The Origins of Section 280E: Marijuana Tax Law

As the legal cannabis industry grows in the U.S., many business owners find themselves facing a surprising tax burden: Section 280E of the Internal Revenue Code. While this provision seems like an obstacle specifically aimed at cannabis companies, its origins date back to the early 1980s and have much to do with the U.S. government's larger efforts during the War on Drugs. Understanding how Section 280E came to exist provides insight into its current impact on legal cannabis businesses and the long-standing federal stance on controlled substances.

Call Turner Business Solutions at (316) 285-0125 if you need a cannabis tax expert to assist you. You can also schedule a free consultation online.

The War on Drugs and the Tax Loophole

To understand Section 280E, we need to go back to 1981. At the time, the U.S. was in the midst of the War on Drugs, an aggressive campaign aimed at reducing illegal drug use and trafficking through both domestic enforcement and international efforts. The country had seen a rise in drug-related crimes, and the federal government was seeking ways to tighten its control over illegal activities, particularly in the drug trade.

The event that led to the creation of Section 280E was a court case involving a convicted cocaine dealer, Jeffrey Edmondson. After being caught selling large quantities of drugs, Edmondson filed his tax returns and, like any other business owner, claimed deductions for "ordinary and necessary" business expenses. This included rent, a portion of his home utilities, a scale used for weighing drugs, and even his car mileage from driving to meet clients.

Remarkably, the Tax Court allowed Edmondson to take these deductions. The court ruled that even though his business was illegal, he was entitled to deduct these expenses because they were directly related to his business activities. This decision raised concerns among lawmakers, who saw it as a loophole that allowed drug dealers to lower their tax liabilities despite their criminal behavior.

The Creation of Section 280E

In response to the Edmondson case, Congress moved swiftly to close the loophole. In 1982, as part of the Tax Equity and Fiscal Responsibility Act (TEFRA), they introduced Section 280E. This new section of the tax code explicitly prohibited businesses engaged in the trafficking of controlled substances—classified as Schedule I or II drugs under the Controlled Substances Act—from deducting ordinary business expenses. The goal was clear: prevent drug traffickers from using tax deductions to reduce their tax bills, effectively making it harder for them to profit from illegal activities.

At the time, Congress had no intention of targeting state-legal businesses. Cannabis, along with other drugs like heroin and cocaine, was classified as a Schedule I drug, meaning it had "no accepted medical use and a high potential for abuse" in the eyes of the federal government. Since there was no legal cannabis industry in 1982, Section 280E was aimed squarely at illegal drug dealers.

The Unexpected Consequences for the Cannabis Industry

Fast forward to today, and the landscape of cannabis in the U.S. has changed dramatically. Over 40 states have legalized cannabis for medical use, and several have legalized it for recreational use. Despite this, cannabis remains a Schedule I substance under federal law, and businesses that sell cannabis—even those fully compliant with state laws—are still considered to be "trafficking" a controlled substance under federal law.

As a result, these legal cannabis businesses are subject to Section 280E. This means they cannot deduct standard business expenses such as rent, employee wages, advertising, or utilities, leaving them with much higher taxable incomes than other businesses. The only deduction they are typically allowed is for the cost of goods sold (COGS), which includes expenses directly related to producing cannabis, such as seeds and growing supplies. The inability to deduct other operating costs often results in effective tax rates as high as 70%, putting a significant strain on cannabis businesses.

Section 280E and Calls for Reform

As the cannabis industry has grown and gained legitimacy, many industry stakeholders have called for reform of Section 280E. They argue that this outdated law, originally designed to target drug cartels, is now unfairly punishing legal businesses that comply with state regulations. Various bills have been introduced in Congress to amend Section 280E or to reclassify cannabis under the Controlled Substances Act, which would exempt cannabis businesses from the law’s harsh tax treatment.

However, the federal government has been slow to act on these reforms, and Section 280E remains in place as a significant financial hurdle for cannabis businesses across the country.

Conclusion

Section 280E was born out of a desire to close a loophole that allowed illegal drug dealers to deduct business expenses from their tax returns. Its origins in the War on Drugs reflect a time when the federal government was focused on cracking down on criminal enterprises. However, as the legal cannabis industry continues to expand in the U.S., Section 280E has taken on an unintended role, acting as a major tax burden on state-legal cannabis businesses. Until federal law changes, this decades-old provision will continue to be a significant obstacle for the industry.

Call Turner Business Solutions at (316) 285-0125 if you need assistance with your cannabis taxes. You can also schedule a free consultation online.