Franchise Law • Tax planning • IRC § 280E • Maryland & Pennsylvania
Section 280E and Cannabis Taxes in Maryland and Pennsylvania: What Marijuana Businesses Need to Know in 2026
Key Points
- § 280E disallows deductions and credits for businesses trafficking in Schedule I or II controlled substances that are illegal under federal law.
- COGS is still generally available: § 280E does not bar reducing gross receipts by properly calculated cost of goods sold to determine gross income.
- State legality doesn’t override federal tax treatment: § 280E can still apply to state-compliant cannabis operations while marijuana remains prohibited federally.
If you own or operate a cannabis business, you already know the whiplash: Maryland allows adult-use, Pennsylvania runs a medical marijuana program, and yet federal law still drives some of the most painful outcomes, especially on taxes. That pain point is Internal Revenue Code (IRC) Section 280E.
Below is a plain-language, business-owner-friendly overview, based heavily on the Congressional Research Service (CRS) analysis found here.
Why cannabis businesses get taxed differently
Section 280E says no deduction or credit is allowed for amounts paid or incurred in a trade or business that consists of “trafficking” in controlled substances (Schedules I or II) that’s prohibited under federal law or the law of the state where conducted.
Because marijuana has historically been treated as a Schedule I controlled substance at the federal level, the IRS has applied §280E to many state-compliant marijuana businesses.
What § 280E actually does to your tax bill
For most businesses, taxable income is: Gross receipts − ordinary and necessary business deductions = taxable income. For many cannabis businesses, § 280E effectively pushes you closer to: Gross receipts − Cost of Goods Sold (COGS) = taxable income (with far fewer deductions).
Because § 280E blocks “deductions and credits,” cannabis operators often lose write-offs for common expenses like:
- Payroll (administrative and retail staff)
- Rent
- Marketing
- Professional fees
- Insurance
- Utilities
- Office expenses
COGS: the one big “allowed” subtraction, and why it becomes a battleground
Here’s the critical distinction: COGS reduces gross receipts to compute gross income; it’s generally not treated as a “deduction,” so it’s typically outside § 280E’s bar.
This is why COGS can become the focal point of both planning and examination. When many other deductions are disallowed, cannabis businesses often focus on:
- Defensible inventory methods
- Accurate product costing
- Clean documentation
- Consistent accounting treatment year over year
This is an area where good compliance can materially reduce audit risk, and where sloppy records can get expensive fast.
“Two-business” strategies: when they work (and when they don’t)
Some taxpayers have tried to separate activities into multiple trades or businesses so that non-trafficking lines can still deduct ordinary expenses.
A key example is Californians Helping to Alleviate Medical Problems, Inc. v. Commissioner (“CHAMP”), 128 T.C. 173 (2007), where the Tax Court recognized separate caregiving services distinct from cannabis sales (so the service side could still deduct its expenses).
- Are there genuinely separate offerings?
- Separate books and records?
- Separate staffing, space allocation, and economics?
Constitutional challenges to § 280E haven’t been the industry’s escape hatch
Operators have attacked § 280E in court on multiple theories. One prominent argument is that disallowing deductions operates like punishment and violates the Eighth Amendment Excessive Fines Clause, an argument the Tax Court rejected in Northern California Small Business Assistants Inc. v. Commissioner, 153 T.C. 65 (2019).
In plain language: courts have generally treated § 280E as a tax rule, not a “fine,” and most constitutional challenges have not succeeded.
What could change: rescheduling and the future of § 280E
A major reason cannabis operators watch federal policy closely is that § 280E applies to Schedule I and II substances. So if marijuana is moved to Schedule III, many observers expect § 280E would no longer apply in the same way.
Where rescheduling stands (high level)
- DOJ/DEA published a proposed rule to transfer marijuana from Schedule I to Schedule III through formal rulemaking.
- As of early 2026, rescheduling remains a process issue, meaning timing and final outcome depend on the administrative rulemaking record, including any hearings and rulings.
- Practical takeaway: rescheduling (if finalized) could be a major tax shift, but it may also create new compliance and operational questions.
Maryland vs. Pennsylvania: what local operators should keep in mind
Maryland: Maryland permits adult-use cannabis for adults 21+ and provides statewide guidance on lawful possession and the regulated marketplace. See the Maryland Cannabis Administration’s adult-use FAQ: here.
Pennsylvania: Pennsylvania operates a medical marijuana program through the Department of Health. Program overview: here.
High-impact compliance moves cannabis businesses should prioritize
These are the areas that often separate “prepared” operators from “audit pain” operators:
- Tight books and records (especially inventory and product costing)
- COGS methodology you can explain and document
- Clean separation (if any) of non-cannabis service lines
- Payroll and sales tax discipline
- Cash-handling controls (many cannabis businesses are cash-heavy; reporting rules can be unforgiving)
How Iqbal Business Law helps cannabis business operators
If you run a cannabis-adjacent or cannabis-facing business in Maryland or Pennsylvania, the “legal” work and the “tax” work collide fast: entity structure, contracts, investor terms, compliance systems, audits, and controversy strategy.
I can help you:
- Structure and document operations with audit-resilient books and controls
- Coordinate with your CPA on COGS methodology and documentation
- Handle IRS and state tax controversy matters
- Negotiate and paper business agreements in a regulated industry
Related service page: Civil Tax Controversies & Penalties.
FAQs
Does IRC § 280E apply if cannabis is legal in my state?
Often, yes. Section 280E can still disallow deductions and credits for a business that the IRS treats as trafficking in a Schedule I or II controlled substance that remains illegal under federal law.
What expenses does § 280E usually disallow for cannabis businesses?
Commonly affected items include rent, marketing, many administrative payroll costs, professional fees, insurance, utilities, and office expenses—because § 280E denies deductions and credits tied to the trafficking business.
Is COGS still allowed under § 280E?
COGS is generally still available because it reduces gross receipts to compute gross income and is typically treated differently than a deduction. The key is calculating and documenting COGS properly under applicable inventory rules and maintaining consistent records year over year.
Do two-business strategies work to reduce § 280E exposure?
Sometimes—but only if the non-cannabis activity is genuinely separate in substance. That typically means separate offerings, credible allocation of space and labor, and separate books and records. Done poorly, it can increase audit risk.
Would rescheduling marijuana to Schedule III remove § 280E?
Section 280E applies to Schedule I and II substances. If marijuana is moved to Schedule III, many observers expect § 280E would no longer apply in the same way—though the timing and final outcome depend on federal rulemaking process.
Disclaimer: This post is for general informational and educational purposes only and does not constitute legal or tax advice. Every situation is fact-specific. If you want advice for your business, consult a qualified attorney and your tax professional.
