxable income. COGS is where the vast majority of 280E tax strategy lives. The goal is to legitimately maximize what goes into COGS, because every dollar properly classified there reduces your tax exposure dollar-for-dollar.
What Goes Into COGS for Cannabis Businesses
The IRS uses the rules under IRC Section 471 to determine what can be included in COGS. For cannabis producers and cultivators, the list is meaningful. What CAN be included in COGS:
- Seeds, clones, and plant stock
- Soil, nutrients, growing media, and fertilizers
- Direct labor costs for cultivation and production employees (trim workers, growers, extraction technicians, processing staff)
- Packaging materials for finished product
- Equipment and supplies used directly in production (depreciation allocable to production assets)
- Utilities directly attributable to production areas (growing rooms, extraction labs)
- Facility costs allocable to production operations
- Testing and compliance costs tied to the product itself
What CANNOT be included in COGS: management and administrative salaries, sales staff compensation, marketing and advertising costs, general overhead not directly tied to production, and retail floor costs.
The practical work here is in properly allocating costs — determining what percentage of your facility, your utility bill, your employees' time, and your overhead legitimately belongs in the production function. This allocation requires careful documentation, consistent methodology, and a clear understanding of IRS standards. Getting it wrong in either direction creates problems: under-claiming leaves real money with the IRS; over-claiming creates audit risk.
This is precisely the kind of work we do for cannabis clients across Washington State. Proper COGS accounting is not a one-time exercise — it requires ongoing attention every month.
The Two-Entity Strategy
One of the most effective planning tools available to cannabis operators under Section 280E is what practitioners commonly call the two-entity strategy. Because 280E applies specifically to businesses engaged in trafficking controlled substances, business activities that are not directly tied to the plant-touching operation may be deductible — if they are properly separated into a distinct legal entity.
- Entity 1 (plant-touching): This entity holds the cannabis license and handles all cultivation, processing, and sales of cannabis products. It is subject to 280E in full. Ordinary business expenses here are non-deductible.
- Entity 2 (non-plant-touching): This separate entity handles activities that can be separated from the cannabis operation — management consulting services, real estate, intellectual property, branding, technology, or ancillary services. Because this entity does not traffic in cannabis, its ordinary business expenses may be deductible.
This structure can meaningfully shift deductible expenses out of the 280E-affected entity and into one where normal tax rules apply. However, this strategy carries real complexity and real risk if implemented carelessly. The IRS has scrutinized two-entity structures aggressively, and the arrangement must reflect genuine economic substance — the entities must operate at arm's length, compensation between them must be at market rates, and the non-plant-touching entity must provide real services.
Attempting this without proper legal and accounting guidance is one of the fastest ways to attract an audit. Done correctly, with the right entity structure, intercompany agreements, and documentation, it can produce substantial tax savings.
Washington State Cannabis Taxes on Top of 280E
Federal 280E exposure is only part of the picture for cannabis operators in Washington State. The state imposes its own cannabis excise tax — currently 37% — on each retail sale. That excise tax is collected at the point of sale and remitted to the Washington State Liquor and Cannabis Board.
Unlike federal income tax, the state excise tax is not a deduction either — it is a cost of doing business in Washington. Combined with federal 280E exposure, the effective total tax burden on Washington cannabis operators can be substantial.
For operators in the Puyallup area and across the South Puget Sound region, these combined tax obligations make proactive planning not just helpful — they make it essential to staying profitable.
How Green Consulting Helps Cannabis Operators
We have worked with cannabis businesses long enough to understand that this industry requires a different kind of accounting partner. The stakes are high, the rules are complex, and the margin for error is narrow. Here is what we bring to cannabis clients:
- Deep Section 280E fluency: We understand the nuances of COGS allocation, the limits of what can be included, and the documentation standards the IRS expects.
- Two-entity structuring guidance: We work with cannabis operators and their legal counsel to evaluate whether a two-entity strategy makes sense, and to implement it properly when it does.
- Washington State compliance: We understand how state excise taxes, state income taxes, and licensing requirements layer on top of federal obligations.
- Bookkeeping built for cannabis: Clean, defensible books are the foundation of every 280E strategy. We provide bookkeeping services designed around the specific needs of cannabis operations.
- Ongoing planning, not just tax prep: Our clients across Washington State are not just filing taxes with us — they are building long-term strategies for minimizing their federal tax exposure legally and sustainably.
If you are running a cannabis business and you are not certain your current accountant has deep 280E experience, that uncertainty is worth resolving before your next tax filing.
Frequently Asked Questions
Does Section 280E apply to my Washington State cannabis business even though cannabis is legal here?
Yes. Section 280E is a federal tax provision and it applies to all businesses that traffic in Schedule I controlled substances regardless of state law. Washington's legalization of cannabis for adult use does not affect your federal tax obligations. Until Congress reclassifies cannabis or exempts state-licensed operators from 280E, the restriction applies fully.
What is the single most important thing a cannabis operator can do to reduce their 280E tax burden?
Maximize legitimate COGS. Every dollar that can properly be classified as a Cost of Goods Sold reduces your gross profit and your taxable income. This requires accurate, detailed records of production costs, proper allocation of shared costs between production and non-production functions, and an accounting methodology that is consistent, documented, and defensible. It also means working with an accountant who understands Section 280E deeply — not just generally.
Can I deduct cannabis business expenses on my Washington State tax return?
Washington State does not have a personal income tax and does not collect corporate income tax in the same way most states do. However, Washington businesses are subject to the Business and Occupation (B&O) tax, which is based on gross receipts rather than net income. Because B&O tax is calculated on gross revenue rather than profit, the non-deductibility of business expenses under 280E is less of a factor at the state level — though the 37% cannabis excise tax remains a significant cost.
Is the two-entity strategy legal, and how do I know if it is right for my business?
Yes, a properly structured two-entity arrangement is a legal tax planning strategy. The IRS has scrutinized these structures, and courts have upheld them when the entities have genuine economic substance and operate at arm's length. The right answer for your business depends on your specific operations, revenue structure, and the activities that can realistically be separated from the plant-touching business. We evaluate this with cannabis clients on a case-by-case basis.
What should I look for in a cannabis accountant?
Look for an accounting firm that has direct, hands-on experience with cannabis clients and can speak fluently about Section 280E, COGS allocation methodology, and cannabis-specific entity structuring. Ask specifically about their cannabis client base, whether they have experience representing cannabis clients in IRS inquiries, and whether they understand Washington State's cannabis tax structure. At Green Consulting, cannabis accounting is one of our core specialties — not a general service we offer alongside every other industry.
Ready to Talk?
Section 280E is not something you navigate alone. If you are a cannabis operator in Washington State and you want to make sure you are not paying more than you legally have to, we are here to help. We offer a free initial consultation — no obligation, no hard sell. Just a real conversation about your situation and what we can do together.
